The 9th Circuit Bankruptcy Appellate Panel decided a case recently with important consequences for delinquent taxpayers. On December 17, 2015, the Bankruptcy Appellate Panel handed down a decision in United States v. Martin that may advance a thorny problem toward resolution by the U.S. Supreme Court. The ruling, although of an interim nature, stated that a document filed by the taxpayer, intended as a tax return, should be considered a tax return and thus a dischargeable debt in bankruptcy. Bankruptcy lawyers and their clients with late tax returns should be well pleased.
The facts of the case are fairly common. Kevin and Susan Martin only got around to filing some missing tax returns after the IRS began collection on some involuntary tax assessments. The late-filed tax returns increased the Martins’ tax liability in some years, and decreased it in at least one tax year. After waiting the two years required by 11 U.S.C. §523(a)(1)(B)(ii) before a tax debt from a late-filed return can be discharged, the Martins filed bankruptcy.
A dispute arose when the IRS did not agree that the Martins’ tax debt had been discharged in the bankruptcy proceeding. To resolve the matter, the Martins filed an adversary proceeding in the bankruptcy court against the IRS. They took this action without the benefit of counsel, on a pro se basis. Bankruptcy Judge Richard Lee, sitting in the Eastern District of California, agreed with the Martins and ruled the tax was dischargeable. It was a well-reasoned opinion by the bankruptcy court that harmonizes the statutory language with the legislative intent of Congress. The reasoning carefully balances the “fresh start” of the debtors against the financial interests of the government.
The IRS did not share my enthusiasm for Judge Lee’s determination and appealed to the Bankruptcy Appellate Panel for the 9th Circuit. With the full weight of the federal government and the U.S. Attorney’s office arrayed against them, one would think the Martins would hire counsel to represent them in the Appellate Court. However, their win in the Bankruptcy Court encouraged them to go it on their own. Their briefs are just that, brief, and verify the pro se nature of this case. In fact, the Martins orally argued the case themselves before the Appellate Panel. The Martins won another round and the Bankruptcy Appellate Panel came back with a wonderful 28 page opinion, mostly in their favor. On the most important issue, the dischargeability of tax on late filed returns, this was an important win for bankruptcy debtors with outstanding tax liability.
Three circuits previously reached the opposite conclusion, holding that late-filed tax returns are no longer considered tax returns for bankruptcy discharge purposes. In the first of these decisions, McCoy v. Mississippi State Tax Commission, the 5th Circuit Appellate Court determined a late-filed state tax return to be disqualified from discharge by the 2005 amendment to 11 U.S.C §523(a)—specifically, the language included as part of a hanging paragraph appended to that section stating:
For the purposes of this subsection, the term ‘return’ means a return that satisfies the requirements of applicable non-bankruptcy law (including applicable filing requirements).
The 5th Circuit in McCoy found a timely filing requirement in the Mississippi state law and disqualified the McCoys’ late-filed tax return from discharge using this language.
I have discussed McCoy and two subsequent cases, Fahey and Mallo, from the 1st and 10th Circuits respectively, in another article “Trouble With Tax Debt in Bankruptcy.” With these three Circuit Court opinions, the trend has not been looking good for delinquent taxpayers. Only the 8th Circuit, with the Colsen case decided based on pre-2005 amendment law, holds that a late return can be discharged if it otherwise meets bankruptcy discharge criteria.
The Martin opinion, containing a comprehensive analysis of just why the McCoy, Fahey, and Mallo decisions are wrong, is only a Bankruptcy Appellate opinion[i]. As such, it does not carry the weight of an opinion from the 9th Circuit Court of Appeals. Bankruptcy judges in the 9th Circuit generally follow Bankruptcy Appellate Panel opinions, and will likely enter discharges in accord with the Martin decision unless and until it is overturned. That may be a long time in coming[ii].
The Martin opinion is interesting because the Bankruptcy Appellate Panel, after 28 pages of discussion, actually returned the case to the Bankruptcy Court for further findings[iii]. This is based on a prior 9th Circuit case, In Re: Hatton, that held the debtor’s behavior must be taken into consideration when determining if the papers filed constitute a tax return for discharge purposes. In that earlier case, the 9th Circuit decided that in the case of a late tax return, there was a good faith requirement. Thus, in the 9th Circuit, the definition of a tax return includes a requirement that the document filed by the debtor be a reasonable attempt to comply with tax laws.
The Martins are not yet home free. Some of the delinquent tax returns were not filed until months after they were prepared, signed, and delivered by their accountant. To meet the good faith requirement, as expressed in Hatton, the debtors must convince the bankruptcy judge they had good reason for their delay in filing tax returns or, at least, had no improper motive.
More interesting than the remand issue is the fact that the decision of the Bankruptcy Appellate Panel is not yet appealable, because the remand order is not technically a final order. The ultimate decision on dischargeability will depend on findings of the bankruptcy court if the case is returned to the Bankruptcy Appellate Panel. Doubtless, this frustrates the Internal Revenue Service and may provide a window of opportunity for delinquent taxpayers to discharge their tax debts in the 9th Circuit.
[i] The Bankruptcy Appellate Panel (BAP) is composed of three bankruptcy judges. It is an optional avenue of appeal from a bankruptcy court decision and must be agreed upon by all parties to the appeal. While persuasive, a BAP opinion is only clear binding authority in the specific case for which a decision is made. The Court of Appeals is superior to the Bankruptcy court and its opinions are binding authority on all district courts and bankruptcy courts in the circuit.
[ii] The 9th Circuit Court of Appeals is currently considering a case with very similar facts. The euphoria over United States v. Martin could be short-lived if the 9th Circuit see the issue differently.
[iii] The BAP remanded the case to the bankruptcy judge for further findings. The record before the court on appeal contained no evidence on something the court considered an important issue.