Tax Tactics in Bankruptcy: Leveraging § 505 After Loper Bright

• Published in: American Bankruptcy Institute journal 2024-11, Vol.43 (11), p.28-50
• Main Authors: Jacobs, Kevin M, Sexton, Anthony V
• Format: Article
• Language: English
• Subjects: Bankruptcy; Debt exchanges; Federal courts; Financial instruments; Insolvency; Internal Revenue Code; Securities markets; Tax refunds; Tax regulations; Treasuries; Validity; Yield to maturity
• ISSN: 1931-7522

(Even the "actual sale" rule, which is the least problematic, is often interpreted to apply to very thinly traded debt that is moving, if at all, only in "private" transactions.) We often derisively refer to "indicative quotes" as "fake quotes" on pricing services, such as BVAL and Markit, that can exist even when as an absolute matter of fact no trading has occurred. [...]these rules operate to cause debt that is not trading at all to be "traded," creating CODI in situations that appear contrary to the statutory language of IRC § 1273. 8 The Loper Bright Decision Section 1.1273-2 of the Treasury Regulation has been on the books for more than a decade, with tax professionals generally resigned to its outcomes in light of the longstanding Chevron doctrine, which generally required courts to defer to federal agencies' "reasonable interpretation" of ambiguous laws (or if the law was silent on an issue). Enter § 505 of the Bankruptcy Code, which grants bankruptcy courts broad discretion to decide substantive tax claims and claims to tax refunds, as long as certain procedural requirements are satisfied.12 Section 505 applies to tax returns for "administrative" tax years, as well as to pre-petition taxable years. [...]the bankruptcy court provides a path for troubled companies to challenge tax liabilities predicated on § 1.1273-2 of the Treasury Regulation. The regulation can affirmatively discourage, or at least significantly increase the risk associated with, some out-of-court transactions, given the risk that some or all of the CODI might be taxable outright given the fact-intensive nature of the "insolvency exclusion," an outcome fundamentally at odds with the general bankruptcy policy of encouraging out-of-court transactions (meaning a bankruptcy court may view this as a systemic issue).