Are Sales Taxes non-dischargeable in Bankruptcy?

April 22, 2011
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Bankruptcy Code §523 declares certain tax claims to be non-dischargeable. “Non-dischargeability” is a big deal. Non-dischargeable claims do not get erased by bankruptcy. Indeed, no subsequent bankruptcy can ever erase them. In other words, like certain loathsome diseases, you live with them forever. The tax claims covered by Code §523 include (1) any tax, incurred at any time, if “required to be collected or withheld,” and (2) excise taxes accruing within the three years before bankruptcy.

The recent case of State of N.J. Div. of Taxation v. Michael Calabrese (In re Michael Calabrese), ___ B.R. ___ (D.N.J. 2011), makes clear that state sales taxes –accruing at any time before bankruptcy — fall into the category of loathsome disease. Business owners are therefore well-advised to ensure that they promptly and fully pay their sales taxes to the state. The consequences of failing to do so are permanent.

In the case, Michael Calabrese ran a bagel business, which unfortunately foundered. He was then forced into personal bankruptcy. New Jersey filed a claim for sales taxes that were collected from the business customers but never paid over to the State. However, these taxes had accrued more than three years before Calabrese’s bankruptcy, and he accordingly argued that they were “excise taxes” and, therefore, dischargeable as being beyond the three year window. The State argued that the taxes were “required to be collected or withheld” and therefore not subject to the three year limitation.

The court ruled for the State. It noted that no case law existed in New Jersey, and it therefore relied on decisions from the Second Circuit, in In re DeChiaro, 760 F.2d 432 (2nd Cir. 1985), and the Ninth Circuit in In re Shank, 792 F.2d 829, 832 (9th Cir. 1986), both of which supported New Jersey’s position. The court also looked to the policies behind the statute, finding that the purpose of collecting sales tax from customers at the time of sale is to ensure payment of such taxes to the State. Thus, the court held, a sales tax collected by a third party and owed to the State “is a tax clearly held in trust” and therefore non-dischargeable.

As noted above, business owners are well-advised to pay sales taxes promptly and fully. There are many valuable and acceptable ways to finance a business. Using your sales tax collections is not one of them.