Last December, in United States v. Martin (In re Martin), 542 B.R. 479 (9th Cir. BAP 2015), the U.S. Bankruptcy Appellate Panel of the Ninth Circuit rejected recent circuit court decisions holding that an untimely Form 1040 is not, by definition, a “return” for purposes of determining whether a tax debt is dischargeable. The BAP instead ruled that a court must examine the totality of the circumstances to determine whether the purported return was “an honest and reasonable attempt to satisfy the requirements of the tax law.” To read the full published decision, click here: http://1.usa.gov/1JziPUx.
When the BAP issued its ruling in December, this issue was already pending before the U.S. Court of Appeals for the Ninth Circuit. On July 13, 2016, in Smith v. IRS (In re Smith), 828 F.3d 1094 (9th Cir. July 13, 2016), the Ninth Circuit declined to rule on the question of whether an untimely Form 1040 filed after an assessment can ever be a “return” for dischargeability purposes. Instead, based on the facts of the case, the Ninth Circuit agreed with the lower court’s determination that the debtor had not made an honest and reasonable attempt to satisfy the requirements of the tax law. To read the full published decision, click here: http://bit.ly/2bUkKrf.
Section 523(a)(1)(B) excepts from discharge a tax debt “with respect to which a [required] return . . . (i) was not filed or given; or (ii) was filed or given after the date on which such return . . . was last due . . . and after two years before the date of the filing of the petition.” Also, section 523(a)(1)(C) excepts from discharge a tax debt “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”
Prior to BAPCPA, the term “return” was undefined in the Bankruptcy Code. In determining whether a particular document qualified as a “return,” most courts adopted the following test developed by the Tax Court in Beard v. Commissioner of Internal Revenue, 82 T.C. 766, 777 (1984):
(1) there must be sufficient data to calculate tax liability;
(2) the document must purport to be a return;
(3) there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and
(4) the taxpayer must execute the return under penalty of perjury.
In 2005, BAPCPA added a “hanging paragraph” at the end of section 523(a). For purposes of section 523(a), “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 U.S.C. § 523(a) (emphasis added).
Particularly since BAPCPA was enacted, courts have struggled to determine when a filing constitutes a “return” for purposes of section 523(a)(1). Four different approaches have been adopted:
(1) under the harsh “One-Day-Late Approach,” an untimely Form 1040 is not a return, even if it is filed only one day late;
(2) under the less harsh “Post-Assessment Approach,” a Form 1040 is not a return if it is filed after the IRS makes an assessment;
(3) under the “Totality-of-the-Circumstances Approach,” courts must take into account not just the timing of the tax filing, but also any evidence of the debtor’s good faith attempts to comply with the tax laws; and
(4) under the “No-Time-Limit Approach,” whether a document evinces an honest and genuine attempt to satisfy the tax laws depends on its form and content, not on when it is filed.
There is also a fifth approach – one favored by the IRS – which does not appear to have been adopted by any court.
IN RE MARTIN
In Martin, the debtors did not timely file Form 1040s for 2004, 2005 or 2006. The IRS issued a notice of deficiency, at which point the debtors hired an accountant to prepare their tax forms. The accountant completed and signed the Form 1040s in late 2008, but the debtors did not get around to signing and filing them until six months later. Unfortunately for the debtors, the IRS made assessments, and started sending notices of the unpaid taxes, a few months before their Form 1040s were filed. After the debtors filed their Form 1040s, the IRS accepted the Form 1040s and adjusted their tax liability based on the information set forth therein.
A few years later, the debtors filed for bankruptcy and filed a complaint seeking a determination that their tax debt was dischargeable. The IRS argued that the debt was nondischargeable merely because the debt recorded by its assessment was not one with respect to which a return had been filed (this is the “IRS Approach”).
The bankruptcy court rejected the IRS Approach, adopted the No-Time-Limit Approach represented by the Eighth Circuit’s decision in In re Colsen, 446 F.3d 836 (8th Cir. 2006), and entered summary judgment in favor of the debtors. The IRS appealed.
The BAP concluded that (at least as to federal tax returns) the hanging paragraph effectively codified the Beard test applied by courts prior to BAPCPA, except with certain enumerated exceptions not relevant to the appeal. Therefore, the BAP examined the Ninth Circuit’s pre-BAPCPA adoption and application of the Beard test in In re Hatton, 220 F.3d 1057 (9th Cir. 2000).
According to the BAP, the Ninth Circuit held in Hatton “that we should use [the] version of the Beard test [adopted by the Sixth Circuit in In re Hindenlang, 164 F.3d 1029 (6th Cir. 1999)] . . . to determine whether the [debtors’] untimely tax returns qualify as tax returns for nondischargeability purposes.” However, according to the BAP, the Ninth Circuit in Hatton did not actually adopt the Post-Assessment Approach adopted by the Sixth Circuit in that case. Instead, based on how the Ninth Circuit analyzed the facts, the BAP concluded that the Ninth Circuit followed a Totality-of-the-Circumstances Approach.
Having concluded that the bankruptcy court incorrectly adopted the No-Time-Limit Approach, the BAP vacated the bankruptcy court’s judgment and remanded for further proceedings. The BAP directed the bankruptcy court to consider “the number of missing returns, the length of the delay, the reasons for the delay, and any other circumstances reasonably pertaining to the honesty and reasonableness of the [debtors’] efforts.”
IN RE SMITH
In Smith, the debtor did not timely file a Form 1040 for 2001. The IRS issued a notice of deficiency in 2006, which the debtor did not contest. Instead, in 2009, the debtor filed a Form 1040 which purported to replace the “Substitute for Return” previously prepared by the IRS based on information it gathered from third parties. The debtor’s Form 1040 actually reported a higher income than that previously calculated by the IRS, thereby increasing his tax liability.
After some time, the debtor filed for bankruptcy and sought to discharge his 2001 tax liability. The question was whether the amount originally assessed by the IRS was dischargeable. The bankruptcy court ruled that it was. However, the district court reversed, adopting the Totality-of-the-Circumstances Approach. In re Smith, 527 B.R. 14 (N.D. Cal. 2014). The debtor appealed.
The Ninth Circuit did not expressly rule in favor of any one particular approach, but it acknowledged Hatton as binding precedent for these situations. The panel expressly declined to decide whether a Form 1040 filed after the IRS makes an assessment can be a “return” for purposes of section 523(a) pursuant to the Post-Assessment Approach, and it passed on deciding the merits of the IRS Approach. The court also did not consider, at least expressly, the One-Day-Late Approach or the No-Time-Limit Approach. Instead, the court looked at the facts and determined that, in light of the amount of time the debtor waited to file his Form 1040, his “belated acceptance of responsibility” was not an honest and reasonable attempt to comply with the tax code, and therefore his Form 1040 did not qualify as a return for purposes of section 523(a)(1).
In light of Smith, courts in this circuit will likely follow either the Post-Assessment Approach (a Form 1040 is not a return if it is filed after the IRS makes an assessment) or the Totality-of-the-Circumstances Approach (courts must take into account not just the timing of the tax filing, but also any evidence of the debtor’s good faith attempts to comply with the tax laws). Courts following the latter approach will examine the number of missing returns, the length of the delay, the reasons for the delay, and any other circumstances reasonably pertaining to the honesty and reasonableness of the debtor’s efforts.
However, in the author’s view, the No-Time-Limit approach is correct. This is the approach adopted by the Eighth Circuit in Colson (a pre-BAPCPA case applying the Beard test) and by Judge Lee in Martin. See In re Martin, 508 B.R. 717 (Bankr. E.D. Cal. 2014). Based on the legislative history of the hanging paragraph, the origins of the Beard test, the Supreme Court’s decision in Badaracco v. Commissioner of Internal Revenue, 464 U.S. 386 (1984) (even if a Form 1040 is admittedly fraudulent, it is still a “return” unless the fraud is evident from the face of the document), and the existence of section 523(a)(1)(C), the author believes that whether a document evinces an honest and genuine attempt to satisfy the tax laws depends on its form and content, not on when it is filed.
This does not mean that dishonest debtors are off the hook. Under section 523(a)(1)(C), a tax debt will not be discharged if the debtor filed a “fraudulent return,” or if the debtor “willfully attempted in any manner to evade or defeat such tax.” The number of missing returns, the length of delay in filing returns, the reasons for such delay, and other circumstances pertaining to the honesty and reasonableness of the debtor’s efforts should be considered in connection with this inquiry under section 523(a)(1)(C). But they should not be considered when determining whether a Form 1040 constitutes a “return” for purposes of section 523(a)(1).
Given the split among the circuits regarding the proper interpretation of the word “return” in section 523(a), this issue seems ripe for Supreme Court review. The debtor in Smith filed a petition for certiorari on October 11, 2016, and responses to the petition are due in mid-November. Martin actually would be a better vehicle for Supreme Court review, but since Martin was remanded for further fact-finding that case cannot reach the Supreme Court anytime soon.
These materials were written by John N. Tedford, IV, of Danning, Gill, Diamond & Kollitz, LLP, in Los Angeles, California (email@example.com). Editorial contributions were provided by Michael T. O’Halloran of the Law Office of Michael T. O’Halloran in San Diego, California.
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Insolvency Law Committee
Asa S. Hami
SulmeyerKupetz, A Professional Corporation
Macdonald Fernandez LLP
Radmila A. Fulton
Law Offices Radmila A. Fulton
John N. Tedford, IV
Danning, Gill, Diamond & Kollitz, LLP