Expenses In Bankruptcy

Agricultural Law Digest, Dec 2000

A major issue with farm bankruptcies, as with other bankruptcies, is how to handle the costs of bankruptcy. The fact that a farm or small business bankruptcy nearly always has non-business aspects as well as a business dimension adds to the complexity of the determination as to what is deductible.

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Expenses In Bankruptcy

Expenses In Bankruptc y Neil Harl 0 1 0 Thi s Article is brought to you for free and open access by the Journals at Iowa State University Digital Repository. It has been accepted for inclusion in Agricultural Law Digest by an authorized editor of Iowa State University Digital Repository. For more information , please contact , USA 1 Iowa State University , USA Follow this and additional works at: http://lib.dr.iastate.edu/aglawdigest Part of the Agricultural and Resource Economics Commons, Agricultural Economics Commons, Agriculture Law Commons, and the Public Economics Commons - Article 1 Agricultural Law Press Publisher/Editor Robert P. Achenbach, Jr. Contributing Editor Dr. Neil E. Harl, Esq. Agricultural Law Digest Volume 11, No. 11 May 26, 2000 ISSN 1051-2780 EXPENSES IN BANKRUPTCY — by Neil E. Harl* A major issue with farm bankruptcies, as with other bankruptcies, is how to handle the costs of bankruptcy.1 The fact that a farm or small business bankruptcy nearly always has non-business aspects as well as a business dimension adds to the complexity of the determination as to what is deductible. Administrative expenses In general, the expenses of administering a bankruptcy estate are deductible.2 Income tax generated on sale or disposition of property by the bankruptcy estate is a liability of the bankruptcy estate and is paid as an administrative expense.3 The deductible amounts include the trustee’s fee4 as well as expenses allowed as a cost of bankruptcy estate administration.5 In general, the determination of whether any amount paid or incurred by the bankruptcy estate is allowable as a deduction or credit is made as if the amount were paid or incurred by the debtor and as if the debtor were engaged in the same trade, business or activity as before commencement of the bankruptcy case.6 Business portion of bankruptcy fees A problem of allocation arises if a bankruptcy has both business and non-business components to the bankruptcy. In a 2000 case, Catalano v. Comm’r,7 the debtor’s personal bankruptcy was proximately caused by liabilities arising from the law firm of which the debtor was the owner.8 The debtor was allowed to deduct an allocable portion of bankruptcy fees as a business expense.9 In 1988, the debtor had purchased a residence which was financed in part by a nonrecourse loan secured by a lien on the residence. In 1994, the debtor was named as a defendant in a number of law suits arising from the law practice and both the debtor and the debtor’s law firm each filed for Chapter 11 bankruptcy.10 The debtor incurred $46,462 for legal fees, accounting costs and U.S. Trustee’s fees. The Tax Court allowed a business deduction for $41,574 of the costs. The court said that the determination as to whether an expense is a deductible trade or business expense or a non-deductible personal, living or family expense depends on the origin of the claims giving rise to the fees.11 In Catalano v. Comm’r,12 93.79 percent of the debtor’s liabilities in bankruptcy were business liabilities; thus, the court concluded, the debtor’s bankruptcy was “proximately caused” by the business liabilities.13 The court invoked a formula which had been applied in an earlier case14 allowing a debtor to deduct a percentage of the bankruptcy fees paid equal to the ratio that the claims of the debtor’s business creditors bore to the total claims.15 That formula produced a deduction of 93.79 percent of the total, substantiated bankruptcy fees as a business expense. Thus, the debtor was allowed to claim a business deduction for $41,574 of ____________________________________________________________________________ * Charles F. Curtiss Distinguished Professor in Agriculture and Professor of Economics, Iowa State University; member of the Iowa Bar. Agricultural Law Digest is published by the Agricultural Law Press, P.O. Box 50703, Eugene, OR 97405 (ph/fax 541-302-1958), bimonthly except June and December. Annual subscription $100 ($90 by e-mail). Copyright 2000 by Robert P. Achenbach, Jr. and Neil E. Harl. No part of this newsletter may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage or retrieval system, without prior permission in writing from the publisher. http://www.agrilawpress.com Printed with soy ink on recycled paper. the bankruptcy costs (93.79 percent times $44,327, the total amount paid in the year in question, 1995).16 consequences which might result from failure to defeat the claim.21 In Cox v. Comm’r,17 the husband was a corporate employee. The wife opened a western wear store which failed the following year. The spouses each filed Chapter 7 bankruptcy. The combined debts totaled $163,819 of which $159,822 was attributable to the wife’s western wear store. The issue before the Tax Court was whether the $1500 attorney’s fee (reduced from $5,000) was deductible as a business expense. The court s (...truncated)


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Neil Harl. Expenses In Bankruptcy, Agricultural Law Digest, 2000, Volume 11, Issue 11,