Ninth Circuit Court of Appeal Rules Tax Debt can be Discharged in Second Bankruptcy

Sacramento area residents considering a Chapter 7 or Chapter 13 bankruptcy should be interested to learn about the recent United States Ninth Circuit Court of Appeals case: In re Brenda Marie Jones, which affects how a second bankruptcy filing affects a persons tax debts. The Ninth Circuit Court of Appeals governs all appeals made from Sacramento area federal courts, including bankruptcy matters.

Federal and State income taxes can typically be discharged if they were due more than three years ago. However, the three-year standard can be extended if the debt could not have been collected. This means that when an automatic stay is issued in a previous bankruptcy, the debt cannot be collected, which therefore extends the time period to which a debtor must wait before he or she can discharge that tax debt.

In the Brenda Marie Jones case, a California woman filing for a Chapter 7 bankruptcy owed a debt, more than three years old, to the California Franchise Tax Board (CFTB). Ms. Jones attempted to discharge that debt in her new bankruptcy but the CFTB argued that because Jones had previously filed for bankruptcy, they were prevented from collecting the tax debt and it was therefore improper for her to discharge the debt in the recently filed case.

Ms. Jones originally filed a joint Chapter 13 Bankruptcy in 2002. As with all bankruptcy filings, upon filing of the Chapter 13 petition, the automatic stay issued by the bankruptcy court froze all attempts by creditors to collect the debts, including the CFTB. In October of 2003 the Jones’ filed a tax return and asked for an extension but failed to pay the balance due. The Jones came out of Chapter 13 in September of 2006. Later, Ms. Jones filed an individual Chapter 7 petition in October of 2007. Naturally, Ms. Jones included the tax debt in her Chapter 7 filing since it was more than three years old.

The CFTB moved to reopen Ms. Jones’ bankruptcy in an attempt to collect the back taxes. The CFTB argued that the three-year window should have been extended due to the prior Chapter 13. While the bankruptcy court re-opened the Jones case it decided against the CFTB. The local bankruptcy court held the CFTB could have collected the debt either during or after Ms. Jones’ bankruptcy. The CFTB appealed to the Bankruptcy Appeals Panel and then later to the Ninth Circuit.

In it’s ruling, The Ninth Circuit specifically noted that the three-year discharge rule for tax debts related to Ms. Jones’ Chapter 7 petition, not her Chapter 13 petition. The Court then looked at whether Ms. Jones’ previous bankruptcy should have suspended the three-year rule. Ultimately, the Ninth Circuit concluded that the Chapter 13 should not have suspended the three year rule. The Court noted that the law permits the three-year rule to be suspended when a stay is in effect in a prior bankruptcy case.

The Ninth circuit noted that some property re-vests in a debtor after the Chapter 13 plan is confirmed. Since the tax debt arose after the Bankruptcy court confirmed the Jones’ Chapter 13 plan, the Ninth Circuit found that the CFTB would have been free to collect against the Jones’ anytime before Ms. Jones’ filed for Chapter 7. Specifically, the Court noted that the CFTB had a year between the bankruptcies where it could have unquestionably collected the tax debt. For that reason, the Ninth Circuit decided that the bankruptcy court properly discharged the tax debt and the three-year rule could not be suspended.

As a Sacramento Bankruptcy Attorney, I believe this ruling can be regarded as a victory for bankruptcy debtors seeking to discharge tax debts more than three years old. Since tax debts are more difficult to discharge than most other debts, I still typically advise my clients to always take care of these debts before other creditors.