Taxing Problems for Debtors - Treatment of Property Taxes

In bankruptcy, a debtor often faces assessments for interest and penalties on property taxes from a variety of taxing jurisdictions. Addressing these claims can be frustrating and time-consuming. Frequently, the most confusing assessments are those for tax periods that straddle the petition date: Is the entire tax post-petition and thus entitled to administrative-expense treatment under § 503(b)(1)(B) of the Bankruptcy Code? Is the tax all pre-petition and thus a pre-petition unsecured claim entitled to priority status under § 507(a)(8)? Is the tax split according to the pre-petition and post-petition periods? The difference is important because administrative-expense claims must be paid in full before payment may be made on pre-petition unsecured claims, and administrative-expense claims may also be entitled to penalties and interest.

Treatment of Priority vs. Administrative-Expense Claims
Significantly, § 507(a)(8)(G) requires that any penalty under § 507(a)(8) must be “in compensation for actual pecuniary loss.” For this reason, although courts often award interest and penalties on taxes that receive administrative expense treatment under § 503(b)(1)(B), taxes that have pre-petition unsecured claim status generally do not receive such treatment. [2] Furthermore, priority claims may be paid over time, up to five years after the petition date, pursuant to § 1129(a)(9)(C), while administrative claims generally must be paid in full, in cash, upon emergence. In the end, determining whether property taxes [3] were incurred post-petition or pre-petition may save debtors from unnecessary interest and penalty costs and allow payment to be deferred. [4]

Section 507(a)(8)(B) establishes that “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” is a pre-petition claim entitled to priority status. [5] To qualify, the tax must be (1) a tax on property, (2) incurred prior to the commencement of the case and (3) last payable without penalty more than one year before the case began. Failure to meet all of these criteria will result in a claim being treated as a general unsecured claim (provided that it is not secured by a lien, thus warranting secured status.) [6]

Incurrence Test Differentiates Between Priority and Administrative-Expense Claims
The inquiry into whether a property tax claim is entitled to administrative-expense or priority status rests on when the tax was “incurred.” Determining when a tax is incurred is the complicated part, and it is possible for a tax to have been incurred pre-petition but for payment to be due post-petition. Regardless of when it becomes due, if a tax meeting the criteria of § 507(a)(8) was incurred pre-petition, then the tax merits priority status, while a tax incurred (by the estate) post-petition is entitled to administrative-expense status. [7]

By focusing on when taxes are incurred, the Bankruptcy Code avoids possible confusion created by tax periods that straddle the petition date. [8] Although courts in other contexts have sought to prorate other taxes to account for pre- and post-petition periods, [9] the entirety of a property tax incurred pre-petition is entitled to priority status, and the entirety of a property tax incurred post-petition is entitled to administrative-expense status. This principle does not hold if the debtor is a lessee who agreed to pay property taxes as part of the lease. These claims are governed by § 365(d)(3) and are often prorated for the portions of the lease that are prepetition and postpetition. [10]

State law governs when a tax is deemed to have incurred. [11] Courts typically find that a tax is incurred when it accrues and becomes a fixed liability. [12] Most courts find that the date on which a property tax is incurred is different from—and earlier than—the date on which payment is due. [13] Such a finding depends on the jurisdiction and the state taxing structure. For example, Maryland courts have held that property taxes are incurred on the “date of finality” (the valuation date), despite the fact that a property holder can transfer the tax liability by filing a timely report of transfer upon selling the property after that date. [14] Similarly, an Indiana court held that property taxes were incurred on the assessment date because that was when the annual tax liability attached. The court relied in part on the fact that “the owner’s liability would not be affected even if the property were sold after this date.” [15] In Georgia, “the owner of real and personal property as of [Jan.] 1 [in any calendar year] is the person that incurs liability for the ad valorem taxes associated with that property.” [16] West Virginia courts look to the period of ownership itself, since it is “the event giving rise to the property tax…even though the amount of tax [has] not yet been determined.” [17]

Conclusion
In determining whether taxes are entitled to priority or administrative-expense status, the inquiry should focus on when the taxes were incurred under state law. Establishing that a property tax was incurred pre-petition may allow the debtor to avoid penalties and interest and defer payment, while a determination that the tax was incurred post-petition would elevate the tax to administrative-expense status, entitling the taxing authority to immediate cash payment of its claim, including penalties and interest.
 

View Online.