Before getting into the meat and potatoes of today’s post, I want to acknowledge a comment by a fellow bankruptcy attorney.  At a recent continuing legal education presentation she asked why I hadn’t been regularly posting, and encouraged me to post more frequently.  I must confess that since I hadn’t heard much from my readership, I was a bit discouraged.  Her words put a fire under my seat — which is better than the fire I get from the spicy food I foolishly love — so I will try to be more regular (daily prune juice is helping).

In any event, I recently answered a couple of questions posed by a fellow bankruptcy attorney — not the same one mentioned in the previous paragraph — and thought you might find the exchange interesting.  The questions were:

Debtor was sued in Superior Court and a judgment was entered relating to the repayment of unemployment claims in 2010 to the Employment Development Department – State of California.

Q1: Is this a priority claim?

Q2: If the Debtor’s chapter 13 plan provides for this claim but the EDD does not file a proof of claim, will the claim be paid by the trustee?  If not, will the debt be discharged?

I.          Priority Debts

To answer the first question we need a little back ground.

In bankruptcy all debts are not created equal (with apologies to Mr. Jefferson).  Some debts are given priority over others.  For example, obligations to pay domestic support come way before credit card debts.  The complete list of priorities, in the order of their priority, is given in 11 U.S.C. § 507(a).

Certain tax debts are given priority, meaning that in a Chapter 13 repayment plan they must be paid in full, even if the other creditors are getting chump change.  I have already discussed in great detail the treatment of income tax debts, so I won’t rehash it here.

Another type of tax is known as a “trust fund tax.”  What is a trust fund tax?  Certain types of taxes must be collected by a third party — typically an employer — and remitted to some government agency.  For example, an employer is required to collect payroll taxes and send them to the appropriate taxing authority — either the IRS or the Franchise Tax Board.  In the process, the employer holds the money in trust for the taxing authority before sending it to the dark side of the force.  This is why the tax is called a trust fund tax.

To be a bit more precise (and, admittedly, pedantic):  A trust fund tax must satisfy two requirements:  (a) it must be a tax, and (b) it must be collected from someone other than the entity sending the money to the taxing authority.  See, e.g., Slodov v. United States, 436 U.S. 238, 243 (1978):

Several provisions of the Internal Revenue Code require third persons to collect taxes from the taxpayer.  Among the more important are 26 U. S. C. §§ 3102 (a) and 3402 (a) (1970 243*243 ed. and Supp. V) which respectively require deduction from wages paid to employees of the employees’ share of FICA taxes, and the withholding tax on wages applicable to individual income taxes.  The withheld sums are commonly referred to as “trust fund taxes,” reflecting the Code’s provision that such withholdings or collections are deemed to be a “special fund in trust for the United States.”

If the employer fails to send the tax to the taxing authority, then the employer incurs a personal liability to the taxing authority.  This type of liability is a priority debt because of 11 U.S.C. § 507(8)(C) (with emphasis added):

The following expenses and claims have priority in the following order: . . . Eighth, allowed unsecured claims of governmental units, only to the extent that such claims are for . . . a tax required to be collected or withheld and for which the debtor is liable in whatever capacity.

The bad news:  this type of debt is NEVER dischargeable in bankruptcy because:  (a) it is a priority debt that has no statute of limitation, and (b) the money does not belong to the debtor — it is, after all, being held for the benefit of the taxing authority.  See, e.g., In re Shank, 792 F. 2d 829, 830 (9th Cir. 1986) (“A trust fund tax is always given a priority and is never subject to discharge in bankruptcy.”)

My colleague’s client was an employer who was supposed to remit unemployment insurance premiums to the Employment Development Department (“EDD” — no relation to Mr. Ed).  He failed to do so.  If those premiums were trust fund taxes, they are nondischargeable and must be paid in full through the Chapter 13 plan.  This leads me to my expansion of my colleague’s first question:  Is this obligation a trust fund tax, making it a priority debt?

II.        In re Hansen

In a recent decision the Bankruptcy Appellate Panel (“BAP”) answered my colleague’s first question by holding that EDD unemployment insurance taxes are NOT priority debts, so, a fortiori, they are not trust fund taxes.

In In re Hansen, 470 B.R. 535, 542 (9th Cir. B.A.P. 2012) the BAP held that an unpaid California unemployment insurance tax for which a responsible officer is personally liable, is NOT a priority “tax required to be collected” under 11 U.S.C. § 507(a)(8)(C), and is therefore NOT nondischargeable under § 523(a)(1)(A) (this reference to § 523(a)(1)(A) is irrelevant in a § 1328(a) discharge, but important in a § 1328(b) discharge).  (“[W]e hold that the UI Tax is not a tax contemplated by § 507(a)(8)(C), and that, consequently, it does not give rise to a nondischargeable debt within the meaning of § 523(a)(1)(A).”)

In sum, according to the BAP an EDD unemployment insurance tax is not a priority debt, so it is not a trust fund tax!  This is important because as previously observed, trust fund taxes are never dischargeable.

III.       Payment Through The Chapter 13 Plan

My colleague’s second question (actually it’s two questions bundled together) asks what happens if EDD fails to timely file a proof of claim.

What is a proof of claim?  It is a formal application, with supporting documentation, filed by a creditor as a way of participating in any payout that might occur in the case.

In a Chapter 7, 12, or 13 case if a creditor fails to file a proof of claim within the time limits found in Rule 3002(c) of the Federal Rules of Bankruptcy Procedure (FRBP) (the gist:  government creditors have 180 days from the filing date, other creditors have 90 days from the first date set for the 341(a) meeting of creditors) it receives no payout.

In a Chapter 9 or 11 case the timetable for filing proofs of claim is set by the Court pursuant to FRBP 3003(c)(3).

Now the answer to my colleague’s two-part question:

  • If a creditor fails to timely file a proof of claim, then pursuant to 11 U.S.C. § 502(b)(9) its claim is disallowed and that creditor will not be paid through the plan.
  • If the claim is dischargeable, then it is discharged upon the debtor receiving a discharge pursuant to either § 1328(a) or (b).

Today’s discussion illustrates some of the many potential complications that you could face when filing for bankruptcy protection.  Bankruptcy is a legal minefield that is best navigated using the services of a good bankruptcy attorney.  Don’t be foolish and go it alone.