Taxpayer Is Liable for Self-Employment Taxes Rather Than His Bankruptcy Estate

(Parker Tax Publishing August 2016)

The Tax Court held that a taxpayer's bankruptcy estate was not liable for the self-employment tax on self-employment income the estate received on the taxpayer's behalf. The court found that bankruptcy estates are generally liable under Code Sec. 1398(c)(1) for the Code Sec. 1 income tax, but not for the self-employment tax. Sisson v. Comm'r, T.C. Memo. 2016-143.

In 2006, Charles Sisson filed for bankruptcy under chapter 11 of the Bankruptcy Code. The filing of his petition created a bankruptcy estate - a separate entity for bankruptcy purposes and a separate taxpayer for federal income tax purposes. During 2007, Sisson, who is a U.S. citizen, performed services in the United States as an employee of the International Monetary Fund (IMF), an international organization. He received wages from the IMF of $207,422. Because it is an international organization subject to special tax rules, the IMF withheld no tax from Sisson's earnings. Sisson's IMF earnings for 2007 became the property of his bankruptcy estate. He paid his IMF earnings over to his bankruptcy estate and his bankruptcy estate paid his personal living expenses during 2007 and continued to do so until he retired from the IMF in 2008.

Sisson and his wife filed a joint Form 1040 for 2007. They reported self-employment losses from consulting and farming activities not related to the IMF. They did not include in self-employment income any of Sisson's IMF earnings.

Under Code Sec. 1402(b), self-employment income is defined as the net earnings from self-employment derived by an individual. Under Code Sec. 1402(a), net earnings from self-employment are defined as the gross income derived by an individual from any trade or business carried on by the individual, minus deductions. While the term "trade or business" generally excludes the performance of service by an individual as an employee, Code Sec. 1402(c)(2) includes the performance of service in the United States by a U.S. citizen working for an international organization.

The IRS audited the Sisson's 2007 return and issued a deficiency notice after determining that, under Code Sec. 1402(c)(2), Sisson's self-employment income for 2007 was $207,422 (the amount of his IMF earnings) and that his self-employment tax liability for the year was $17,512. The notice of deficiency also disallowed losses from the consulting and farming activities.

The case went before the Tax Court which was asked to rule on whether or not Sisson owed self-employment tax for 2007. Sisson argued that he did not owe the tax because his bankruptcy estate was liable for the self-employment tax liability corresponding to his IMF earnings.

The Tax Court held that Sisson, and not his bankruptcy estate, was liable for the self-employment tax. As an initial matter, the court found that, under the special rule in Code Sec. 1402(c)(2), Sisson's income from IMF constituted self-employment income because his services were provided to an international organization.

In determining whether the tax on such self-employment income was the responsibility of Sisson's bankruptcy estate, the court looked to Code Sec. 1398 and Code Sec. 1399. Under Code Sec. 1398(e)(1), the gross income of a bankruptcy estate includes the gross income of the debtor to which the estate is entitled under the Bankruptcy Code. Code Sec. 1398(e)(2) provides that the gross income of the debtor does not include any item to the extent the item is included in the gross income of the estate by reason of Code Sec. 1398(e)(1).

Code Sec. 1399 provides that, except in any case to which Code Sec. 1398 applies, no separate taxable entity results from the commencement of a case under title 11 of the U.S. Code. Code Sec. 1398 applied to Sisson's bankruptcy case, the Tax Court stated, because his case was a chapter 11 case and he was an individual debtor. Thus, the court opined, Sisson's bankruptcy estate was a separate taxable entity and was liable for the "tax" referred to in Code Sec. 1398(c)(1). Under Code Sec. 1398(c)(1), except as otherwise provided, the taxable income of a bankruptcy estate is computed in the same manner as for an individual. The tax computed on such taxable income is paid by the bankruptcy trustee.

The Tax Court noted that the tax referred to in Code Sec. 1398(c)(1) includes the income tax under Code Sec. 1 because Code Sec. 1398(c)(1) defines the "taxable income" of the bankruptcy estate and requires the "tax" computed on "such taxable income" to be paid by the bankruptcy trustee. According to the court, Code Sec. 1 is a tax on taxable income and, thus, the Code Sec. 1 tax is a tax imposed on the bankruptcy estate by operation of Code Sec. 1398(c)(1).

In contrast, the court noted, the self-employment tax is not a tax on taxable income. It is therefore not a tax imposed on the bankruptcy estate by Code Sec. 1398(c)(1). Code Sec. 1398 includes no other provision, apart from Code Sec. 1398(c)(1), imposing tax liability on a bankruptcy estate. As a result, the court inferred that because Code Sec. 1398(c)(1) imposes the Code Sec. 1 income tax on the bankruptcy estate, but not the self-employment tax, Congress did not intend a bankruptcy estate to be subject to the self-employment tax. Thus, Sisson's bankruptcy estate was not liable for the self-employment tax.

For a discussion of the rules relating to bankruptcy estates, see Parker Tax ¶16,100.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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