One often used technique for resolving unpaid personal income tax debt is now in doubt. Practitioners should take care in advising delinquent return filers that bankruptcy may be available, after a two year waiting period, to discharge the tax debt.
Whether or not a tax obligation is dischargeable in bankruptcy is, in part, determined by 11 U.S.C. § 523(a)(1). That statute provides:
A discharge under section 727, 1141, 1228(a), 1228(b), or1328(b) of this title does not discharge an individual debtor from any debt—
(1) for a tax or a customs duty—
(A) of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed;
(B) with respect to which a return, or equivalent report or notice, if required—
(i) was not filed or given; or
(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition;
This language has long been interpreted to meant that a tax return must of have been filed more than two years prior to commencement of the bankruptcy case for the tax debt to be dischargeable.
In 2005, for the first time Congress created a definition of “return.” Language was inserted, in a hanging paragraph, as part of the Bankruptcy Abuse Prevention and Consumer Protection Act:
. . . the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law. 11 USC § 523(a)(*).
In 2012, the 5th Circuit decided McCoy v. Mississippi State Tax Commission (In re McCoy), 666 F.3d 924 (5th Cir. 2012). That decision, relying on the new definition of return and focusing on the parenthetic language “including applicable filing requirements”, held that an untimely filed state tax return was not a “return” for bankruptcy discharge purposes. Now, two more circuits have rendered similar opinions.
The McCoy case was based on the language of Mississippi state law. However, a second case, Mallo v. Internal Revenue Service (In re Mallo), 774 F.3d 1313 (10th Cir. 2014) came up with the same result by applying 26 U.S.C. § 6072(a) language “shall be filed on or before” a particular date as an “applicable filing requirement.” Thus, the federal income tax return that was filed late, despite the intervening delay of more than two years between the tax filing and commencement of the bankruptcy case, disqualified the document filed as a “return” for bankruptcy discharge purposes.
The third opinion, Fahey v. Mass. Dep’t of Revenue (In re Fahey), 2015 U.S. App. LEXIS 2458, has followed this line of analysis and has similarly determine that a tax return, filed one day late, will never qualify the resulting debt as dischargeable in bankruptcy. Although a dissenting opinion by Judge Thompson argues for a debtor friendly interpretation of the new provision, the majority is emphatic in its plain language analysis that prohibits discharge of the tax due on a late filed return.
While the same question is currently pending in other circuits, three times is clearly the charm for the purpose of ringing alarm bells in the tax practitioner community. In the past, those of us who have worked to clean up tax delinquencies have generally considered bankruptcy a possible alternative strategy. Tax problems created by the lack of our clients’ diligence in timely complying with income return filing requirements would be well advised to seek another avenue for resolving the debt.
Before this unfavorable interpretation of the 2005 legislation, a typical non-filer may have been told to file the missing returns and then wait two years to file bankruptcy; with the promise that the unpaid tax will be discharged and the problem solved. This advice can no longer be given without strong qualification.
While the 9th Circuit has yet to address the timeliness issue in determining whether or not a late tax filing constitutes a return for bankruptcy discharge purposes, three other circuits have ruled decisively against the taxpayer on this issue and it would be imprudent to assume a different result in this circuit.
There remain two other avenues for converting an unfiled return into a future dischargeable debt. The tax court offers one alternative and a collaborative effort with the IRS to prepare a tax return pursuant to 26 U.S.C. § 6020(a) provides another. A stipulated resolution in the U.S. Tax Court should meet the requirements of “a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal.” It will now be even more important to file a timely Tax Court complaint in response to a Statutory Notice of Deficiency. The language “a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986” suggests the second route to a dischargeable tax debt for a delinquent taxpayer.
The practice of preparing a return pursuant to section 6020(a) has become so uncommon as to render it an unlikely alternative. Yet one case cited by the majority in Fahey shows a bankruptcy court willing to construe an IRS assessment made after the submission of information by the taxpayer as meeting the requirements of that statute. See In re Kemendo, 516 B.R. 434 (Bankr. S.D. Tex. 2014). If a substitute for return is pending, it may be helpful to supply information to the IRS in order to assist in the calculation of any tax due.
The ABA Taxation Section has made a formal recommendation to Congress for a change in 11 U.S.C. § 523(a) to remedy this problem. It is recommends that the phrase “other than timeliness” be added to the parenthetical language so that it would read “(including applicable filing requirements other than timeliness).” The National Taxpayer Advocate supports a change of this nature and, in its 2014 Report to Congress, recommends amendment of the bankruptcy code in order to ”provide that a late-filed tax return may be considered a return for purposes of obtaining a bankruptcy discharge.”