Protecting Tax Revenue When Businesses File for Bankruptcy

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

Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.

Director: Jennie S. Stathis Team: General Accounting Office: General Government Division Phone: (202) 275-6407