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Tax Debt to California Can Be Discharged in Second Bankruptcy, Ninth Circuit Rules - In re Brenda Marie Jones

July 25, 2011

Our Rancho Cucamonga consumer bankruptcy lawyers were interested to see a recent Ninth U.S. Circuit Court of Appeals decision on how a second bankruptcy affects tax debts. Normally, tax debts, including debts to states as well as the IRS, are dischargeable if they were due more than three years ago. However, that three-year rule can be suspended if the debts not collectable, for example, because of an automatic stay in a previous bankruptcy. That was the allegation in In re Brenda Marie Jones, concerning a California woman seeking a Chapter 7 bankruptcy. Jones owed a debt to the California Franchise Tax Board that was more than three years old. The FTB argued that it should not be dischargeable because Jones had previously been through another bankruptcy that included an automatic stay on collections. The Ninth Circuit ultimately disagreed.

Jones filed a joint Chapter 13 bankruptcy with her husband in 2002. Like all bankruptcies, this created an automatic stay against attempts by any creditor to collect debts, including tax debts. The Joneses filed a tax return with an extension in October of 2003 but did not pay what they owed. Their bankruptcy was ended in September of 2006. In October of 2007, Jones alone filed a Chapter 7 bankruptcy. At that point, the tax debt for the 2003 tax filing was more than three years old, so it could be and was discharged when the bankruptcy ended in January of 2008. In 2009, the FTB moved to reopen the bankruptcy and collect the debt from Jones, arguing that the three-year deadline should have been extended because of the prior bankruptcy. The bankruptcy court reopened the case but decided against the FTB, saying it could have collected the debt during or after the Chapter 13 bankruptcy. The Ninth Circuit's Bankruptcy Appeals Panel agreed and the FTB appealed to a three-judge panel of the Ninth.

The Ninth started by noting that the three-year rule specifically refers to the newer Chapter 7 petition, not any bankruptcy. It then looked at whether the three-year rule should have been suspended by the previous bankruptcy, and concluded that it should not. In relevant part, the law says the rule can be suspended when a stay is in effect in a prior bankruptcy case. After looking at legislative history, the Ninth said the stay must apply specifically to tax agencies. It then looked at whether the FTB in this case was stayed from collecting the tax debt owed by Jones, and concluded that it was not. The Ninth held that at least some property re-vests in the debtor when a bankruptcy plan is confirmed. Because the tax debt of the Joneses arose after the plan was confirmed, the FTB would have been able to collect from that property anytime before the second bankruptcy was filed. Indeed, it said the FTB had a year between the bankruptcies when there was no question that it could have collected. For that reason, the Ninth ruled that the three-year rule could not be suspended and the tax debt was properly discharged.

As Santa Ana personal bankruptcy attorneys, we think this ruling is a victory for our clients and potential clients with tax debts. In this case, the Ninth Circuit clarified when the three-year rule can and cannot be suspended. By ruling that it may only be suspended for stays specific to tax debts, it narrowed the number of situations where stays are appropriate -- thus increasing the chances that tax debts will be discharged. Tax debts are harder to discharge than most other debts, so our Corona individual bankruptcy lawyers still advise clients to tackle these first.

If you're deep in debt and you don't believe you can realistically pay it off, you should talk to Howard Law PC about the possibility of a bankruptcy. For a free, confidential case evaluation, send us a message online or call 1-800-872-5925.

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