CHAPTER EIGHT

State and Local Taxes

§ 8.1 Introduction 471

§ 8.2 Bankruptcy Estates 472

(a) Practice Prior to 2005 Act 472

(i) Individual Cases—Chapters 7, 11, or 12 472

(ii) Individual Cases—Chapter 12 and Chapter 13 Cases 474

(iii) Corporations and Partnerships 474

(b) Changes Enacted 475

(i) Section 346: Special Provisions Related to the Treatment of State and Local Taxes 475

(ii) 11 U.S.C. Section 1146(a) 477

(iii) 11 U.S.C. Section 1231 477

(iv) Summary of Changes 477

(c) Impact of Changes 479

§ 8.3 Stock for Debt 479

§ 8.4 Cancellation of Indebtedness 479

(a) 11 U.S.C. Section 346(j) 479

§ 8.5 Net Operating Loss Carryback and Carryover 480

(a) Introduction 480

(b) Impact of Changes 480

(c) Carryback and Carryforward 480

(d) Consolidated Groups 481

(e) Apportionment 481

§ 8.6 Stamp Tax 481

(a) Introduction 481

(b) Stamp Tax or Similar Tax 481

(c) Imposed on the Purchaser 483

(d) Under the Plan 484

(e) Liquidation Sales 485

§ 8.7 Tax Impact of Plan for State and Local Purposes 485

§ 8.1 INTRODUCTION

The Bankruptcy Reform Act of 1978, as originally drafted in H.R. 8200, contained many tax provisions, including ones for the handling of income from debt discharge, the use of net operating loss (NOL) carryforwards, termination of taxable years of the estate, and the responsibility for filing income tax returns. In the early stages of the revision of the bankruptcy law, it appeared that leaving the federal tax provisions in the bankruptcy bill was acceptable to the House Committee on Ways and Means. However, with a change in committee chairmanship, the federal tax provisions were removed from the bill by inserting “state and local” before the word “tax.” It was contemplated that the federal tax laws would conform to the state and local tax laws or, if changes were made in the federal laws, that the Judiciary Committees of both the House and the Senate would amend the state and local provisions of the Bankruptcy Code so that the state and local tax rules would conform with the federal rules. After a delay of over two years, the House and Senate passed the bill on December 13, 1980, and the president signed the Bankruptcy Tax Act of 1980 on December 24, 1980. Almost 25 years later, Congress included provisions in the 2005 Act that conform the state and local tax laws with those contained in the Bankruptcy Tax Act of 1980.

Because the Bankruptcy Code covers only state and local taxes for an entity in title 11, the impact of debt discharge, preservation of NOLs, and so on in an out-of-court workout are governed by state and local tax laws. Thus, although the tax impact of debt discharge by an insolvent taxpayer in an out-of-court settlement or by a debtor in bankruptcy will be the same for federal tax purposes, the tax impact may differ significantly for state and local tax purposes.

Code section 346 applicable to state and local taxes has been changed by section 719 of the 2005 Act to follow the same provisions that apply for federal income tax purposes. Considerable conflicts existed between state and local taxes and federal taxes. As noted, Congress indicated at the time the Bankruptcy Reform Act of 1978 became law that the state and local tax issues would be changed when Congress passed the federal bankruptcy tax laws. A few years later, Congress passed the Bankruptcy Tax Act of 1980, but no action was taken until 2005 (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005) to eliminate the tax problems that arose because of differences between the two federal laws. To correct these problems, an amendment to Code section 346 was written to conform Code section 346 to the provisions of the Internal Revenue Code (I.R.C.), including sections 1398, 1399, 108, and 1017.

As with most of the changes made by the 2005 Act, the changes related to state and local taxes became effective with respect to cases commencing on or after October 17, 2005.

§ 8.2 BANKRUPTCY ESTATES

(a) Practice Prior to 2005 Act

Code sections 346, 728, 1146, and 1231 outlined special state and local tax provisions applying to individual and business cases. In many instances the tax treatment under these provisions did not coincide with federal tax provisions of the IRC.

(i) Individual Cases—Chapters 7, 11, or 12

I.R.C. section 1398 governs the income taxation of individual chapter 7 and 11 bankruptcy cases. Pursuant to this section, a new taxpaying entity, the bankruptcy estate, comes into existence upon the filing of a petition for an individual under chapter 7 or 11 of the U.S. Bankruptcy Code. The bankruptcy estate succeeds to and takes into account specific tax attributes of the debtor, determined as of the first day of the debtor’s taxable year in which the case commences, including NOL carryovers, charitable contributions carryovers, recovery of tax benefit items, credit carryovers, capital loss carryovers, basis, holding period and character of assets, method of accounting, suspended passive activity losses and credits, and suspended “at-risk” losses. Subject to minimum income thresholds, the bankruptcy estate is required to file income tax returns and pay income taxes on its taxable income. Taxable income of the estate is computed in the same manner as for an individual. Tax liability is determined under the regular income tax provisions that apply to married individuals filing separately. The income tax liability incurred by the estate becomes an administrative claim in the bankruptcy case.

For state and local income tax purposes, for cases involving individuals who file chapter 7, 11, or 12 bankruptcies, income of the estate was taxable to the estate—not to the debtor. The estate was required to use the same accounting method the debtor used immediately before the commencement of the case. If such individual was a partner in a partnership, any postpetition income from the partnership was generally taxable to the estate. In contrast to the federal provisions, which tax the estate as a married individual filing separately, the estate was taxed as an estate for state and local purposes.

The trustee assigned to a chapter 7 or 11 case or a debtor in possession in a chapter 13 case was required to withhold and make appropriate payments of state and local taxes on payment of claims for wages, salaries, commission, dividends, interest, or other payments.

No gain or loss was recognized on the transfer of property from the debtor to the estate. The estate succeeds to the character, basis, and holding period in assets transferred from the debtor. Property transferred from the estate to the debtor, other than through a sale, results in no gain or loss to the estate.

The tax attributes to which the estate succeeds were all-inclusive for state and local purposes. For federal purposes, the tax attributes to which the estate is entitled are limited to a specific list of items (see I.R.C. section 1398(g)). The estate may carry back losses to prepetition tax years of the debtor, but the debtor is not allowed to carry back losses to any prepetition tax year during the pendency of the case. Any tax attribute transferred to the estate that remains unused will transfer back to the debtor subject to reduction from any cancellation of indebtedness that occurs pursuant to the bankruptcy upon the conclusion of the case.

Under general income tax law, income is realized upon the satisfaction of indebtedness for an amount that is less than the full amount of the obligation. However, for federal purposes, pursuant to safe harbors provided in I.R.C. section 108, gross income does not include any amount that could be included in gross income by reason of the discharge of indebtedness of the taxpayer if the discharge occurs in a title 11 (bankruptcy) case. Rather, NOLs, general business credits, minimum tax credits, capital loss carryovers, adjusted tax basis of assets, passive activity losses and credits carryovers, and foreign tax credit carryovers are reduced. The operating rules for this required attribute reduction are found in I.R.C. sections 108 and 1017 and the regulations thereunder.

For state and local income tax purposes, when a discharge of indebtedness occurs in a bankruptcy case, such income was not recognized by the estate, the debtor, or a successor to the debtor. NOLs, including NOL carryovers, were reduced by the amount of the excludable discharge of indebtedness income. No income from discharge of indebtedness is realized where the indebtedness that was discharged consisted of items of a deductible nature that were not deducted or resulted in an expired NOL carryover or other deduction that did not offset income for any taxable period or contribute to an NOL. To the extent the amount of excludable discharge of indebtedness income exceeds the amount of NOL reduction required above, the basis of the debtor’s property shall be reduced by the amount of the remaining excludable discharge of indebtedness income. The reduction in the aggregate basis of property is limited to the aggregate total liabilities remaining after the discharge of indebtedness.

For federal purposes, an individual debtor who files a chapter 7 or 11 case can make an irrevocable election to terminate his or her tax year as of the day preceding the day he or she files bankruptcy. When the election is made, the debtor will be required to file a tax return for two short return periods, the first of which will begin on January 1 for a calendar-year taxpayer and end on the day preceding the date the case commenced. The second short year will begin on the date the bankruptcy case commenced and end on December 31. The election must be timely filed with the IRS in order for the tax year of the debtor to be divided into prepetition and postpetition periods (see I.R.C. section 1398(d)). For state and local purposes, the debtor’s tax year is automatically split into two short-year periods pursuant to provisions of the Bankruptcy Code. The ending date for the first short period is the date the bankruptcy case commences, which differs by one day from the applicable date for federal purposes.

Unlike federal filing requirements, which were based on a gross income filing threshold, state and local income tax returns for individual chapter 7 estates are required to be filed only if the estate has net taxable income for the entire period of administration of the chapter 7 case.

(ii) Individual Cases—Chapter 12 and Chapter 13 Cases

In chapter 13 cases, income of both the estate and the debtor are taxable to the debtor, not to the estate. No new entity is created when an individual files a chapter 12 or chapter 13 case.

(iii) Corporations and Partnerships

Pursuant to I.R.C. section 1399, for federal income tax purposes, no separate taxable entity shall result from the filing of a bankruptcy petition on behalf of a corporation or partnership.

State and local income tax laws generally apply to corporations and partnerships in bankruptcy as if no case had been commenced. In chapter 7 corporate cases, state and local income tax returns for corporations in chapter 7 are required to be filed only if the corporation has net taxable income for the entire chapter 7 administrative period of the case.

(b) Changes Enacted

(i) Section 346: Special Provisions Related to the Treatment of State and Local Taxes

The special provisions established by U.S. Code section 346 are as follows.

(ii) 11 U.S.C. Section 1146(a)

Code section 1146(a) and (b) dealing with the short tax year and subsequent-year returns was repealed because these provisions are not provided for in revised Code section 347. Likewise, Code section 728 was repealed for the same reason.

Code section 1146(c), providing that a transfer of securities under Code section 1129 may not be taxed by any law imposing a stamp tax or similar tax, was not repealed but continues in effect as Code section 1146(a). Code section 1146(d), authorizing the proponent of a plan to request a determination for state and local tax purposes, limited to questions of law, of the tax effects of a plan also was not repealed, but continues in effect as Code section 1146(b).

(iii) 11 U.S.C. Section 1231

Code section 1231 was also modified in a similar manner to Code section 1146 except that the determination of the tax effect of the plan applies to any governmental unit and not just a state or local taxing authority. This change was not made to Code section 1146(b). However, the extent to which the federal tax may be determined may be limited by the reference to Code section 346. The revised Code section 1231 follows.

(b) The court may authorize the proponent of a plan to request a determination, limited to questions of law, by any governmental unit charged with responsibility for collection or determination of a tax on or measured by income, of the tax effects, under section 346 of this title and under the law imposing such tax, of the plan. In the event of an actual controversy, the court may declare such effects after the earlier of—

(1) the date on which such governmental unit responds to the request under this subsection; or

(2) 270 days after such request.

(iv) Summary of Changes

In summary, Code section 346 is modified to provide these provisions, related to I.R.C. sections 1398 and 1399:

• If section 1398 of the Internal Revenue Code of 1986 provides that a separate taxable estate or entity is created upon the filing of a bankruptcy case, a separate taxable estate is also created for state and local tax purposes. Under I.R.C. section 1398, a separate estate is created for an individual in chapters 7 and 11. If the case is dismissed, the estate would not file separate returns for federal, state, and local tax returns. In this instance, all income and expenses related to the estate would be reported on the individual’s return for federal and for state and local tax purposes. The trustee or debtor in possession has the duty to make tax returns that are required under applicable state and local law.
• If section 1399 of the Internal Revenue Code of 1986 provides that no separate taxable entity is created upon the filing of a bankruptcy case for federal tax purposes, as would be the case if the entity filing the petition is not an individual, no separate taxable estate is created for state and local purposes either. Thus, the trustee or debtor in possession has the duty to make required corporate and partnership income tax returns. Such returns would be filed in the normal manner, as if a bankruptcy petition was not filed. The estate is liable for any tax imposed on such corporation or partnership but not for any tax imposed on partners or members. Partnership taxable income is generally passed through and taxed to the partner or member of such partnership.
• The bankruptcy estate is required to use the same accounting method used by the debtor immediately before the commencement of the case, provided such method is appropriate for state and local tax purposes.
• The time and manner of filing state and local income tax returns shall be determined under applicable nonbankruptcy law.
• State and local income tax returns must be filed in all chapter 7 cases even though there may not be net taxable income over the pendency of a chapter 7 case. Prior to the 2005 Act, as noted earlier, no state and local returns were required if there was no taxable income over the pendency of the chapter 7 case. Thus, minimum franchise tax and income tax provisions imposed by many state governments may now apply universally to taxpayers in chapter 7 bankruptcy.
• In the year in which the bankruptcy petition is filed, the debtor’s tax period will terminate only if and to the extent that the taxable period of such debtor terminates under I.R.C. section 1398. Thus, the election to end the taxable year the day before the petition is filed will apply to state and local taxes only if the election is made to file a short taxable year return for federal tax purposes.
• Transfers of property from the debtor to the estate or from the estate to the debtor are not treated as a disposition for state and local income tax purposes, except to the extent that such transfer is treated as a disposition under the Internal Revenue Code of 1986. Thus, abandonment of property that is not considered a sale for federal tax purposes will not be a sale for state and local tax purposes.
• State and local income tax is imposed at rates generally applicable to the same types of entities. In other words, for example, bankruptcy estates of individuals will be taxed at rates generally applicable to individuals, and corporate estates will be taxed at corporate tax rates.
• The trustee is required to withhold and make appropriate payments of state and local taxes on payment of claims for wages, salaries, commission, dividends, interest, or other payments. Such payment has the same priority as the underlying claim and is to be made at a time and in a manner required by such tax law.
• For state and local income tax purposes, in a title 11 case for which a new tax entity is created, this entity shall succeed to all tax attributes available to be carried over from one taxable period to a subsequent taxable period. To the extent such tax attributes still exist at the time the case is closed, they revert back to the debtor. The estate may carry back any loss or tax attribute to a prepetition tax period of the debtor if the applicable state or local law provides for a carryback, and the same or a similar tax attribute may be carried back by the estate to such a taxable period of the debtor under the Internal Revenue Code of 1986.

(c) Impact of Changes

Since 1980, many significant differences have existed between federal income tax provisions and state and local income tax provisions when bankruptcy is involved. In the 2005 Act, section 719 attempts to reconcile many of these discrepancies by requiring that state and local law follow the existing federal rules that are now applicable to bankruptcy estates. The impact of these changes, however, may be limited because, even though the differences existed, many tax professionals and debtors used the federal tax basis for state and local tax purposes.

There will, however, be more state and local income tax returns filed in chapter 7 cases, and minimum tax amounts will be paid because the provision that returns need to be filed for state and local tax purposes only if income was earned during the entire bankruptcy proceeding has been repealed. As noted earlier, minimum franchise tax and income tax provisions imposed by many state governments may now apply universally to taxpayers in chapter 7 bankruptcy.

§ 8.3 STOCK FOR DEBT

Section 346(j)(7) provided that no income from debt forgiveness or discharge was recognized when an equity security was issued in satisfaction of its debt. Since the passage of the Bankruptcy Tax Act of 1980, several restrictions have been placed on the exchange of stock for debt. It appears that most of these restrictions did not apply for state and local tax purposes. Because, the I.R.C. will now apply, any restrictions that may not have applied under prior law, will most likely now apply under the 2005 Act.

§ 8.4 CANCELLATION OF INDEBTEDNESS

Section 346(j) as noted above was revised to provide:

(a) 11 U.S.C. Section 346(j)

In summary, section 346 also provides, related to the cancellation of indebtedness and the reduction of tax attributes:

• For state and local income tax purposes, income from the cancellation of indebtedness is not realized by the estate, the debtor, or the successor to the debtor unless such income is taxable under the I.R.C., especially sections 61 and 108.
• The provisions in I.R.C. sections 108 and 1017, requiring the reduction of tax attributes associated with nontaxable cancellation of debt income, apply for state and local income tax purposes to the extent applicable state and local law recognizes such attributes. If there are state or local laws providing for the reduction of other attributes, such reduction should be made to the extent the discharge of indebtedness has not been fully applied.

The modifications to Code section 346 by the 2005 Act did not address the issues of the carryover or carryback of a corporation’s net operating losses.

As previously discussed, the tax impact of cancellation of indebtedness was generally less for state and local tax purposes than for federal tax purposes. Most of these advantages, such as the order of the reduction of tax attributes and the attributes to be addressed, are no longer available. Because Code section 346 does not address NOLs for corporations, the uncertainties regarding the extent to which NOLs can be preserved for state and local tax purposes continue under the 2005 Act as described next.

§ 8.5 NET OPERATING LOSS CARRYBACK AND CARRYOVER

(a) Introduction

The modifications to Code section 346 by the 2005 Act did not address the issues of the carryover or carryback of a corporation’s NOLs.

(b) Impact of Changes

The tax impact of cancellation of indebtedness was generally less for state and local tax purposes than for federal tax purposes. Most of these advantages, such as the order of the reduction of tax attributes and the attributes to be addressed, are no longer available. Because Code section 346 does not address NOLs for corporations, the uncertainties regarding the extent to which NOLs can be preserved for state and local tax purposes continue under the 2005 Act.

(c) Carryback and Carryforward

Generally there is a difference between federal and state NOL carrybacks and carryforwards.1 However, a large number of states have conformed generally to the federal rule regarding carrybacks and carryforwards. Still, a majority of the states do not allow carrybacks and a majority of the states did not adopt the 5-year carryback period for 2008 and 2009 NOLs. The carryforward period may be less than the 20-year period that is allowed for federal tax purposes. Due to the budget problems faced by state and local governments, some states have temporarily suspended the NOL deductions. Some states may limit the use of NOLs to an established dollar amount or in cases where the entity was not subject to a state or local tax in the year the loss occurred.

(d) Consolidated Groups

The treatment of NOLs for state and local tax purposes may differ from that for federal taxes for consolidated groups, depending on whether the state allows or requires a consolidated, combined, nexus combined, or separate company filing option. For example, in California, members of a unitary group filing a combined report may combine taxable income and losses in the current year. However, the members of the group must determine the NOL carryover as well as the utilization of the carryover on a separate company basis.2 This approach prevents the offset of one member’s loss carryover against the future income of another member.

(e) Apportionment

Most states require apportionment to be used to determine the portion of a corporation’s income that is attributable to a particular state. Once the NOL applicable to a particular state has been calculated, only that loss can be utilized against income from that state.3

§ 8.6 STAMP TAX

(a) Introduction

Section 1146(a) of the Bankruptcy Code provides: “The issuance, transfer, or exchange of a security, or the making or delivery of an instrument of transfer under a plan confirmed under section 1129, may not be taxed under any law imposing a stamp tax or similar tax.”

A tax that qualifies under this provision generally has the following characteristics:

• A stamp tax or similar tax is imposed.
• The stamp tax is imposed on the purchaser.
• The stamp tax is imposed in connection with a plan.

Each of these characteristics is discussed in the following sections.

(b) Stamp Tax or Similar Tax

Section 1146(a) of the Bankruptcy Code does not define a stamp tax or similar tax. In general, the courts have held that the essential common element of a stamp tax is the levying of the tax on a written instrument representing a transfer or sale. In In re Amsterdam Ave. Development Association,4 the court established criteria for a stamp tax or similar tax that have been followed by other courts:

• The amount is determined by the consideration stated in the document.
• Payment is required before the document can be recorded.
• The tax is imposed on a written instrument.

A stamp tax or similar tax has been interpreted to include:

• Tax imposed on recording liens against the debtor. The exception has not been applied to purchase money mortgage liens relating to liabilities incurred upon purchase by third parties from the debtor.5
• State and local realty transfer taxes. In In re Jacoby-Bender, Inc.,6 realty transfer taxes were held to be the equivalent of a stamp tax.
• Gains taxes. The courts have reached conflicting results on the question of whether section 1146(c) of the Bankruptcy Code applies to state or local gains tax. In In re 999 Fifth Avenue Assoc, L.P.,7 the district court affirmed the bankruptcy court’s decision that section 1146(c) of the Bankruptcy Code barred New York State from imposing the state’s real property gains tax on the sale of the Stanhope Hotel pursuant to a chapter 11 plan. The district court concluded that the gains tax contained the essential characteristics of a stamp tax. It was imposed on a transaction-by-transaction basis and payable at the time of transfer, without regard to other transfers over time. The consideration paid to the transferor and recited in the deed is essential in assessing the amount of the real property gains tax due. The tax must be paid at the time of the transfer, and the conveyance under state law cannot be recorded before the tax is paid.
• The court concluded that the real property gains tax was not an income tax because the gains tax lacked many of the essential characteristics of an income tax. The tax does not measure changes in the taxpayer’s economic status because no allowance is made for depreciation. The tax was not assessed against profitable transactions, because, under New York law, only transfers that exceed $1 million are subject to the tax. (Once the transaction exceeds $1 million, the entire gain is taxed.) In addition, the purchaser may be liable for the tax if the seller does not pay the tax. Thus, the district court concluded that the New York real property gains tax has many of the characteristics of the stamp tax and very few of the income tax.
• In In re Jacoby-Bender, Inc.,8 the bankruptcy court concluded that the New York real property gains tax is an income tax. The court held that the gains tax is not a tax on the transfer but on the gain realized by the transferor. The court also interpreted the stamp tax to apply to the making and delivery of a deed.
• Sales and use taxes. Again, the courts are divided as to the extent that the exception under section 1146(c) of the Bankruptcy Code applies to sales and use taxes. A sales or use tax is often imposed on the sale of personal property that is generally sold without an instrument of transfer. Thus, section 1146(c), if interpreted literally, would not apply because the sale is not effected through an instrument. A literal interpretation would lead to the exemption of the tax for real property transfers and not for personal property transfers. In Linden Hill Associates Limited Partnership v. Comptroller,9 the court held that the sale of personal property pursuant to a chapter 11 plan was not exempt from the Maryland retail sales tax, because the tax is imposed regardless of any instrument of transfer. In In re A.H. Robins Co.,10 the sale of personal property was not subject to the sales tax because of section 1146(c).
• O’Neill and Ruez11 point out that, even though section 1146(c) may not exempt a transaction from sales tax, most states provide for some form of exemption for casual or isolated sales. State statutes that allow an exemption from the tax for the bulk sale of tangible personal property may require that advance notice be given of the proposed sale, or may limit the exemption to those taxpayers not regularly engaged in the retail sales business.

(c) Imposed on the Purchaser

Section 1146(a) of the Bankruptcy Code forbids the imposition of a stamp tax on the “making or delivery of any instrument of transfer.”12 It would appear that this section literally applies to the purchaser; however, courts have generally held that both the transferor and the transferee of an instrument are exempt from the tax. In In re Hans B. Cantrup,13 the bankruptcy court held that section 1146(a) applied to a real estate transfer tax that was imposed on the acceptance of a deed and presentation for recording by the transferee. The court concluded that the intent of section 1146(a) was to bar a tax on the transfer, regardless of whether it was presented for recording by the transferor or transferee. A similar decision was made by the bankruptcy court in In the matter of CCA Partnership,14 where the realty transfer taxes were apportioned equally between the grantor and grantee. In Lake v. Gleason,15 the court held that the predecessor section of the Bankruptcy Act (to section 1146(c) of the Bankruptcy Code) did not exempt a grantee who presented a deed to be recorded from the Pennsylvania realty transfer tax.

The exemption would not apply to subsequent transfers by the purchaser. Thus, section 1146(a) of the Bankruptcy Code would not exempt the recording of a mortgage granted by the purchaser to a third-party lender. O’Neill and Ruez suggest that the recording tax may be exempted if the debtor grants the mortgage to the third-party lender and then transfers the property subject to the mortgage.

(d) Under the Plan

Tax must be imposed in connection with a plan that is confirmed under the Bankruptcy Code. Courts have generally held that the tax need only be imposed on a transaction that is consummated on confirmation of the plan or that is essential to the plan’s consummation or confirmation. For example, in In re Jacoby-Bender, Inc.,16 the Second Circuit held that section 1146(a) of the Bankruptcy Code applied to the sale of a building after the plan had been confirmed. Authorization for the sale of the building was not contained in the plan, but the court did obtain subsequent separate approval for the sale. The court held that, because consummation of the debtor’s plan depends almost entirely on the sale of the building, the transfer should be regarded as being made under the plan for purposes of section 1146(c).

In In re Permar Provisions, Inc.,17 the bankruptcy court held that section 1146(a) of the Bankruptcy Code applied to the sale of a building before the plan was confirmed because the sale facilitated confirmation of the plan and without the sale, the plan in all probability would not have been confirmed.

In In re Smoss Enterprises Corp.,18 the court held that section 1146(a) of the Bankruptcy Code applied to a sale of property under a prepetition contract that was made prior to confirmation of a liquidating plan. The court determined that the transfer of the property was essential to the confirmation of the plan. The district court, in In re The Baldwin League of Independent Schools,19 approved the mortgage of a building, prior to confirmation of the plan, that provided the sole source of funding for the plan and was necessary for confirmation of the plan.

The conflict as to whether a transfer must be provided in the plan confirmed or can be made at any other time as long as the transfer is approved by the court in order to be exempt from the stamp tax will be resolved by the Supreme Court. In In re Piccadilly Cafeteria Company, Inc., the bankruptcy court, district court, and Eleventh Circuit held that transfers are exempt under the statute as long as a bankruptcy plan is eventually confirmed. Hearings were held on the decision by the Eleventh Circuit that was appealed to the Supreme Court.20 The Second Circuit21 held that section 1146(c) [now section 1146(a)] applied to the sale of a building that was not contained in the plan. The sale was subsequently approved by the court; however, according to the Eleventh Circuit, the Second Circuit failed to address the timing issue. The Third22 and Fourth Circuits23 held that the sale must have already been confirmed at the time of transfer for the exemption to apply.

On June 16, 2008, the Supreme Court held that Section 1146(a) of the Bankruptcy Code provides a stamp-tax exemption only to transfers made pursuant to a chapter 11 plan that has been confirmed.24 This exemption existed for a long time to allow unsecured creditors to receive a larger recovery because transfer taxes did not have to be paid. The technical ruling by the Supreme Court now limits the benefit creditors may receive, creating the need to modify the Bankruptcy Code to allow exemption of business sales approved by the bankruptcy court in advance of the drafting of a plan.

Even though courts have generally given broad interpretation to the meaning of “under the plan,” it is advisable to refer, in the plan or in the disclosure statement, to any completed or proposed transfer of property where section 1146(a) would apply and to indicate that the purpose of the transfer was to effectuate the plan.

(e) Liquidation Sales

The Supreme Court, in California State Board of Equalization v. Sierra Summit,25 held that the state has the power to impose sales and use taxes on liquidations in both chapter 7 and chapter 11. It would also be presumed that any tax imposed by a local taxing authority would apply to liquidation sales. At least three circuit courts have held that sales taxes on liquidation sales are an impermissible burden on a bankruptcy liquidation and thus were excluded from section 960 of title 28 of the United States Code.26 In Missouri v. Gleick,27 the Eighth Circuit held that taxes could be imposed against bankruptcy liquidations. Section 960 of title 28 of the United States Code provides that any officer or agents conducting business under authority of a United States court shall be subject to all federal, state, and local taxes that are applicable to the business, to the same extent as if the business were conducted by an individual or corporation.

The Supreme Court did not consider the application of section 1146(a) of the Bankruptcy Code to these taxes but instead ruled that the doctrine of intergovernmental tax immunity or section 960 of title 28 of the United States Code does not prevent states from imposing these taxes on liquidation sales.

§ 8.7 TAX IMPACT OF PLAN FOR STATE AND LOCAL PURPOSES

The 2005 Act renumbered section 1146(d) as section 1146(b) but did not change, delete, or modify its contents. For a discussion of the tax impact of a plan for state and local tax purposes see § 10.3(e).

1Nakamura, Thompson and Ferris, Beware of State-Federal NOL differences, Journal of Accountancy (August 20, 2010).

2O’Neill and Ruez, State and Local Tax Issues to a Debtor in Bankruptcy, in Bezozo and Phelan, Bankruptcy Taxation: Critical Current Issues 535 (1991).

3Id. at 536.

4 103 B.R. 454 (Bankr. S.D. N.Y. 1989).

5See In re The Baldwin League of Independent Schools, 110 B.R. 125 (S.D. N.Y. 1990); In re Eastmet Corp., 907 F.2d 1487 (4th Cir. 1990) and In re Amsterdam Ave., Develt Assoc., supra note 4.

6 40 B.R. 10 (Bankr. E.D. N.Y. 1984), aff’d on another issue, 758 F.2d 840 (2d Cir. 1985).

7 1991 U.S. Dist. LEXIS 6514 (S.D. N.Y. 1991).

8Supra note 6.

9 1989 Md. Tax LEXIS 13 (1989).

10 88 B.R. 742 (Bankr. E.D. Va. 1988).

11Supra note 2, at 550.

12See § 8.6(b).

1353 B.R. 104 (D. Colo. 1985).

14 72 B.R. 765 (D. Del. 1987), aff’d, 833 F.2d 303, 833 F.2d 304 (3rd Cir. 1987).

15 11 Pa. D. & C. 584 (Pa. 1956).

16 758 F.2d 840 (2d Cir. 1985).

17 79 B.R. 530 (E.D. N.Y. 1987).

18 54 B.R. 950 (E.D. N.Y. 1985).

19Supra note 5.

20 Writ of Certiorari granted, 128 S. Ct. 741 (U.S. 2007). See Sup. Ct. Dkt. No. 07-312.

21In re Jacoby-Bender, Inc., 758 F.2d 840 (2d Cir. 1985).

22In re Hechinger Inv. Co. of Delaware, Inc., 335 F.3d 243 (3rd Cir. 2003).

23In re NVR, LP, 189 F 3d 442 (4th Cir. 1999).

24Fla. Dep’t of Revenue v. Piccadilly Cafeterias, Inc., 128 S. Ct. 2326 (2008).

25 109 S. Ct. 2228 (1989).

26See In re Leavy, 85 F.2d 25 (2d Cir. 1985); California State Board of Equalization v. Goggin, 245 F.2d 44 (9th Cir. 1957), cert. denied, 353 U.S. 961 (1957); In re Cusato Brothers Int’l, Inc., 750 F.2d 25 (11th Cir. 1985).

27 135 F.2d 134 (8th Cir. 1943).