Tag Archives: tax debt

Gambling with your Credit

When I was a kid, we would occasionally have disputes about how to spell things. Settling the matter took about four stages: first, we would both insist that we were right; second, we would escalate our insistence, through raised fists, threatening eyebrows, and oaths taken on our mothers’ lives; third, one of us would dare the other to check the dictionary; fourth, the loser would declare the winner a nerd.

The French, at the end of their kingdom and the beginning of their empire, had a similar idea, only it would spread to all disputes ever. They had this idea that The Law should be simple enough to fit into a single book that everybody could have on their bookshelf. The idea was that two Frenchmen could have any dispute at all and resolve it by going through the four phases I mentioned: (1) I’m right / no, I’m right; (2) I swear I’m right / yeah, well I would bet my last bottle of wine that I’m right; (3) oh yeah? Why don’t you check The Code?; (4) you’re such a nerd.

Only: the law deals with life, and life is more complicated than spelling. In the first place, Napoleon’s “book” has spread to over 3,000 pages. In the second place, the hardest part of practicing law is almost never finding a piece of law to support your position. Rather, it’s deciding which arguments of several would be best and most likely to help you win.

Take this week’s case, In re Nicolaus, out of the 8th Circuit. Anthony Nicolaus ran a business with his brother. They ran into trouble with the IRS, apparently failing to pay withholding taxes. The IRS began collection efforts, so Nicolaus filed bankruptcy under Chapter 7.

Let’s pause for just a second. Chapter 7 is frequently touted as an “easy” way to get rid of debt without paying it. But there are some debts that don’t get discharged in Chapter 7. For example, child support is never discharged, nor is any debt for death or personal injury resulting from a D.W.I. 11 U.S.C. § 523(a)(5), (9). Student loans are almost never discharged. 11 U.S.C. § 523(a)(8). And debts for taxes are very difficult to discharge. 11 U.S.C. § 523(a)(1)(A) (referring to 11 U.S.C. § 507(a)(8) (referring to any tax “to be collected or withheld and for which the debtor is liable in whatever capacity,” including withholding taxes)). So if Mr. Nicolaus wanted to get out of his debt for not paying withholding taxes, Chapter 7 may not have been the way to go.

Back to the case. He files for bankruptcy. The IRS files a proof of claim. He files an objection. The IRS never responds. The bankruptcy court sustains the objection and disallows the claim. He does not have to pay the IRS.

A year later, the IRS files a motion to vacate the order disallowing the claim. According to the IRS, Mr. Nicolaus had to serve the objection not just on the IRS, but also on the attorney general and the local U.S. attorney. Since he had only served the IRS, the order disallowing the claim was invalid for lack of personal jurisdiction. The bankruptcy court agreed, as did the district court on appeal. The Eighth Circuit, however, disagreed. At the time Mr. Nicolaus filed his objection, the rules only required service on the IRS. The requirement of service on the attorney general and the local U.S. attorney were added later. Therefore, the IRS was properly served, and the bankruptcy court had jurisdiction to sustain the objection and disallow the claim. Mr. Nicolaus does not have to pay the IRS.

But that’s largely because the IRS wasn’t paying attention. If Mr. Nicolaus filed for bankruptcy in order to get out of his debt to the IRS, he was taking a major gamble. If the IRS had been paying attention, he could have ruined his credit for nothing.