Publish Date

Nov 05, 2020

Navigating Chapter 11 First Day Tax Motions in the Midst of Ambiguity

A&M Tax Advisor Weekly

Benjamin Franklin said it best: “In this world nothing can be said to be certain, except death and taxes.” However, in the bankruptcy world, there is little certainty even when it comes to taxes. The inherent ambiguity surrounding Chapter 11 bankruptcies – Which creditors get paid first? Will there be enough money or assets to go around? – may make creditors nervous and leave “responsible persons” exposed. One way debtors and responsible persons can prepare for inevitable uncertainty is through careful pre-petition planning and the strategic use of First Day Tax Motions.

Responsible Person Liability

Many states have provisions in their tax law that hold responsible persons personally liable for certain unpaid taxes of the debtor. In most states, responsible person liability is limited to trust fund taxes, which are taxes collected and held “in trust” on behalf of the state until remittance (for example, sales tax), whether collected or uncollected. However, in a handful of states (for example, Michigan), responsible person liability applies to all unpaid taxes of the debtor.

As such, it is important to identify those who may be considered a responsible person. Like the scope of responsible person liability, the definition of responsible person varies by state. Therefore, it is necessary to look at the law in each state in which the debtor may have a tax liability.

Common definitions include:

  • An individual who has ultimate authority for the decision not to pay the trust fund taxes,
  • An individual who has the effective power to pay the taxes,
  • An individual who has the authority to direct payment of creditors,
  • An individual who has significant control or authority over the business finances, or
  • An individual who has control over the allocation of funds.

The common theme, regardless of the jurisdiction, is that the definition of responsible person generally includes persons that a debtor looks to help run the business (both before and during bankruptcy)…