Bankruptcy and Taxes

A chapter nine is for reorganization of municipalities. A chapter 11, which I'm going to be spending most of my time about discussing because that's really the meat and potatoes of a bankruptcy, it's really a reorganization primarily for business. The debtor would propose a plan for repayment that is overseen by an independent administrator, and generally plans are completed in 120 days, but extensions can be granted and, of course, creditors can agree to longer terms as well. A chapter 12-

Daniel Gibson: Hey Jay, on chapter 11, I've heard that those are pretty expensive. Is there a reason for that, for the expenses in chapter 11 why you wouldn't possibly go to chapter 11?

Jay Lindenberg: Yeah, well, I'll probably explain that a little later if I could answer your question. But basically in a chapter 11, there are lots of professionals involved, both a creditor's committee, as well as a debtor. So there is an independent committee involved that also retains independent counsel and financial advisors, et cetera. But I'll get more into it in my presentation, but thank you Dan.

Daniel Gibson: Okay.

Jay Lindenberg: Chapter 12 is for a family farmer or fishermen and chapter 13, not that I get that much involved with them, but they are a pretty good tool for individuals who have the ability to repay the debt, have income and can work out a plan with the creditors. It's also referred to a payback or a wage earner plan, and the plan is overseen by a trustee. Generally it's completed in about 60 days and, of course, it could be extended. And then the other bankruptcy chapter, you might've heard of the chapter 15, which is for foreign entities and basically just have access to bankruptcy courts. And at this point, I'm going to pass it over to Bella.

Bella Brickle: Poll #2

Jay Lindenberg: I also wanted to, while you're answering your question, identify some of the financial difficulties that you might be looking for or be concerned about if a company might need to file bankruptcy. I'm a strong believer in cash is king, so you always monitor the money, the cash and where it's going or the lack thereof. Obviously the going concern when you work in financial statements and all that would be an indicator. And then also you want to look at the company's solvency. If the liabilities are an S-X of the assets, that is obvious a concern, as well as their ability to meet their obligations when they become due.

Jay Lindenberg: Okay. Most of you had it correct. This next slide I thought was interesting. It really applies to individual debtors, even though there are some components such as lack of financial planning, reduced income, business failures, would also apply to business entities. But what's most important is the number one factor that causes bankruptcies of individuals are medical bills. So that one sitting at the top and it's interesting, that's the biggest cause of bankruptcies. I'm going to talk a little bit about chapter 11. A chapter 11 proceeding is really designed for big business, even though individuals and other entities can file for chapter 11 protection. The debtor management remains in control of the business and the debtor will ultimately file a plan to emerge from bankruptcy. A chapter 11 proceeding is a very expensive proposition, but if properly utilized and it could be a valuable tool to restructuring a business or reorganizing some debt obligations.

In bankruptcy, if warranted, a creditor's committee would be appointed. And that's a little bit what I spoke about earlier, that it's made up of five to seven of the creditors. They formulate a committee, an odd number so they can have a vote and they are a committee put together that really represents all the creditors for their benefits in the case. And there's one case that I had some years back that keeps in mind regarding this topic because it was the largest creditor in a particular bankruptcy proceeding and they never perfected their lien. So really they should have been a secured creditor, but since the lien was never perfected, they get the honor of being the largest unsecured creditor, which they got the chair of the committee as being the largest unsecured creditor and they worked very successfully to formulate and work with the debtor in formulating a plan. And they emerged from bankruptcy and had a very decent distribution of dividends and then six months later, they decided to pull the plug and no longer do business with the debtor. So needless to say, everything crashed and burned.

So you wonder in that situation, did they really act in the best interest of all the committee, of all the creditors if they had no interest in continuing business with this particular entity? In addition to monitoring every case, the Office of the United States Trustee also imposes a quarterly fee, which the debtors require to pay on a quarterly basis as long as they remain in bankruptcy. And over my years, a lot of times when I discussed with bankrupt debtors and their principles about this fee, they say, "I'm bankrupt. I really can't afford this." So I'll talk a little bit later about there is some new provision in the code that there's ways to work around that by filing a sub five, which we'll get to on the sub five. Professionals are retained through court order in a bankruptcy proceeding, which would include submitting an affidavit of disinterestedness in the beginning of the case and disclosing everything about your firm and your experiences and your abilities to perform the services required.

And ultimately, a fee application is submitted at the end of the case, which is how you get paid. And like everything else in bankruptcy, it's transparent. All interesting parties are allowed to serve notice and aware of what's going on and obviously can object if there's something to be objected to. Every bankruptcy case files a petition. In the beginning of the case, they select the chapter and they will proceed under those guidelines. There is something called, or it's also an involuntary chapter 11 proceeding, and that comes about when three creditors get together and can file a proceeding against the debtor. I've had a handful of these matters in my career and usually they turn out very interesting as far as what the case is really about.

Another important part or at the beginning of a bankruptcy case, statements and schedules are filed by the debtor. I guess another part of this would be the statement of financial affairs, also known as the SOFA. So these documents or information is presented in the beginning of the case. All parties receive this information and really, as far as for financial advisors and other service professionals providing services to a debtor, it has a wealth of the historical information about the company. It gives you information regarding their assets and liabilities. It talks about providing bank account information and other key information, including historically who was involved with the books of records, the prior accountants, prior bookkeepers, et cetera. This is one that I always find very interesting and I look to it because obviously it's important to get the financial data to properly administer a case. There's another part of the initial filing, something known as first day motions. These are filed in the beginning of the case, dealing with critical vendors, banking issues, payments to professionals, payroll, utilities, et cetera.

It's important in the beginning of the case that these things are identified and if you're ever looking at a case or want to find out anything going on, looking at the first day orders usually does have a lot of information valuable for you for future use. One of the things I mentioned was a critical vendor, and if I recall, it might be one of the first things that came about with these first day motions and it really gives permission to pay a pre-petition obligation, which you're not allowed to, and so you go to the court because if the business cannot survive without the vendor providing the product for them to successfully continue, this provision came about that you can go into court, identify what are these critical vendors and you can arrange for payments and business transactions to be made. Unfortunately, what has happened over the years is everybody makes everything a critical vendor. So like everything else, it gets taken advantage of, but that's the history behind it.

Monthly operating reports are a big part of the bankruptcy process and the service that they need to provide. That's on a monthly basis. Debtors are required to provide financial data consisting of banking information, balance sheets, profit and loss statements, cash flows, accounts receivables. It really helps monitor the affairs of the case for all the parties involved. If there's no creditors' committee, at least the US trustee and various other parties do have this information. And if there is a creditors' committee, obviously it's very valuable to them as well.

Bankruptcy proceedings as proceedings considered an exit strategy, part of the exit strategy is obviously the claims process, which requires a bar date, that's a deadline for all claims against the estates to be satisfied or you need to file the claims to see if anyone has an interest or claims against the estate. The bar date is important to exit the case and to understand who and what obligations are out there so that you can work out to get them repaid. A lot of times there could be duplications or issues if a local business and a parent company located in another state both submit a claim. So obviously, there's a duplication and these could be clearly corrected.

To exit from a bankruptcy, you need to file a disclosure statement and plan a reorganization or a liquidation depending where the case is going. A plan of reorganization basically is a fresh start for the business. The business gets an opportunity to get a fresh start verse a plan of liquidation, the company is liquidated. The difference between a chapter 11 liquidation verse a chapter 7 liquidation is management which stay involved. So a lot of times there is benefit for management with their contacts in the industry to work with the bankruptcy case to maximize the liquidation values for the assets. There's also something called a 363 sale of assets, which is a bankruptcy proceeding, actually you get the assets free and clear of liens, so it's quite a valuable tool in acquiring businesses and assets out of a bankruptcy proceeding. In a bankruptcy chapter 11 case or traditional case, a plan needs to get voted on by the creditors.

There would be a confirmation hearing where all parties, if they have any contested matters or anything in the case, has an opportunity to appear in the court, make their position heard, and ultimately a judge will rule and grant an order, a confirmation order of the plan, and that is the closing of the case. The order would include something called an effective date, which is usually about 30 days, but it's really a point in time after the confirmation hearing to act on all the issues that have been decided in the plan. As an example, if you were going to get some exit financing, the bank's not going to be waiting in the courtroom before the judge blesses the plan to close on the transaction, but a couple days afterwards, you can have a bank closing and all that. All the terms sheets and all the terms of the financing could be disclosed, it would be disclosed in the confirmation hearing.

A very exciting part of bankruptcy, I guess both as a professional and a lot of people unfortunately get involved with this as being the claims made against them for preferential payments or payments in the 90-day period known as avoidance actions, clawbacks, et cetera. Any payment made in the 90-day period is subject to a clawback or preferential payment. Payroll, payroll taxes, obviously a lot of these types of disbursements, no one ever pursues because obviously services have been provided, but the preference is a 90-day lookback period. If it's an insider or related party, the lookback period is a one-year period and this pursuing and recoveries could also be a fraudulent conveyance, which could be a four-year period normally involving some kind of benefit or something that somebody got or took from the company without any benefit relating to the company. And normally, depending on the type of case to what the extent it needs to be pursued, including in any kind of avoidance, action recovery is the issue of solvency.

Now, normally a debtor is presumed to be insolvent on the petition date and prior to that date it's determined when the actual insolvency is prepared. An insolvency analysis would be prepared. And the benefit of that as accountants is if at the date the accounts receivable were $10 million but after the fact they only collected $6 million of this 10, then really the asset would be worth $6 million, which is what you would put in your insolvency analysis. So it's important to know. And another thing I wanted to issue, I know generally we receive our fees and everything, what we call an ordinary course or get paid on a monthly basis for our annual services, which is a good protection for a preference defense because for a preference, the two key defenses in preference would be the ordinary course which would be paid in an ordinary course of business and that would be your defense for those payments or something that we call new value.

That would be providing new services for payments. So if somebody paid you $10,000, you provide them $10,000 worth of product, that $10,000 payment even in the 90-day period would not be considered a preference. So it's important to know, I know some professionals in our organization reach out to me from time to time, they want to get retained to do some tax work and there's some preferences, et cetera. So my suggestion is reach out to us. I would be more than happy to help you work through these matters. Another, as we mentioned earlier, is the creditors' committee. That's an independent team of professionals who work with the creditors' committee for the best benefits of the case. They organize and monitor the affairs. They'll negotiate a distribution to the creditors. And what's important is so the debtor's professionals say, "Hey, we can give you a 10 cent distribution." And the creditors' committee will come back and say, "Well, we think it's more like a quarter."So obviously that gives us some leverage of where to come up with a final distribution number or calculation.

As I mentioned earlier, subchapter five bankruptcy, it's been around about three, four years now, and it really gives the opportunity for small business corporations and other individuals to reorganize or to liquidate. It's originally, I think, designed to reorganize, but I'll have to say the majority of the cases I've been involved with have liquidated. A subchapter five trustee is appointed to assist with the process, and what's important to know is he is different than a chapter 7 trustee who steps in the shoes and takes over. The sub five trustee more facilitates the case. It's designed for small businesses with debts of $2.75 million, but the CARES Act it is up to $7.5 million. So if you can have obligations secured, unsecured up to $7.5 million subchapter five could be a very smart way to go for resolving your business matters.

It's a lot faster and less expensive. There's no creditor's committee, no additional costs for the creditor's committee. The plan does not require any voting. There are no quarterly fees and other savings and there's no new value required. And what that means is in a chapter 11, when you reorganize your plan, the management ownership usually needs to put some money into the company, good faith, new value, skin in the game, whatever you want to call it. If creditors are getting paid out over time, they should put something in. In a sub five, this is not required. It's also quite powerful for that. And of course the debtor maintains the ownership of the company. Liquidating trusts is usually formed subsequent to the plan of liquidation. So it's basically through a trust agreement and trust documents and extension of the bankruptcy case, but it just limits to the specific issues, such as some litigation matters and matters that have not been finalized in the bankruptcy, this liquidating trust is formed, the trustee is appointed, retains the professionals needed and they can pursue the matters ultimately to make the distribution to the beneficiaries.

Chapter 7, we spoke about a little earlier, is an ordinary liquidation of the assets of the estate. An independent trustee would be appointed and he would monetize the assets for the maximum distribution to the unsecured creditors and ultimately would close up the case. The trustee can pursue avoidance actions and recoveries, even if they were started in the chapter 11, the trustee would pursue them in chapter 7. A corporation, partnership or individual can file for chapter 7 protection. A business entity ceases to operate and the trustee is responsible for the final tax returns.

A lot of chapter 7 trustees have also been asked to, not that they like to, get involved in being responsible for 401ks and pension plans and as such and through the courts they work that out as well. Briefly, chapter 13, basically if you have earnings and disposable income that you can repay your creditors at some limited amount, there is a means test to determine what your disposable income is, and usually it deals with debts of $419,000 of unsecured debt and secure debt of $1,257,00. There is what we call panel chapter 13 trustee who is responsible for the collections and distributions of these matters and they usually can last about five years.

Just quickly you can note on this slide what's important, what's non-dischargeable in bankruptcy. So if you're considering filing and you've got those types of obligations, you might want to think twice. Some alternatives to bankruptcy and one of the biggest ones is the assignment for the benefit of creditors, or I should say the most popular. It is a state proceeding for the liquidation of a company. Obviously it's different in every state, but it is very lucrative in New Jersey. There are advantages. It's a much faster process, a lot less expensive, and if you don't have too many complex issues, it can be the way to liquidate your company and it's only for a liquidation. The disadvantages is there's no Automatic Stay, which is important, in a bankruptcy is a very powerful tool. There's no answer for creditors. Contracts and leases that can be rejected in a bankruptcy proceeding cannot be rejected and there's no success or liability.

I just have another minute. I just want to quickly summarize on this slide here is some information about the services financial advisors can do, assist debtors with, such as statement of financial affairs and schedules, preparation of monthly operating reports, liquidation analysis and calculation of distributions, plan forecasts, which is projections for feasibility. If a plan is determined that it's being paid its distribution over time, there has to accompany a forecast with the feasibility that the debtor or the reorganized company can meet these obligations.

And one final I just wanted to mention to everybody, one of the most valuable tools in bankruptcy is the 505(b) or prompt determination election. This is submitted, a second copy of your tax return is sent to a insolvency office in Philadelphia and they have to decide if they want to audit that return and respond to you within 60 days. So it's a very powerful tool and you reorganize a company and you have a tight forecast about available funds and you get zapped with an IRS audit that would destroy, crash and burn the whole thing. I think I'm going to turn it over for our next polling question.

Bella Brickle: Poll #3

Jay Lindenberg: Just while you are answering your polling question, I just wanted to share with you the bankruptcy, insolvency and restructuring team at EisnerAmper. Our leadership of partners, directors, there's nine individuals. We primarily in New York, New Jersey and the Philadelphia office is the core of our team. Our team is staffed with CPAs, CFEs, CIRAs, CTPs, CIRA is a certified restructuring officer, certified turnaround professionals, valuation experts, tax advisors, and strategy consultants.

Jay Lindenberg: Actually, it's back to Dan.

Daniel Gibson: Before you go on mute, Jay, that was a great overview of bankruptcy and you're probably just scratching the surface, I'm sure. But to summarize what you've gone over, the bankruptcy chapters that we talk about, 7, 11 and 13, 7 appears to be one where it's just strictly, you're going in, you're just liquidating, I guess you're getting rid of all the liabilities, you're selling all your assets, getting rid of all the liabilities in general. I know there's always exceptions, but in general, that's what you're doing in 7, right?

Jay Lindenberg: Correct. That's correct.

Daniel Gibson: And then for 11 and 13, they're work out arrangements, I guess, that you get involved in. And in 11, I guess with the exception of the subchapter five that you were talking about, it's really for more larger businesses, probably for high net worth individuals because it seems to be you spend a ton of time on it, so it would lead me to believe that's probably the more complicated chapter to go through and probably expensive to boot, right?

Jay Lindenberg: That is correct, yes. An 11 is really a bankruptcy case, so it has all the bells and whistles, so I approached it that way.

Daniel Gibson: Yeah. And 13 is just for individuals, probably the ones that are not classified as high net worth individuals, right?

Jay Lindenberg: Correct. That's correct, yes.

Daniel Gibson: All right, great. Okay, so I'm going to go through some of the tax consequences in bankruptcy and I'm going to start out with what I call the 10 rules in chapter 7 filings when it comes to discharging taxes and you can discharge taxes in 11 and 13s. It's a little bit more wonkier. I don't want to get into all that because we just don't have the time. But I thought I'd go through some of these 10 rules when you're going into bankruptcy and trying to discharge taxes. Rule number one is there's a three-year rule and that three-year rule is dependent upon the due date of the return in question. It doesn't matter whether the return has been filed, it's the due date and it's got to be at least three years out. So as an example, if you were dealing with a 2010 return that was not extended and it's due on 4/15, the three years would be met after 4/15/2014. And if it was an extended return, then the date would be 10/15/2014.

Rule number two is the 240-day rule and the tax must be assessed more than 240 days prior to the bankruptcy filing. The assessment date is the date that there's an assessment officer at the IRS that signs off on a certificate. So it's probably a pretty good idea to run a transcript to make sure you have the dates properly. And these are really more applicable to not originally filed returns, but they're those returns that are amended or there's an audit that takes place. So that assessment has to be more than 240 days, otherwise it's not dischargeable. Then you have a two-year rule. These are for late returns. So if you're filing a timely filed return and you're within the three-year rule, then this really isn't an issue. The late filing return, they need to be actually filed two years before the filing of the bankruptcy petition. There is some controversy out there, and I'm going to go through it a little bit later.

There's a McCoy test and a birds test that's out there, or Beard Test, I should say, that there's splits within the circuits and I'll go through all that in the next couple of slides. Obviously any taxes that are associated with any unfiled returns can never be discharged. All right, so that could be an issue with people that are going to bankruptcy, quite frankly. The profile could be that, especially with individuals, they are late in filing their returns and they could run into trouble here. There's special treatment with the substitute for returns, which, again, I'm going to talk about a little bit in some later slides.

Fraudulent returns cannot be considered to be discharged in bankruptcy. But the IRS does have the burden of proof in those instances, there's got to be the taxpayer, the IRS has to prove that the taxpayer had the knowledge of the falsehood in the returns, was intending to evade taxes and was underpaying the taxes. Rule five tax evasion. Again, that the taxpayer must not have been fully attempted to evade the taxes. And again, the IRS needs to establish that there was a duty to pay the taxes. The taxpayer knew that there was a duty and that they deliberately acted to avoid the tax. Rule six, unassessed taxes. Taxes, they must be assessed prior to petition. Any taxes assessed subsequent to the petition will not be dischargeable.

Rule seven, employee payroll, withholding and other trust funds, so primarily the taxes that can be discharged in bankruptcy. And again, there's a couple of exceptions that I talk about a little bit later, primarily income taxes. But when it comes to those taxes that the taxpayer has been put in trust with to collect for the government, namely the payroll taxes, any withholdings from its employees, any sales taxes that it's collecting from its customers, and if there are any other taxes that they're collecting on behalf of the government, those can never be discharged in bankruptcy. All right. Property taxes, they must have been assessed at least a year before the filing of the bankruptcy. Any excise taxes or custom duties, gift estate, highway use, custom duties on imports, they must have been imposed three years before the filing. And rule number 10, the gap claims. Taxpayers forced into involuntary bankruptcy by creditors. But before the trustee is appointed, any tax claims arising between those two occurrences is not dischargeable.

By the way, to just divert a little bit here, make sure if you have any questions, make sure you're posting them up in the chat that we have. We'll be taking a look at those. To the extent that we have time to answer them, we will. In the extent that we don't, we'll follow up with you afterwards. So the other thing you have to be careful about in this area, as well as other tax controversy areas is the tolling of time. And there are times at which the IRS is halted in its collection actions, such as offers and compromise. Collection, due process request, those things could extend this three year and 240-day rule. So you want to be careful of that. And what you need to do is you really need to obtain IRS transcripts, review the transcripts, make sure you have the sufficient time, the sufficient timing. You don't want to be caught in a position where you're filing for bankruptcy and maybe if you had waited a couple of months, you could have discharged a lot more taxes. So you want to be very careful with that.

You also can call up the IRS and merely ask. A lot of those people are just government workers. They're not really caring why you call up and ask about tolling events and that sort of nature, but you can call them up and ask them for that as well. Also, discharging of penalties, interest and liens, on the penalties, most of these are ones that are associated with the taxes that are being discharged, could be the accuracy penalty, could be the failure to file, could be the failure to pay. Those can be discharged as long as the taxes are being discharged. And as we stated before, any penalties that are meant to be repaid to the government are not discharged. We talked about some of the trust fund monies that would not be discharged. I didn't mention the trust fund recovery. So if you've been deemed as a responsible person because you were an officer or a person responsible for payroll and the government assessed you, the trust fund recovery for the unpaid payroll taxes, that is not dischargeable.

Interest is like penalties. It follows the tax. So if the tax has been discharged, the interest will be discharged. The other thing is the liens, which is a very important area that you should be aware of going through bankruptcy. You can be discharged of the taxes and bankruptcy, but in most cases, you're not going to be discharged of a lien, all right? And in most cases, if the IRS has placed a lien on any real estate you have, your residence, your second home, other property that you may have, those liens will remain in place. Now, there is statute of limitations of 10 years for the IRS to satisfy itself with that lien. So there's a time that could tick off and make sure that the IRS not able to act on that.

But if you go into the bankruptcy, they discharge the taxes, those liens, any liens that you would have on any of the real estate that you have is definitely going to remain in place. And to the extent that you sell any of that property or try to attempt to sell any of that property before the end of the collection statute period, the IRS would likely have access to that money. And that takes us to the next polling question.

Bella Brickle: Poll #4

Daniel Gibson: Yeah, just to give everybody a heads-up on a future webinar that we're doing in the month of January, it's part of the retirement series webinars. We had a couple of them last year, Social Security and Medicare, we had done those last year. And to the extent that you're interested in those areas, they are recorded and they are on the EisnerAmper website. So I would encourage you to take a look at those. And in January, we're doing a program on annuities in retirement. That's going to be with me and Marc Scudillo of our wealth management group. And I know that most people out there when they hear the words or they say the words annuities, want to spit on the floor when they hear it. But I would encourage you to keep an open mind. And this is not a sales pitch for annuities themselves, but it's an opportunity to get some education on what annuities can do for you in retirement.

Daniel Gibson: Okay, thank you very much. Okay, so I'm going to go into that controversy with the late filing returns for a little bit here. If you look at this map, this is a map of all the circuit courts of appeal in the United States and there were 13 in total. And what happens in a lot of these instances, not all instances, but when there are disagreements amongst the circuits, often the Supreme Court referees all that and makes a judgment. They have yet to do that on this particular case when it comes to late filing returns, which I'll show you in a sec. All right, so there was a big bankruptcy legislation act that was passed in 2005 and some of it had to do with the means testing and getting it to bankruptcy. At the time, there was basically, if you look at a chart, it was a hockey stick effect with the people that were going at the bankruptcy during this period of time.

And they passed a means test, made a little, not a little, made it more difficult to get into bankruptcy. And you saw the bankruptcy petitions change quickly thereafter. But within that legislation there was this, they called the hanging paragraph that was in there. And it was set up as such that it addressed the fact that returns had to satisfy various requirements in order to be eligible for a late filing. And they went through this discussion where it said for purposes of subsection that the term return means return that satisfies the requirement of applicable non bankruptcy law, including applicable filing requirements. Such terms include returns prepared pursuant to section 620(a) of the internal Revenue Code of 1986 or similar state, or local law or written stipulation to the judgment or a final order entered by the non bankruptcy tribunal, but not including a return made pursuant to sections 6020(b) of the internal Revenue Code of 1986 or similar state or law. That's a mouthful.

So the plain language to all that is that a document is a return for discharge purposes if it satisfies the requirement of a non bankruptcy law including applicable requirements. What does that mean? Under the Beard Test, which was a case that proceeded this legislation, it spelled out what a return is. It's a document that purports to be a return. It's executed under penalties of perjury. It contains sufficient data to allow calculation of the tax, and it represents an honest and reasonable attempt to satisfy the requirements of the law. Well, the requirements of the law, and some of the circuits have been that this should be a timely filed return and the ending section also excluded the definition of the reasonably attempted to satisfy the requirements of law as a substitute for return prepared for the IRS. And a substitute of return is a return which the IRS will file on your behalf taking out information that's been reported to them by third parties, like 1099s, brokerage statements, W2s, all that stuff.

They calculate your return. By default, you're considered single. They put all the income in there. If they don't have the information regarding stock sales, the tax is calculated on the gross amount as opposed to the net gain or loss. And the IRS, they will do that for you and they don't look kindly on having to do that for you. So the McCoy ruling, which is a very strict ruling out of the 5th, 10th and 1st circuits have basically said that even if you are a one day that you're late in filing a return, that that return cannot be discharged in bankruptcy. All right?

And many scholars out there pointed out that this is basically negated the whole two-year rule that I talked about earlier. And the IRS surprisingly enough, because you don't see the IRS normally disagreeing with the courts when it comes to an unfavorable decision for the taxpayers, they even said it was too strict and they disagreed with that ruling. But those are the rulings for those three statutes. The first is up in the very northeastern part of the United States and 5 and 10 are in the Midwest.

Then you have the Beard Test, which is more in the middle of the road and it's abided by the 9th, 3rd, 11th, 6th and 4th circuits of appeal. And again, to go back to the return to the Beard Test we talked about before. It has to be purported to be returned, be executed under penalties of perjury, contain sufficient data and be a reasonable, honest and attempt to satisfy the requirements. And that fourth one, the IRS has basically said that even if it's late, then you have a substitute for return that's filed by the IRS, that will not be allowed in the discharging those taxes. And these circuits, these five circuits have agreed to that as well. All right?

So filing this return, as you can see these jurisdictions that we've cited before. There's a real inconsistency amongst the circuits that are out there. I think everybody would agree in those circuits that if the IRS has to end up filing a substitute for return for the taxpayer because they haven't filed a return, that return is best definitely taken out of the ability to be able to be discharged in bankruptcy. But then again, you're still left with circuit courts of appeal that won't even allow a day. Whereas other ones will allow the two-year rule as long as the SFRs have not been completed.

And again, this area is consistently evolving and practitioners should just keep an eye on what circuit they are practicing in when it comes to these things. And that really this inconsistency amongst the law has to be addressed somewhere or the other by the Supreme Court or Congress at some point. And this is a saying that resounds through our hallways in our office is that don't forget the states, there's always states to have to deal with. None of the stuff that I dealt with is directly applicable to states. Those states may follow it. So you really have to be on your toes, not only to deal with the federal tax consequences, but the state tax debts as well.

This is just a summary of the things that Jay has already talked about in some of his discussions that he had with the 1113 filings. I thought something that's of interest, and I talked to Jay about this before, is this whole idea about filing it at chapter 20, which is really the ability to file a 7 and then thereafter file a chapter 13. So the 7 would discharge the taxes and the 13 would force the IRS to abide by whatever payment plan that the bankruptcy court had come up with. So Jay, I don't know if you have any comments on that.

Jay Lindenberg: No, it is something that can be done. I've never had an experience, but it does work because you can follow the chapters and you get the full discharge of the chapter 7 and then you can reorganize whatever additional obligations you have in the 13.

Daniel Gibson: So just want to make sure that everyone knows the information that we provided here is not comprehensive. This was a basic course in bankruptcy and discharging taxes in bankruptcy. This is not a do it yourself project. In other words, don't handle bankruptcy to the equivalency of doing your tax return on TurboTax. You need to get a professional involved, a good bankruptcy attorney that can walk you through the whole bankruptcy proceeding and utilize our group, our bankruptcy and insolvency group that Jay works for. I found in many cases where I've had clients who were maybe looking or thinking about it and as with a lot of things, you'd like to get ahead of it and it's good to have the resources that we have to bring in to help us through in getting a client possibly set up for a bankruptcy filing. So Jay, I don't know if you have any closing comments or if there were any questions that you think that you could answer at this point.

Jay Lindenberg: There are a few questions and I think the easiest would probably be get back to those people with their individual questions. And other than that, I think you covered it pretty well as far as the tax side of it goes, Dan.

Daniel Gibson: Okay. All right, so we'll hand it back to the Bella to close out.

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