A receiver's obligations with respect to federal income taxes can be very complicated, especially given the different circumstances in which a receivership may arise. While a receivership generally does not create a separate taxable entity, the receiver may be required to notify the Internal Revenue Service of the receivership and file income tax returns for the entity or owner of the property in receivership. For receivers of individuals unable to file their own returns, the receiver must file the individual's returns unless the receiver is in possession of only a part of the individual's assets. For receivers of corporations, the receiver must file the corporation's returns when in possession of all or substantially all of the corporation's assets. For partnerships, there is no express duty under the Internal Revenue Code for a receiver to file the partnerships' returns though the IRS takes the position that a receiver in control of the partnership must do so. Determining when a receiver is required to file returns sometimes can be difficult, even for a traditional equity receiver in possession of a business or a rents-and-profits receiver in possession of a single property, due to lack of information on the entity's ownership structure or the owner's other assets. When the receiver is not required to file returns, the receiver must provide the owner with the information necessary so that it can file its own returns.
Even though a receivership is generally not a separate taxable entity, a receivership that constitutes a qualified settlement fund (QSF) under Treasury Regulations Section 1.468B-1 is generally treated as a separate taxable entity. A QSF is a fund, account, or trust that:
- is established by government or court order;
- is established to resolve or satisfy claims (with certain exceptions) that arose either a) under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), b) out of a tort, breach of contract, or violation of law, or c) under other circumstances the IRS may designate; and
- is a trust under state law or segregates its assets from the transferor's other assets.
QSFs have been found to exist in federal receiverships involving recovery of funds in fraudulent investment schemes and will arise in any other cases in which the elements for a QSF are satisfied. A few years ago there were concerns that the IRS might treat even typical rents-and-profits receiverships as QSFs, but those concerns have generally subsided.
A receiver must carefully ascertain the exact filing and payment requirements as the receiver may be held personally liable, pursuant to 31 U.S.C. Section 3713, for failing to pay federal claims, including tax claims, before other claims. While this federal priority statute is absolute on its face, a few exceptions have been carved out. A receiver may pay necessary and reasonable administrative expenses before payment of unsecured federal claims, and the IRS even states in its Internal Revenue Manual that administrative expenses should be paid ahead of a federal tax lien. Furthermore, perfected secured claims retain priority over unsecured federal claims as the federal priority statute does not create a lien or provide priority over other liens.
A receiver is generally responsible for paying federal income taxes incurred during the pendency of the receivership, but this will also depend on the type of receivership. Pursuant to 28 U.S.C. Section 960, a federal court appointed receiver is required to pay all taxes (not just federal) incurred during the receivership, with payment pro rata with other operating expenses. A state court appointed receiver for a C corporation who must file the corporation's returns is responsible for paying federal income taxes that the corporation incurs during the receivership, although it is unclear whether such taxes are entitled to priority as administrative expenses or pursuant to the federal priority statute. A receiver required to file returns for a flow-through entity such as an S corporation, partnership, or multi-member limited liability company treated as a partnership will file information returns for these entities, with any federal income tax liability flowing through to the owners of such entities. A single-member limited liability company is disregarded for federal income tax purposes, and no separate federal return is filed for the entity (though in California a state income tax return is required).
Complications arise exponentially for a receiver who is required to file returns and discovers that the owner either failed to file prior year returns or filed materially incorrect returns. While there is no clear guidance on when the receiver must file or amend prior year returns, a bankruptcy court held that a trustee for a debtor corporation is responsible for filing returns due prepetition. For partnerships, the IRS has stated that a bankruptcy trustee is not obligated to file prior year returns and may rely on current year information to the extent possible for current year returns (although a receiver is well advised to consider any available prior year records and, if necessary, disclose the basis for any departure from positions taken on any prior year returns that the partnership did file). In addition, a receiver for a partnership that has another partnership as a partner, may not be permitted to file amended returns for the partnership. Given this and so many other hidden traps, a receiver is well advised is seek guidance from experienced tax counsel from the beginning of the receivership.
Chad Coombs is a Shareholder in the Tax Practice Group in the Los Angeles Office.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.