Many small business owners are concerned about tax liability, and whether it can be discharged through bankruptcy. If you have studied bankruptcy much, you likely know that income taxes owed can be discharged so long as the tax return was filed at least three (3) years prior to the debtor filing a bankruptcy petition. However, for many small businesses, an issue of sales taxes can come up in their bankruptcy filings.
A 1986 Ninth Circuit Court of Appeals case (In re Shank) reviewed whether sales taxes can be discharged. In that case, Shank ran a business in the State of Washington. For each of his sales, Shank was to collect sales tax and remit the funds to the State as sales tax. Shank, in turn, failed to remit the funds and ultimately filed bankruptcy five (5) years after the business ceased operations. He sought to discharge the debts in the bankruptcy.
The court reviewed the rule that certain tax debts can be discharged after three (3) years. However, a law was enacted under the Bankruptcy Code in 1966 wherein certain tax liabilities would not be dischargeable, no matter how much time had passed. One such tax was “trust-fund tax.” The case went on to review the history of the legislation enactment through both the United State House of Representatives and the United State Senate.
The court’s ruling presented two separate forms of sales tax liability: “ those owed personally by a retailer and  those incurred by a retailer’s customers which are collected by the retailer under the authority of the state, held in trust, and then remitted by the retailer to the state.” To understand the difference between the two taxes, a Seventh Circuit Court of Appeals case determined that a 5% occupation tax on the gross receipts was not considered a “trust fund tax.” However, Shank’s obligation to remit the sales tax he collected for his sales, did fall under the trust category, and could not be discharged. Another court reasoned that if the tax is paid by the purchasers of goods or services, it is likely that the tax is part of a trust that will not be discharged.
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