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Unpaid Unemployment Taxes Are Not Nondischargeable Debt, Ninth Circuit BAP Rules - In re Hansen

May 4, 2012

One piece of advice our Rancho Cucamonga consumer bankruptcy attorneys commonly give clients at Howard Law, P.C., is that tax debts are often not dischargeable in bankruptcy. The public policy goal of this rule is clear: bankruptcy must not allow debtors to escape debts to the government, sometimes including honest debtors. However, as the Bankruptcy Appellate Panel of the Ninth U.S. Circuit Court of Appeals recently ruled, not every tax debt falls under this rule. In In re Hansen, the panel upheld a ruling by the bankruptcy court for Eastern California that unpaid taxes to California's Employment Development Department may not be exempted from discharge. Michael Hansen and some business associates agreed to pay the debt to the EDD in installments, but Hansen defaulted and then filed for bankruptcy along with his wife, Amy Hansen. The bankruptcy court rejected the EDD's adversary proceeding to find the debt nondischargeable, and the BAP affirmed.

Michael Hansen was president of Onvoi Business Solutions, part of the Onvoi Entities. When Onvoi bought Birdcage Travel in 2002, executives noticed that Birdcage had an unemployment tax rate of 0.09%, as opposed to Onvoi's 4.7%, so they transferred all employees to Birdcage's account, creating a savings of $2.8 million. The EDD noticed in 2004 and issued a notice of assessment to Hansen individually, for a total of $4.82 million in taxes, interest and penalties. Hansen and three other principals of the Onvoi Entities agreed to settle this debt with eleven regular payments, with Hansen responsible for any default. Hansen made six payments before defaulting in October of 2009; he and his wife filed for Chapter 7 bankruptcy in January of 2010. In its adversary proceeding, the EDD sought a determination that the balance of the owed assessment was a nondischargeable tax under the bankruptcy code. After a hearing, the bankruptcy court determined that the debt was dischargeable because the original taxpaying entity was Onvoi, not Michael Hansen.

The EDD appealed, but the BAP upheld this finding. Under the bankruptcy code, a nondischargeable tax debt comes from "a tax required to be collected"; the BAP found this ambiguous. Using legislative history, it ultimately decided that it meant the tax must be collected from others or withheld, as with income taxes from employees' paychecks. In this case, the panel said, the tax was always intended to be paid directly by the employer, Onvoi, without deductions from employers. And because this was not "a tax required to be collected," the court said, it was not excepted from discharge. While it was still a tax debt, it was not a priority tax within the meaning of the bankruptcy code. Because the panel found dischargeabilty as to Michael Hansen, it did not need to decide whether Amy Hansen's assets would be at issue, nor did it address any issues related to penalties or interest, before it upheld the bankruptcy court.

Vincent Howard and our Santa Ana personal bankruptcy lawyers are always pleased to see a victory for debtors as well as a clarification of the law. We agree with the panel that the phrase "a tax required to be collected" is less than helpful, so we appreciate its effort to clarify by looking at the code's legislative history. That history suggests that income taxes were first and foremost on the minds of the legislators who drafted the code, and that third-party obligations like Onvoi's were not contemplated. However, because income taxes are far more common in our experience as Oceanside individual bankruptcy attorneys, we expect to continue counseling clients on this important issue, so they can make good decisions about and in bankruptcy.

If you're deep in any kind of debt and you're considering bankruptcy as a way to get back on your feet, don't hesitate to call Vincent Howard and Howard Law, P.C., for help. You can reach us through our website or call toll-free at 1-800-872-5925.

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