The U.S. District Court for the District of Delaware held that corporate income tax liability attributable to transactions before the filing of a bankruptcy petition are nevertheless administrative expenses because the corporation’s taxable year ended after the bankruptcy petition was filed. United States v. Beskone, (In re Affirmative Ins. Holdings Inc.), No. 15-12136-CSS, 2020 WL 4287375, (D. Del. July 27, 2020). Because the income taxes attributable to the entire taxable year were treated as accruing on the last day of the taxable year, the District Court gave them top priority as post-petition bankruptcy administrative expenses.
In “tax speak,” a “straddle year” refers to a taxable year that begins before a specific event and ends after that event. For example, when all the stock of a corporation is purchased in the middle of the corporation’s taxable year, the taxable year straddles the closing date. Stock purchase agreements generally provide (other than for publicly held entities) that the tax liability attributable to the pre-closing period is the responsibility of the seller, and the tax liability attributable to the post-closing period is the responsibility of the buyer. The rationale is that the seller controls the corporation during the pre-closing period and the buyer controls the corporation during the post-closing period, thus the financial benefits and burdens of the straddle year should be bifurcated with the financial benefits and burdens of the pre-closing period falling to the seller and financial benefits and burdens of the post-closing period falling to the buyer. Pursuant to the typical stock purchase agreement, the fact that under the Internal Revenue Code the corporation’s income tax liability accrues and becomes a fixed liability at the end of the taxable year (after the transfer) does not mean that the seller has no financial obligation to pay the amount of taxes that accrued before the closing date. However, if the stock purchase agreement were silent as to who bears the financial burden of the corporate income tax, the buyer would bear the burden because it would own the corporate stock when the tax return is actually filed and/or on the due date for the payment.[1]
This equitable allocation of the liability for income taxes in a straddle year is not available in bankruptcy, at least according to the District Court in In Re Affirmative Insurance Holdings Inc. The Affirmative Insurance opinion is the first appellate decision interpreting how to determine...
