What is so surprising about a court holding that a tax return for nonbankruptcy purposes is a tax return for bankruptcy purposes? Three federal appeals courts that have considered the question have held that a late filed return that is treated as a return for nonbankruptcy purposes is not a return for purposes of the bankruptcy discharge rules. Fahey v. Massachusetts Dep’t of Revenue (In re Fahey), 779 F.3d 1, 4-5 (1st Cir. 2015); Mallo v. IRS (In re Mallo), 774 F.3d 1313, 1325-27 (10th Cir. 2014); McCoy v. Miss. State Tax Comm’n (In re McCoy), 666 F.3d 924, 928, 932 (5th Cir. 2012) . The reason given by these courts was a 2005 amendment to the Bankruptcy Code’s discharge rules. The amendment states that a “return” means a return that satisfies the requirements of nonbankruptcy law, including applicable filing requirements. According to these courts, the date for filing a return is an “applicable filing requirement.” Thus, a person who files a return even one day late would not be able to discharge the unpaid tax in bankruptcy.
In Smith v. IRS, decided July 13, Mr. Smith failed to file his 2001 tax return. The IRS issued a notice of deficiency based on a “substitute for return.” When he did not file a Tax Court petition, the IRS assessed the tax. In 2009, Mr. Smith filed a return for 2001 reporting more income than the IRS had determined. The IRS increased the assessment by the additional tax due. Mr. Smith made some monthly payments. In 2013 he filed a bankruptcy petition. He sought to have his tax debt discharged.
Consistent with its position that taxes based on a substitute for return are not dischargeable, the IRS conceded that the additional tax based on Mr. Smith’s return was discharged. It argued that the original assessment was not discharged. Mr. Smith claimed that the entire liability was discharged and the bankruptcy court agreed. The district court reversed. The Ninth Circuit affirmed the district court.
Unlike the First, Fifth and Tenth Circuits, the Ninth Circuit refused to interpret the 2005 amendment as requiring that a return be filed by the due date to be a “return” for bankruptcy purposes. Instead, it adhered to the four part test that the Tax Court has consistently used: to be a return, a document 1) must purport to be a return, 2) must be signed under penalty of perjury, 3) must contain sufficient data to allow tax to be calculated and 4) must be “an honest and reasonable attempt to satisfy the requirements of the tax law.” Both the IRS and Mr. Smith this was the test that should be applied.
The Ninth Circuit held that Mr. Smith did not make an honest and reasonable attempt to satisfy the requirements of the tax law. The “return” he filed was 7 years late and three years after the IRS assessment. Mr. Smith’s claim that “honest and reasonable” requires the court to look only at the face of the return was rejected.
The Ninth Circuit did not discuss the three circuit cases holding that the 2005 amendment requires a return to be filed on time in order to be a return for purposes of bankruptcy. The Ninth Circuit cited two circuit courts as supporting its interpretation. In one, In re Justice, 817 F.3rd 728 (11th Cir. 2016), the court expressly avoided deciding the issue and assumed, for the sake of argument, that the four part test applied. It held, on facts similar to those in Mr. Smith’s case, that the tax was not dischargeable. In the other, In re Ciotti, 638 F.3rd 276 (4th Cir. 2011), the debtor failed to notify Maryland of a federal adjustment to a tax return. The question before the court was whether Maryland’s requirement that notice be given of federal adjustments was the equivalent of a return. There was no issue as to whether a late filed “return” is a return.
The Ninth Circuit’s decision in Smith v. IRS creates a direct conflict between the circuits. Will either side seek certiorari? No. Both the IRS and the debtor agree that the four-part test applies and that the 2005 amendment does not impose a timeliness requirement. Neither wants the Supreme Court to hold that the 2005 amendment requires a return to be filed on time in order to be dischargeable. We will have to wait for the question to be decided by the Supreme Court.
ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – horwitz@taxlitigator.com or 310.281.3200 Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com
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