Debtor's Pre-Bankruptcy Tax Status Not Property Interest

Pursuant to Section 541(a) of Title 11 of the U.S. Code (the Bankruptcy Code), the filing of a bankruptcy petition creates an estate composed of "all legal or equitable interests of the debtor in property as of the commencement of the case." The term "property of the estate" has been broadly construed to include tangible or intangible property in which the debtor has an interest at the time it seeks bankruptcy protection. (See, e.g., In re Kane, 628 F.3d 631, 637 (3d Cir. 2010).) On May 21, the U.S. Court of Appeals for the Third Circuit in Majestic Star Casino LLC v. Barden Development (In re Majestic Star Casino LLC), Case Nos. 12-3200 and 12-3201 (3d Cir. 2013), determined that the broad scope of § 541(a) did not include a debtor corporation's status as an S corporation under the Internal Revenue Code. Though a matter of first impression before the circuit court, the decision marks a departure from a line of lower and appellate court decisions that have held a debtor's tax status to be property of the debtor's bankruptcy estate. (See, e.g., In re Trans-Lines West, 203 B.R. 653 (Bankr. E.D. Tenn. 1996).)

In Majestic Star Casino, the Third Circuit was presented with the specific question of whether a nondebtor company's decision to abandon its classification as an S corp is void as a post-petition transfer of property of the bankruptcy estate or is avoidable under §§ 362 or 549 of the Bankruptcy Code. At the time of the debtors' bankruptcy filings, Majestic Star Casino II Inc. (MSC) owned and operated a hotel and casino in Indiana. MSC was wholly owned by Barden Development Inc. (BDI), which in turn was wholly owned by Don H. Barden. Before the bankruptcy, BDI qualified as a "small business corporation" under § 1361(b) of the Internal Revenue Code and had elected to be treated as an S corp for federal income tax purposes. As an S corp, BDI was not subject to federal taxation or state taxation; rather, its income and losses were passed through to Barden, who was required to report BDI's income on his individual tax returns. Similarly, pursuant to § 1361(b)(3)(B) of the Internal Revenue Code, BDI elected to treat MSC as a "qualified subchapter S subsidiary" (QSub), which "meant that MSC was not treated as a separate tax entity from BDI, but rather that all of its assets, liabilities, and income were treated for federal tax purposes as the assets, liabilities and income of BDI," the opinion said. As a result, MSC paid no federal taxes.