Protecting Tax Revenue When Businesses File for Bankruptcy

GGD-86-20: Published: Feb 21, 1986. Publicly Released: Feb 21, 1986.

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In response to a congressional request, GAO reviewed the Internal Revenue Service's (IRS) procedures for protecting the government's interest when taxpayers go through bankruptcy proceedings, specifically: (1) detecting and minimizing the accumulation of employment tax delinquencies; and (2) filing claims for delinquent taxes with the bankruptcy court.

The Bankruptcy Code provides financially troubled businesses with two basic ways to deal with their financial obligations: (1) liquidation, where a business' assets are sold and the proceeds used to pay creditors; and (2) reorganization, where the business attempts to continue operating while it develops a plan to pay its debt. IRS, as the principal federal creditor in most bankruptcies: (1) files claims for payment of taxes; (2) monitors the progress of reorganizing businesses; (3) keeps track of actual tax payments; and (4) reviews proposed tax payment plans. GAO reviewed three bankruptcy court districts and found that: (1) an estimated 254 of the 583 businesses that filed for reorganization in 1981 accumulated $6.6 million in delinquent taxes after bankruptcy proceedings began; (2) $5.5 million of these delinquencies were still outstanding in 1984; (3) court referrals took an average of 15 months to come to court after the first delinquent tax return was due; (4) the IRS bankruptcy manual has only limited guidance on referrals and contains inconsistent information; and (5) 77 percent of IRS claims for liquidation bankruptcies contained errors totalling $1.7 million in overclaims, underclaims, and misclassified priorities because IRS district personnel lacked guidance in computing interest and penalties for bankruptcies. GAO noted that, since its review, IRS has somewhat improved its procedures for dealing with delinquent taxes by providing additional guidance and improving the referral process.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: The bankruptcy manual was revised to require that case files contain adequate documentation of claim computations to facilitate more thorough reviews.

    Recommendation: The Commissioner of Internal Revenue should revise the bankruptcy manual to require that bankruptcy case files contain adequate documentation of claim computations and that supervisory or quality control reviews of these computations be made to ensure that claims are accurately prepared.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Comments: IRM instructions were written establishing such criteria.

    Recommendation: The Commissioner of Internal Revenue should develop and include in the bankruptcy manual minimum criteria for referral of cases to district counsel and the bankruptcy courts. The manual should also state that each referral must include information on the business' operating status and the size of its employment tax liability.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Implemented

    Comments: IRM instructions were prepared to provide that monthly filing of tax returns be considered for those insurers whose past history warrants such action.

    Recommendation: The Commissioner of Internal Revenue should make greater use of IRS authority to require businesses with employment tax liabilities to file monthly rather than quarterly returns.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Closed - Implemented

    Comments: Instructions were prepared for the Internal Revenue Manual (IRM), which require employees to consider past delinquency history in determining how to monitor a business.

    Recommendation: The Commissioner of Internal Revenue should develop and include in the bankruptcy manual additional indicators for IRS personnel to use in deciding how often to monitor bankrupt businesses. One indicator that has been incorporated into the manual is the size of a business' payroll and another could be a prior delinquency history.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Closed - Not Implemented

    Comments: A study was conducted to determine the effects of the revised bankruptcy rule. This study was completed in March 1987. Based on its results, IRS decided not to seek a change to the current bankruptcy rule regarding notice to IRS of liquidating bankruptcies.

    Recommendation: The Commissioner of Internal Revenue should periodically test the effects of the revised bankruptcy court rules' notification requirements to: (1) determine the extent to which liquidating businesses are not listing IRS as a creditor on bankruptcy petitions; and (2) provide the basis for developing corrective action if needed.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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