Not So Fast! South Carolina's Position on Discharging Sales and Use Taxes in Bankruptcy

South Carolina imposes a sales and complimentary use tax on the retail sale or use of tangible personal property in the state. The taxes are assessed by the South Carolina Department of Revenue (DOR). Retailers are generally required to collect and remit the sales tax to the DOR, while purchasers are required to directly pay the use tax. There are significant exclusions and exemptions to both taxes. If a business retailer or purchaser does not pay the sales or use tax, the DOR may have the ability to make a "responsible person" assessment of the tax (including penalties and interest) against individuals associated with the business. The potential discharge of sales and use taxes in bankruptcy may be an open issue in South Carolina, depending on whether the sales or use tax under South Carolina's statute is considered to be an "excise" or "trust fund" type of tax.

Section 523(a)(1)(A) of the Bankruptcy Code (the Code) excepts from discharge any debt "for a tax or customs duty" specified in section 507(a)(3) or 507(a)(8) of the Code whether or not a claim for such tax was filed or allowed. Thus, if a tax has priority status under the Code, it is not dischargeable.

Section 507(a)(8) of the Code gives priority to claims for certain taxes in subsection (A), (C), and (E). Subsection (C) of Section 507(a)(8) of the Code give priority to "a tax required to be collected or withheld and for which the debtor is liable in whatever capacity" - "trust fund" tax. Subsection (E) of Section 507(a)(8) of the Code gives priority to an "excise tax" on a transaction occurring less than three years prior to filing the bankruptcy petition.

For sales taxes, the issue is whether the tax should be considered a "trust fund"[1] tax under Section 507(a)(8)(C) of the Code or an "excise"[2] tax under Section 507(a)(8)(E) of the Code. The inquiry under the Code is whether the tax is one owed by a party other than the debtor, and the tax was collected or withheld by the debtor from the other party. If the tax is owed directly by the debtor, the tax is not a trust fund tax and may be an excise tax.

Under South Carolina law, a sales tax, equal to six percent of the gross proceeds of sales, is imposed upon every person engaged or continuing within this State in the business of selling tangible personal property at retail. SC Code § 12-36-910(A). The retailer may add the state sales tax to the sales price charged the purchaser. SC Code § 12-36-940(A). The inability, impracticability, refusal, or failure to add these amounts to the sales price and collect them from the purchaser does not relieve the seller from the tax levied. SC Code § 12-36-940(B).

The South Carolina sales tax statue is a vendor or seller tax liability statute. The South Carolina Supreme Court has held that a seller carries the burden of paying state sales taxes. Southeastern Steel Co. v. Burton Block and Concrete Co., 273 S.C. 634, 258 S.E.2d 888 (1979). The seller is liable for the tax whether or not the tax is passed on to the purchaser. SC Code § 12-36-940(B). The statute allows vendors to pass the sales tax on to the purchasers by adding the sales tax to the purchase price, collecting the tax from the purchaser and then remitting the tax to the DOR. The vendor remains fully liable for the sales tax and is not relieved of the liability if the purchaser/consumer does not pay the tax. SC Code § 12-36-940.

Neither the U.S. Bankruptcy Court nor the U.S. District Court for the District of South Carolina has ruled on the issue of whether South Carolina state sales taxes are "trust fund" or "excise" taxes under Section 507(a)(8) of the Code. The requisite inquiry in South Carolina should be whether the seller of goods or services is required to collect sales tax from a purchaser and pay the tax over to the DOR. If the seller does actually collect the sales tax, but does remit them to the DOR, the argument is that the seller has already collected the taxes, holds them in "trust" for the DOR, and the tax liability is not dischargeable by the seller. Alternatively, if the seller has not collected the tax, there is nothing to remit, and the "trust" argument is less persuasive, with the result that, in this case, the tax liability may be dischargeable in bankruptcy as an "excise" tax.

[1] Trust fund taxes are always prioritized and are never dischargeable irrespective of the age of the liability.
[2] Excise taxes receive priority and are non-dischargeable, if they are less than three years old, as measured from the date of the bankruptcy petition.
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