A discharge in Chapter 7 bankruptcy does not cover certain income taxes, as we all know. But the dischargeability of property taxes is rarely an issue in bankruptcy court. You may be surprised to find out that certain property taxes may not be discharged in bankruptcy.
Section 523 of the Bankruptcy Code sets forth certain debts that are not discharged in bankruptcy. Section 523(a)(1)(A) declares non-dischargeable debts for taxes of the kind and for the periods specified in Section 507(a)(8), regardless of whether or not a claim for such tax was filed or allowed.
Section 507(a)(8) refers to “allowed unsecured claims of governmental units, only to the extent such claims are for . . . (B) a property tax incurred before the commencement of the case and last payable without penalty after one year before the date of the filing of the petition.”
Allowed Unsecured Claims for a Property Tax?
An allowed unsecured claim for a property tax certainly seems like an oxymoron when it comes to Texas property taxes. By statute, property taxes are secured by a lien against the property relating to the tax. So, an allowed unsecured claim for property taxes would rarely, if ever, arise.
Not surprisingly, there has been litigation regarding the conflict between section 523, which says “whether or not a claim . . . was filed or allowed” and 507(a)(8), which speaks in terms of allowed unsecured claims. Does the property tax have to be “unsecured” in order to be non-dischargeable?
While the Tenth Circuit opinion in U.S. v. Victor, 121 F.3d 1383 (10th Cir. 1997) held that the tax claim must be unsecured in order to meet the exception in 523(a)(1)(A), the Eleventh Circuit in Gust v. U.S., 197 F.3d 1112 (11th Cir. 1999) (adopting the district court’s opinion in Gust v. U.S., 239 B.R. 630 (S.D. Ga. 1999)) and the Ninth Circuit in Miller v. U.S., 363 F.3d 999 (9th Cir. 2004) criticized this interpretation and held that it is the type of tax, not the type of claim, that determine dischargeability. See also the opinions in Hornick v. IRS, 85 A.F.T.R.2d (RIA) 320 (Bankr. W.D. Pa. 1999) and Barranco v. U.S., 307 B.R. 539 (Bankr. W.D. Va. 2004).
All of those cases involve federal income taxes secured by a perfected lien. In general, while federal income taxes are always secured by a statutory lien, the lien is not perfected unless the IRS files a notice of the lien in the county property records. The Gust and Miller courts were reluctant to penalize the IRS merely because the IRS has pursued collections by filing a lien of record. The debtors acknowledged that if the lien had not been filed, the tax was not dischargeable.
But what about property taxes, which are generally always secured by a perfected lien? The Tenth Circuit’s opinion in Victor suggests that if the tax creditor has property that it can pursue for the debt, then there is no need for non-dischargeability.
The Fifth Circuit does not appear to have addressed the issue, yet. But, one Bankruptcy Court in the 5th Circuit has ruled that secured property taxes are not discharged. In Miss. Dept. of Ag. & Com. v. McCain, 237 B.R. 881 (Bankr. N.D. Miss. 1998) the court found that an assessment under the Boll Weevil Management Act was in the nature of a property tax, was secured, was last payable without penalty within one year prior to the filing of the petition, and was therefore not discharged.
Advising Your Client
With property taxes secured by real estate, rarely is discharge an issue. The property tax authority is generally going to pursue its claims against the property first and foremost and any subsequent purchaser of the property is going to have to cure any tax liens in order to get clear title. So, whether chapter 7 debtors are surrendering or retaining real estate, one way or another, the property tax claims will generally be satisfied.
Be careful, though, of business personal property taxes. Self-employed or small business owners who are personally liable for business personal property taxes can find themselves the target of a post-discharge lawsuit by the local taxing authorities. The taxing authorities may take the position that the taxes for the year of the filing, and for the prior year, are not dischargeable and may pursue personal liability against your debtor client.
The Lawyer to Lawyer series is authored by the bankruptcy and consumer credit attorneys at Armstrong Kellett Bartholow P.C. for the use and education of other members of the bankruptcy and consumer credit bar.