Bankruptcy Courts Resolving Tax Disputes Under § 505—What Are The Limits? (Bush v. U.S.; Etc.)

By: Donald L Swanson

What are the limits of a bankruptcy court’s jurisdiction and authority to resolve tax disputes under § 505?[Fn. 1]

That’s the issue before the U.S. Supreme Court in a Petition filed on July 25, 2025, in Bush v. United States of America, Case No. 25-108. The specific questions are:

1. “Whether §505(a)(1) confers jurisdiction on the bankruptcy court to adjudicate the amount and legality of a debtor’s tax liabilities”; and
2. “Whether the bankruptcy court has jurisdiction under 28 U.S.C. §1334(b) to determine the amount of a debtor’s non-dischargeable debt.”

Facts

Debtors live on a farm. 

On September 6, 2013, the IRS issues a Notice of Deficiency for 2009, 2010, and 2011 in amounts that include 75% fraud penalties of $80,275.50.  Then, Debtors file a petition with the U.S. Tax Court and stipulate with the IRS to a total tax deficiency of $100,136.  Penalties and interest remain to be resolved at trial.

On the morning the Tax Court trial is to begin, Debtors file bankruptcy.  So, the U.S. files an emergency motion to lift the automatic stay, which motion is denied by the Bankruptcy Court.

Debtors schedule assets at $308,748 value (claiming $35,705 as exempt) and liabilities of $281,750 (including $229,257 secured), with federal and state taxes listed as amounts “unknown” while noting that the federal tax liability is “$100,000ish.”

The IRS files a Proof of Claim and Debtors object. Debtors also ask the Bankruptcy Court to determine whether the IRS is entitled to, (i) the 75% fraud tax penalty it asserts, or (ii) a 20% negligence penalty instead. The Bankruptcy Court rules in Debtors’ favor, and the U.S. appeals.

After appellate machinations to the Seventh Circuit and back again, the case ends up before the U.S. District Court for Southern Indiana.  What follows is a summary of the District Court’s ruling and rationale.

District Court Ruling & Rationale

The jurisdiction of bankruptcy courts is limited by statute to “civil proceedings arising under title 11, or arising in or related to cases under title 11.” A bankruptcy court will have related-to jurisdiction:

• if the outcome of the proceeding could affect the amount of property available for distribution to creditors; but
• such outcome “must be assessed at the outset of the dispute.”

At the time Debtors filed their § 505 Motion, no realistic possibility exists that the penalty determination could impact estate administration.  That’s because:

• Debtors schedule the value of all their assets at $308,748 which amount, after deducting secured claims and exemptions, leaves only $43,786 to satisfy priority and general unsecured claims; and
• the IRS priority tax claim, scheduled at “$100,000ish,” could not be satisfied by the $43,786 amount.

Debtors “resist this conclusion” by suggesting their scheduled values should not be binding because, for example:

• Debtors schedule the unpaid balance on their “land contract with parents” at “$0.00” value; but
• Trustee alleges in an adversary complaint that the value of this asset is in a range between $80,000 and $118,000; and
• so, this asset has a conceivable value of $118,000.

The Court rejects Debtors’ suggestion because:

• the Trustee’s adversary complaint was filed 21 months after the § 505 Motion; and
• any suggestion that assets could be sold for substantially more than the scheduled values is “based on nothing more than gross speculation.”

So, Debtor’s § 505 Motion must be denied because the Bankruptcy Court “did not have related-to jurisdiction over the matter.” The Seventh Circuit affirms, and Debtors file their Petition with the U.S. Supreme Court.

Extent & Limits of Jurisdiction

Shedding light on the extent and limits of bankruptcy court authority to resolve tax issues under § 505 are various cases cited in the certiorari Petition as contrary to the Seventh Circuit’s ruling.  What follows are quick summaries of those contrary cases.

United States v. Bond, 762 F.3d 255 (2nd Cir. 2014), holds that “administrative exhaustion” requirements “are jurisdictional” and “cannot be satisfied post-confirmation” by a Liquidating Trustee, so the bankruptcy court lacked subject matter jurisdiction to adjudicate the Liquidating Trustee’s tax refund issue.

In re Bunyan, 354 F.3d 1149 (9th Cir. 2004), holds that (i) “the bankruptcy court lacks jurisdiction to determine the amount of the tax deficiencies, because that issue was litigated before and decided by the tax court,” and (ii) on the question of the legality of the tax assessments, “our prior proceedings satisfy all the elements of § 505(a)(2)(A),” so the bankruptcy court “lacks jurisdiction to consider the legality of the tax assessments.”

In IRS v. Luongo (In re Luongo), 259 F.3d 323 (5th Cir. 2001), Debtor files Chapter 7 bankruptcy on May 19, 1998, (i) owing $3,800 in unpaid taxes from the 1993 tax year, and (ii) entitled to a $1,395.94 refund from the 1997 tax year.  Debtor receives a Chapter 7 discharge on September 10, 1998 (which discharged the 1993 tax liability).  In November 1998, the IRS sets off Debtor’s 1997 overpayment against Debtor’s discharged 1993 tax liability.  The Fifth Circuit rules, (i) “the bankruptcy court had jurisdiction to resolve the debtor’s tax dispute and did not abuse its discretion in not abstaining,” and (ii) “the IRS permissibly set off Appellant’s prepetition tax overpayment against her discharged debt” under § 553(a). 

In United States v. Kearnes, 177 F.3d 706 (8th Cir. 1999), Debtor files Chapter 11, and the IRS files a $142,718 proof of claim based on unreported 1989 embezzlement income.  Debtor objects.  The Bankruptcy Court reduces the amount of the IRS claim because, (i) Debtor already reported $59,508 of the embezzlement income on the 1989 tax return, (ii) Debtor’s wife is entitled to a theft-loss deduction of $129,877, and (iii) Debtor is entitled to deductions for the restitution payments made.  The IRS appeals, and the Eighth Circuit BAP declares that the Bankruptcy Court lacked jurisdiction for such rulings.  The Eighth Circuit reverses: “we read § 505 to confer on the bankruptcy courts jurisdiction to determine tax liability beyond the year stated in the proof of claim when that liability involves deductions resulting from repayment of embezzled funds.”

In United States v. Wilson, 974 F.3d 514 (4th Cir. 1992), the Chapter 11 Trustee and the IRS enter into a settlement resolving Debtor’s tax liability and seek Bankruptcy Court approval.  Debtor objects to Bankruptcy Court jurisdiction over the approval motion because, (i) Debtor’s tax liability was being contested before the United States Tax Court at bankruptcy filing, and (ii) the automatic stay had been lifted, prior to the settlement, giving exclusive jurisdiction over the matter to the Tax Court.  The Bankruptcy Court approves the settlement, and both the District Court and the Circuit Court affirm.

In Islamov v. Ungar (In re Ungar), 633 F.3d 675 (8th Cir. 2011), the Bankruptcy Court enters a nondischargability judgment against Debtor in the amount of $228,791 on grounds of fraud. The Circuit Court affirms, declaring: “We agree with” the unanimous determinations of other circuits that a “bankruptcy court, in addition to declaring a debt nondischargeable, has jurisdiction to liquidate the debt and enter a monetary judgment against the debtor.”

Conclusion

It will be interesting to see what the U.S. Supreme Court does with the Bush v. U.S. Petition.

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Footnote 1.  11 U.S.C. § 505(a)(1)&(2)(A) provide: “(a)(1) Except as provided in paragraph (2) of this subsection, the court may determine the amount or legality of any tax, any fine or penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction. (2) The court may not so determine—(A) the amount or legality of a tax, fine, penalty, or addition to tax if such amount or legality was contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction before the commencement of the case under this title.”

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