When Paths Cross
For years I have told practically anyone who would listen that there are two kinds of “codes”: those with an upper case “C”, like the Ten Commandments and the Internal Revenue Code (the “Code”), and those with a lower case “c”, like the Bankruptcy code.[i]
There are times, however, when the veil separating the rarefied world of tax from the gritty environment of the bankruptcy bar is pierced, and practitioners from one world slip through the opening to engage with their colleagues in the other.[ii]
This should not come as a surprise to anyone who has advised closely held businesses, most of which are treated as passthrough entities for tax purposes.
Tax Attributes
By the time such a business starts to experience serious difficulties with its creditors, it may have developed, or elected into, certain tax attributes.
The preservation of some attributes may help to generate liquidity that is badly needed for the recovery of the business,[iii] while the continued maintenance of others may facilitate the satisfaction of indebtedness owed to the creditors of the business.
A recent decision of the federal Court of Appeals for the Eleventh Circuit considered the status under the bankruptcy law of one such “elected attribute.”[iv]
The “Unwanted” S Corp Election
Corp was a state law corporation that was founded by Taxpayer, who also served as a director and officer of the corporation for many years.
Not long after organizing Corp, Taxpayer, as Corp’s sole shareholder, elected to classify Corp as a Subchapter S Corporation.[v]
Consequently, Corp ceased to be subject to the federal income tax;[vi] instead, Taxpayer was required to report Corp’s items of income, deduction, etc. on his individual federal income tax return, whether or not distributed.[vii]
Bankruptcy
Just a few years ago, Corp filed a Chapter 11 petition with the bankruptcy court,[viii] which resulted in an automatic stay of creditor actions against Corp.[ix]
Shortly thereafter, Corp’s reconstituted board of directors removed Taxpayer from his position as CEO and terminated his membership on the board.[x]
Notwithstanding his loss of any managerial authority over Corp’s business, Taxpayer was still Corp’s sole shareholder; thus, Taxpayer remained obligated under Subchapter S of the Code to report on his individual return the income tax consequences arising from the operation of Corp.
This continuing exposure to tax liability for Corp’s items of income and gain motivated Taxpayer’s subsequent activities.
First Motion
Following his removal as an officer and director of Corp, Taxpayer filed a motion for confirmation that the automatic stay[xi] did not apply to prevent the revocation of Corp’s Subchapter S status (“S Status”); specifically, that such revocation would not constitute an “act to obtain possession of property of Corp’s bankruptcy estate or of property from the estate or to exercise control over property of the estate.”
The bankruptcy court denied the motion, reasoning that “[b]ecause [Corp’s] S election gives it the valued right to avoid tax liability, the S election is property of the estate and therefore protected by the automatic stay.”
The Sale
After the bankruptcy court’s denial of Taxpayer’s motion, and while Taxpayer was still Corp’s only shareholder, the corporation sold its assets to unrelated Buyer.
Pursuant to the plan confirmed by the bankruptcy court, Corp’s remaining interests were then automatically and irrevocably vested in a trustee (the “Trustee.”)[xii]
Second Motion
Thereafter, Taxpayer filed a motion for relief from the automatic stay so that he could terminate[xiii] Corp’s Subchapter S election (“S Election”) retroactively; i.e., to a point in time that preceded the sale of Corp’s assets.
The bankruptcy court denied that motion.
Taxpayer appealed the bankruptcy court’s decision to the district court, and the Trustee moved to dismiss the appeal.
The district court denied the Trustee’s motion to dismiss, consolidated Taxpayer’s appeals of the bankruptcy court’s denial of both his motions regarding Corp’s S Election, and granted his request for certification of a direct appeal to the Eleventh Circuit.[xiv]
The Court of Appeals
Although Taxpayer’s appeal raised several issues, the one of interest to this post, and which the Court described as “the heart of this appeal,” was whether the bankruptcy court erred in concluding that, as a debtor, Corp’s S Status – resulting from Corp’s earlier S Election – constituted property of the corporation’s bankruptcy estate.[xv]
The Issue
If the S Election was not property of Corp’s bankruptcy estate, then Taxpayer could have revoked Corp’s S Election, which would have converted Corp into a C corporation. In that case, provided the revocation was effective prior to the sale of Corp’s assets, the gain from such sale would have been taxable to Corp – not to Taxpayer – and Corp’s payment of the tax liability attributable to such gain would have reduced the amount of the sale proceeds remaining to satisfy the claims of Corp’s creditors.
However, if the S Election constituted property of the Corp’s bankruptcy estate, then Taxpayer would have been powerless to revoke the election, and the gain from the sale of Corp’s assets would have been taxable to Taxpayer, in accordance with Subchapter S of the Code, notwithstanding that all of the net proceeds from the sale would have been used to satisfy Corp’s outstanding debts instead of being distributed to Taxpayer.[xvi]
The Court of Appeals reversed the bankruptcy court, holding that a corporate debtor’s S Election was not property of the corporation’s bankruptcy estate because the S Election “belonged” to the individual shareholder, and not to the corporate debtor.
Mootness
Before ruling on the “ownership” of Corp’s S Election and the resultant S Status, the Court considered and dismissed various arguments made by the Trustee as to the mootness of Taxpayer’s motions (described above) and of its appeal from the bankruptcy court’s denial therefrom.
The Trustee argued that Taxpayer’s appeal from the bankruptcy court was moot because Corp (1) had sold its assets, (2) transferred its remaining interest in the proceeds to the Trust (i.e., liquidated), (3) cancelled its shares, all of which were held by Taxpayer, and (4) filed its final federal tax return (as an S corporation) with the IRS.
In the Trustee’s view, Taxpayer could not, under these circumstances, retroactively revoke or terminate Corp’s S Status for the year of the sale of Corp’s assets.[xvii]
Taxpayer’s Arguments
Revocation of a corporation’s S Status, the Court explained, requires consent from the majority of its shareholders.[xviii] But the corporation – not its shareholders – must file a statement of revocation, signed by the corporate officer who is authorized to sign the corporation’s federal income tax return.[xix]
Taxpayer conceded that he could not compel Corp’s executives to prepare and submit to the IRS a written statement revoking Corp’s S Election.
Still, Taxpayer argued that the bankruptcy court could have appointed him as an officer of Corp to submit the statement of revocation. What’s more, if his shares of Corp stock were reinstated, Taxpayer would have sought to revoke the S Election.
Alternatively, if the bankruptcy court had ruled that the shares could be reissued to Taxpayer retroactively, then Taxpayer unilaterally could have sought to terminate Corp’s S Status by transferring shares to an ineligible taxpayer.[xx] [xxi]
The Court’s Response
The Court observed that Trustee’s argument seemed to ignore that courts can sometimes “undo what has been done.” Taxpayer had a “concrete interest” in the reversal of the bankruptcy court’s order denying his request for confirmation that the automatic stay did not apply to revocation or termination of Corp’s S Status.
The Court stated that the effect of such a reversal on the ultimate tax status of Corp did not moot the case before it. Nor did the effect of a reversal on the transfer and sale of Corp’s assets render the case moot.
At this point, the Court explained, Taxpayer did not seek to revest himself with property from the Trust. He did not claim ownership of any assets then owned by Buyer. He instead sought to retroactively relieve the tax burden passed onto him as the former sole shareholder of Corp. The Court was not convinced that it was impossible to grant such relief; therefore, the case was not moot.
Still, the Court conceded that, if “a third party has altered its position in reliance on a bankruptcy court’s order, or if a transaction is simply too complex or difficult to unwind, an appeal may be moot as a matter of equity.”[xxii]
Before addressing this point, the Court considered several factors to determine whether the doctrine of equitable mootness applied, including (1) whether a stay pending appeal had been obtained; (2) whether the plan had been substantially consummated; (3) whether the type of relief sought by the Taxpayer would affect the interest of third parties; and (4) whether the requested relief would affect the reemergence of Corp as a revitalized entity.
The Court observed that Taxpayer did not seek a stay pending appeal, was not challenging the plan confirmed by the bankruptcy court, and was not seeking to unwind transactions that were taken in reliance on the plan.
Instead, Taxpayer sought to reinstate his shares of Corp stock. He sought to enjoin the Trustee from extinguishing his equity interest in Corp, a request which was denied by the bankruptcy court.[xxiii]
The requested reinstatement of shares would simply have put Taxpayer back in the position, as a shareholder, to seek revocation of Corp’s S Election or termination of its S Status.
According to the Trustee, such a change in Corp’s tax status would have burdened the Trust but, according to the Court, the Trust was not an affected third party here.
If Corp was worthless as an entity, the Court continued, it was unclear how retroactively changing its tax status would have burdened its creditors.[xxiv] “The sheer complexity of that issue did not make Taxpayer’s requested relief impossible to provide.”
After weighing the above factors, the Court observed that, while a reversal of the bankruptcy court’s decision would “present complexities on remand, we can still grant some effective relief.”
Taxpayer, the Court stated, was presently burdened by the bankruptcy court’s imposition of the automatic stay on Corp’s S Status. Because reversal of the bankruptcy court’s decision would provide Taxpayer a chance to argue for reinstatement of his shares and request relief from the IRS, the Court determined that it could afford Taxpayer relief “without greatly disturbing the plan.”[xxv]
In other words, the appeal was not equitably moot.[xxvi]
“S Status” – Whose Property is It?
Having set aside the issue of mootness – less than convincingly, I’ll add – the Court turned its attention toward considering whether Corp’s S Status was property of Corp’s bankruptcy estate.
An automatic stay in a bankruptcy proceeding, the Court explained, applies to “any act [a] to obtain possession [i] of property of the estate,” regardless of by whom such property was being held, or [ii] “of property from the estate, or [b] to exercise control over property of the estate.”[xxvii]
By its terms, the Court continued, the automatic stay imposed under the Bankruptcy code[xxviii] only applied to “actions against the debtor, property of the debtor, and property of the estate.”
The automatic stay, therefore, would not apply to Taxpayer’s attempts to revoke or terminate Corp’s S Status if such status was not property of Corp or of the corporation’s bankruptcy estate.
Property of the Estate
The Bankruptcy code,[xxix] the Court explained, defines “property of the estate” as “all legal or equitable interests of the debtor in property as of the commencement of the case[.]”[xxx]
The Court stated that, “[a]lthough the estate is construed broadly, Congress expressly cautioned that the Bankruptcy code was not intended to expand the debtor’s rights against others more than they exist at the commencement of the case.” In other words, the Trustee could take no greater rights in Corp’s assets than Corp (the debtor) itself had.
The Court also noted that, although state law often governed the extent of a debtor’s property interests, the parties to the present case generally agreed that the specific question before the Court would be resolved by the provisions of the Code concerning a corporation’s S Status.[xxxi]
Control vs Benefit
The Court observed that the parties’ arguments regarding ownership of Corp’s S Status focused on who exercised control over such status and who reaped the benefits from the continuation of such status.
According to the Court, the “critical events” concerning a corporation’s S Status largely fell within the control of its shareholders. For example, the election of such status required unanimous shareholder consent.[xxxii]
The termination of a corporation’s S Status, the Court continued, can be achieved in three ways. First, a majority of its shareholders can consent to revoke that status.[xxxiii] Second, the corporation can cease to be a small business corporation.[xxxiv] This would occur, for example, when an individual shareholder transfers his shares to a corporate entity[xxxv] or to a nonresident alien.[xxxvi] However, the Court added that a corporation can also terminate its S Status by issuing new classes of stock or by issuing shares to enough individuals to violate the 100-shareholder limit.[xxxvii] Third, S Status ceases when the corporation (1) “has accumulated earnings and profits at the close of each of 3 consecutive taxable years, and (2) has gross receipts for each of such taxable years more than 25 percent of which are passive investment income.”[xxxviii]
Thus, according to the Court, a corporation’s shareholders control the creation and termination of its eligibility for S Status. The corporation has no unilateral control over any of the events that could trigger termination of its S Status.[xxxix]
In contrast to the Court’s reasoning regarding who controlled a corporation’s S Status, the Trustee focused on the corporation’s right to benefit from that status.
The Trustee pointed out that the courts had, generally, treated certain tax attributes (like net operating loss carrybacks and carryforwards) as property of a corporation’s bankruptcy estate because they could be used to reduce the corporation’s income tax liability.
The Court disagreed with the Trustee’s analogy of a corporation’s net operating losses to its status as an S corporation. The Court stated that, by its terms, the Code “does not, and cannot, guarantee a corporation’s right to S-corp. status, because the corporation’s shareholders may elect to revoke that status at will.”
In addition, the Court stated it could not accept that S Status conferred a benefit on the corporation’s estate on the theory that the corporation would keep the proceeds from the sale of its assets but pass the tax liability to the shareholders, which would leave the corporation with more money to pay creditors.[xl] To do so, the Court explained, would expand the assets of the corporation’s estate beyond what they were at the commencement of the bankruptcy proceeding.[xli]
Moreover, enjoyment of a benefit alone, the Court stated, did not create a property interest. In the case of Corp and Taxpayer, the Court continued, it was “the substantial control that the shareholders exercise[d] over [Corp’s] tax status that sound[ed] in property rights.”
The Court explained that “a corporation cannot claim a legal or equitable property interest to a valuable benefit that another party has the power to legally revoke at any time.”
Therefore, the Court concluded that S Status was not property of Corp’s bankruptcy estate.[xlii]
With that, the Court reversed the bankruptcy court’s denial of Taxpayer’s motions for confirmation that the automatic stay did not apply to the revocation or termination of Corp’s S Status, and remanded the matter to the lower court for proceedings consistent with the Court’s opinion.
The “Why” and Timing of Terminating S Status
Is the Court’s conclusion defensible? Let’s turn back to some of the facts.
Until his removal from the management of Corp and of its business, it appears that Taxpayer was not alarmed at the prospect of paying tax on any phantom operating income that flowed through to him (under Subchapter S of the Code) as the sole shareholder of Corp. Perhaps he even had suspended losses[xliii] that could be used to offset this ordinary income.[xliv]
At that point, however, as it became clear that Trustee was preparing to sell Corp’s assets, presumably to generate liquidity to satisfy claims of the corporation’s creditors, Taxpayer probably realized that the gain from the sale was likely going to be more than any losses he had available to offset it. The motions to terminate Corp’s S Status, described above, followed.
Pre-Petition?
Query why Taxpayer did not revoke Corp’s S Election when he had full control over the corporation, before filing its Chapter 11 petition with the bankruptcy court? It may be that Taxpayer had a more sanguine outlook for Corp’s business at that time and did not want to give up a valuable tax election.
Then again, if Taxpayer had revoked the S Election prior to Corp’s filing the petition, it was likely Corp’s creditors would have claimed that the revocation constituted a voidable conveyance of a corporate asset in contemplation of the bankruptcy petition.[xlv]
Even in that case, however, the “ownership” of the corporation’s S Status would have had to be determined.
Does it Make Sense?
What can we take away from the Court’s decision?
The Court considered the proposed termination of an S Election that was made by a corporate debtor and its shareholder years before the debtor filed a petition with the bankruptcy court.
The issue confronting the Court was the “ownership” of Corp’s S Status for purposes of the Bankruptcy code – was it an asset of the debtor-corporation and, therefore, an asset of its estate, as argued by the Trustee and the IRS, or was it an asset of the shareholder of the debtor-corporation (i.e., Taxpayer)?
From the perspective of a shareholder, the resolution of this question would determine whether any tax liabilities attributable to the sale of the debtor corporation’s assets would be payable (i) by the shareholder (if the election was property of the corporation and not revocable by the shareholder) or (ii) by the corporation (if the election was property of the shareholder and, thus, revocable by him).
Non-Corporate Passthrough
But what if the business entity in question was treated as a passthrough entity without regard to the presence of an election? Specifically, by virtue of being a partnership, or an LLC treated as a partnership,[xlvi] for purposes of the income tax.
Like the S corporation, a tax partnership does not pay an entity-level income tax, and its items of income, gain, etc., are reported by and taxed to its members, regardless of whether any distribution is made to them by the partnership.
Having just considered a Circuit Court’s treatment of a state law corporation’s S Status, what if the debtor entity that petitioned the bankruptcy court was, instead, a tax partnership? Unlike a corporation – the default treatment of which for tax purposes is as a taxable C corporation – the partnership’s default treatment for tax purposes is as a passthrough entity; no affirmative election is required by either the entity or its members to achieve passthrough treatment.[xlvii]
In that case, might the tax partnership and its members seek to make an election – not to revoke one, as in the case of Taxpayer with respect to Corp’s S Election, discussed above – to be treated and taxed as an association (i.e., a C corporation) for tax purposes?[xlviii]
Such an election would trap the recognition of gain from the sale of the debtor entity’s assets at the level of the debtor entity (i.e., the association) and make the entity responsible for payment of the resulting tax liability.[xlix]
Is its default passthrough treatment an asset of the tax partnership? No special election is required for such status,[l] whereas all the members of the partnership would have to consent to file an election to treat the entity as a taxable association (i.e., a C corporation) for tax purposes.[li]
While the election may benefit the members of the debtor partnership,[lii] shouldn’t the more relevant question be whether the election benefits the partnership, its estate, and its creditors?
After all, making the election would benefit the debtor partnership’s members to the detriment of its creditors by shifting funds from the creditors to the taxing authorities in satisfaction of a post-petition income tax liability attributable to a post-petition event.[liii]
How is this equitable? Shouldn’t the same standard apply in the case of a debtor S corporation?
Prior to filing its petition, the owners of a passthrough debtor entity retained the benefit of favorable tax treatment through any depreciation or other losses that flowed through debtor as a pass-through entity.[liv]
After the filing of the petition, should these owners be able to change the tax treatment of the debtor entity in order to shift to the debtor – and to the detriment of the debtor’s creditors – the unfavorable tax treatment arising from the sale of the debtor’s assets?
The election, or the revocation of one, hardly seems to be in the best interests of the debtor, the debtor’s estate, or its creditors. Even on a visceral level, it doesn’t seem right.
Of course, what feels right is not always consistent with what the law allows in a given set of circumstances.[lv]
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the firm.
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[i] If you’ve watched bankruptcy folks at work, you know that their code is more like a set of guidelines than actual rules, to paraphrase Captain Barbossa from the first Pirates of the Caribbean movie.
[ii] If you have read Salman Rushdie’s Two Years Eight Months and Twenty-Eight Nights, you’ll understand the reference; if you haven’t, I recommend it to you.
[iii] For example, before the passage of the Tax Cuts and Jobs Act (P.L. 115-97), a troubled taxpayer was able to carry its NOLs back two years in order to generate a refund and some badly needed cash. The Act eliminated the carryback. That being said, it also eliminated the 20-year carryforward, thereby allowing NOLs to be carried forward “indefinitely” – i.e., until they are exhausted – and removing some of the sting from the ownership change rules under Section 382 of the Code, which limit the amount of NOL that may be utilized in any taxable year. At the same time, however, the Act also limited the amount of loss that may be utilized in any tax year to 80-percent of the taxpayer’s taxable income or the year. IRC Sec. 172.
[iv] Owoc v. The Liquidating Trustee on Behalf of The Liquidating Trust, No. 24-14048 (11th Cir. 2026); 2026 WL 2294569.— F.4th —-, 2026 WL 2294569.
[v] IRC Sec.1362(a), Sec. 1361.
[vi] IRC Sec. 1363.
[vii] IRC Sec. 1366.
[viii] The Southern District of Florida.
[ix] 11 U.S.C. Sec. 362(a). The automatic stay provides a period of time in which all judgments, collection activities, foreclosures, and repossessions of property are suspended and may not be pursued by creditors on any debt or claim that arose before the filing of the bankruptcy petition. The stay provides a breathing spell for the debtor, during which negotiations can take place to try to resolve the difficulties in the debtor’s financial situation. The filing of a petition, however, does not operate as a stay for certain types of actions listed under 11 U.S.C. Sec. 362(b).
[x] It appears the debtor was no longer “in possession.”
[xi] 11 U.S.C. Sec. 362.
[xii] Under chapter 11 of the Bankruptcy code, the debtor becomes a “debtor in possession” – i.e., the business continues to control its assets and to operate its business after the petition in filed with the bankruptcy court. The debtor is basically vested with most of the powers and duties of a trustee for the benefit of the creditors. However, there are circumstances where a debtor cannot or should not be vested with those trustee powers and duties, in which case chapter 11 trustee is appointed. 11 U.S.C. Sec. 1104(a). Such an appointment is made “for cause” or where in the interest of the creditors. It occurs after the commencement of the case but before confirmation of a plan, on request of a party in interest or the U.S. trustee, and after notice and a hearing. That appears to have been the case for Corp. (Probably doesn’t speak well of Taxpayer.)
[xiii] Note that the first motion sought confirmation of Taxpayer’s right to “revoke” Corp’s S Election. Compare this to the second motion, which sought confirmation of Taxpayer’s ability to “terminate” the S Election by causing Corp to fail the requirements for treatment as a “small business corporation” as defined in IRC Sec. 1361(b).
[xiv] The “Court.” Appeal from the United States District Court for the Southern District of Florida, D.C. Docket No. 0:23-cv-62016-RS, Bkcy No. 0:22-bk-17842-PDR
[xv] Within the meaning of 11 U.S.C. Sec. 541.
[xvi] Phantom income to Taxpayer. A hefty price to pay.
[xvii] The Trustee and the government also argued that the IRS lacked the authority to grant Taxpayer the requested relief under the plain text of Code, which stated that: (i) a revocation made during the taxable year and on or before the 15th day of the 3d month thereof shall be effective on the 1st day of such taxable year, and (ii) a revocation made during the taxable year but after such 15th day shall be effective on the 1st day of the following taxable year.
According to the Trustee, those dates for the year of the sale had long passed, but Taxpayer argued that if the bankruptcy court’s order were reversed he could still seek retroactive relief from the IRS through a private letter ruling.
[xviii] IRC Sec. 1362(d)(1)(B) (“An election may be revoked only if shareholders holding more than one-half of the shares of stock of the corporation on the day on which the revocation is made consent to the revocation.”).
[xix] On IRS Form 1120-S. See Reg. Sec. 1.1362-2(a) and Sec. 1.1362-6(a)(3).
[xx] Pursuant to IRC Sec. 1362(d)(2). Easier said than done, at least where there are two or more shareholders.
[xxi] The government asserted that the IRS could not grant Taxpayer his requested retroactive relief, but the Court observed that the IRS did not cite any authority stating that a private letter ruling could not override the ordinary rules for the S-termination year.
[xxii] “Equitable mootness,” the Court stated, is “a doctrine of equity that moots an appeal because of (1) the effects of a reversal on third parties who have relied on a bankruptcy court’s order or (2) the complexity and difficulty of unwinding a contested transaction.”
[xxiii] These shares would have been worthless because Corp’s assets had been sold to Buyer and the proceeds thereof were paid to Corp’s creditors.
[xxiv] Seriously? Wouldn’t they have been required to return some portion of the funds (i.e., the amount of corporate income tax that Corp would have owed if the S Election had been revoked) paid out to them in satisfaction of their claims?
[xxv] I guess the payment of as much as approximately one-fifth of the sale proceeds to the IRS (not to mention state taxing authorities) would not “greatly disturb” the plan.
[xxvi] For what it’s worth, I think the Court’s reasoning here was strained, to say the least.
[xxvii] 11 U.S.C. Sec. 362(a)(3).
[xxviii] 11 U.S.C. Sec. 362(a)(3).
[xxix] For the reasons given earlier, I couldn’t capitalize the “c” in “Bankruptcy code.” To paraphrase a line from the movie, A Knight’s Tale: it has been weighed, it has been measured, and it has been found wanting; in what world could the bankruptcy code equal, let alone surpass the Internal Revenue Code, in any respect?
[xxx] 11 U.S.C. Sec. 541(a)(1).
[xxxi] Toward that end, the Court explained that the Third Circuit Court of Appeals had answered the question before the Court when it held that S Status – “a tax classification over which the debtor has no control” – was not a “legal or equitable interest of the debtor in property” for purposes of identifying the assets of a debtor-corporation’s bankruptcy estate. In re Majestic Star Casino, LLC, 716 F.3d 736 (3rd Cir. 2023).
[xxxii] IRC Sec. 1362(a)(2). (“An election under this subsection shall be valid only if all persons who are shareholders in such corporation on the day on which such election is made consent to such election.”)
[xxxiii] See § 1362(d)(1)(B).
[xxxiv] Described in IRC Sec. 1361(b). See IRC Sec. 1362(d)(2).
[xxxv] See IRC Sec. 1361(b)(1)(B), (c)(2), (c)(6).
[xxxvi] IRC Sec. 1361(b)(1)(C).
[xxxvii] See IRC Sec. 1361(b)(1)(A) and (b)(1)(D). Shareholders could then, of course, vote to replace the board members of the corporation if they are displeased with the decisions concerning the issuance of shares. Moreover, the Court added, “a corporation’s directors must observe their fiduciary responsibilities in issuing new shares; otherwise the shares may be subject to cancellation.”
It’s interesting that the Court relies on principles of fiduciary duty to defeat a corporation’s issuance of a second class of stock but ignores the same principles when it states that a shareholder could transfer his stock to an ineligible person.
[xxxviii] IRC Sec. 1362(d)(3)(A)(i).
[xxxix] Query how the third means of terminating the S Election (excess passive investment income) is controlled by the shareholders of the corporation.
[xl] Seems pretty reasonable to me. What did I miss?
[xli] See 11 U.S.C. Sec. 541(a)(1).
[xlii] The Trustee also argued that the doctrine of laches should bar Taxpayer’s request for relief from the automatic stay so that he may terminate, rather than revoke, Corp’s S Status under IRC Sec. 1362(d)(2). In the Trustee’s view, Taxpayer inexcusably delayed his request for the bankruptcy court’s approval to terminate Corp’s status until after the closing of the sale. “To establish laches,” the Court stated, the moving party “must demonstrate 1) a delay in asserting a right or a claim, 2) that the delay was not excusable, and 3) that there was undue prejudice to the party against whom the claim is asserted.” Having set forth this standard, the Court stated that it made little sense for it to review the bankruptcy court’s decision to apply laches when the property of the estate issue undergirded that decision.
[xliii] IRC Sec. 1366(d).
[xliv] Of course, I’m speculating here, albeit on the basis of the facts set out in the Court’s opinion and my own experience.
[xlv] 11 U.S.C. Sec. 548. This covers any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition.
[xlvi] A “tax partnership.” See IRC Sec. 761; Reg. Sec. 301.7701-3.
[xlvii] A partnership’s bankruptcy filing does not alter its tax status. Thus, partnership income continues to be taxed as though a bankruptcy case had not been commenced. That being said, the partnership is recognized as an entity separate from its members in bankruptcy proceedings.
[xlviii] Reg. Sec. 301.7701-3.
[xlix] The gain would not pass through to its members.
[l] Absent such an election, a tax partnership would continue to be taxed as a partnership.
[li] Form 8832, Entity Classification Election, must be signed by: (a) each member of the electing entity who is an owner at the time the election is filed; or (b) any officer, manager, or member of the electing entity who is authorized (under local law or the organizational documents) to make the election.
What if such election were effectuated through the filing of an S Election on Form 2553 instead of Form 8832? Reg. Sec. 301.7701-3(c)(v)(C).
[lii] By preventing the passthrough to its members of the gain from the sale of the debtor entity’s assets.
[liii] It would dilute the class of unsecured creditors. I’ll defer to the bankruptcy folks on this, but doesn’t the absolute priority rule provides that the owners of a debtor may not receive or retain under the bankruptcy plan any property, because of that ownership, unless all general unsecured claims are paid in full? 11 U.S.C. Sec. 1129(b).
[liv] Provided, of course, they had sufficient basis for their partnership interest or S corporation stock. IRC Sec. 704(d), Sec. 1366(d).
[lv] I guess that’s why the good Lord gave us bankruptcy and tax advisers.
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