The Bankruptcy Appellate Panel (BAP) for the Ninth Circuit ruled that debtors who file income tax returns late—even after the IRS assesses taxes for the years in question—can still discharge those income tax liabilities in bankruptcy. The decision contradicts holdings from the First, Fifth, and Tenth circuits that late-filed tax returns do not count as returns for determining whether such obligations can be discharged in bankruptcy (see In re Fahey, 779 F.3d 1 (1st Cir. 2015); In re McCoy, 666 F.3d 924 (5th Cir. 2012); and In re Mallo, 774 F.3d 1313 (10th Cir. 2014)).
Facts: The debtors, married couple Kevin Wayne Martin and Susan Martin, did not file their tax returns for 2004, 2005, and 2006 when due. As a result, the IRS conducted an audit examination in June 2008 to fix the amount of liability for the three years. In December 2008 the Martins hired an accountant who completed their returns for the three years, but the couple did not sign and file the returns until June 2009. In March 2009, the IRS assessed the Martins for the three years. The IRS accepted the Martins' returns and adjusted their tax liability based on the information in the returns. The Martins filed a Chapter 7 bankruptcy case in 2011 and filed a complaint in Bankruptcy Court requesting discharge of the tax debt.
Issues: The IRS argued that the debt was not dischargeable because the Martins filed their returns only after the IRS had made the assessment. Thus, the returns did not meet a provision defining a "return" under the Bankruptcy Code's nondischargeability provisions: one that "satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements)." The definition was added to the Bankruptcy Code as flush language, or a "hanging paragraph," to 11 U.S.C. Section 523(a) by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005, P.L. 109-8.
However, the bankruptcy trial court (Martin, 508 B.R. 717 (2014)) held that, despite the BAPCPA amendment, the test established in Beard, 82 T.C. 766 (1984), aff'd, 793 F.2d 139 (6th Cir. 1986), still applied to determine whether the debtors had filed a return. That test required considering whether the return represented an honest and reasonable attempt to satisfy the requirements of the tax law. The bankruptcy court held that the Martins' returns were such an attempt and granted their request.
The IRS appealed, again arguing that returns filed after it had made an assessment should not count as returns. The BAP noted that the holdings in the other three circuits literally applied the definition to hold that a tax return filed late—whether before or after an IRS assessment—is not a return for purposes of exception from dischargeability. The IRS itself has expressly rejected that construction as "overly harsh," the BAP noted (quoting Wogoman, 475 B.R. 239, 250)). The BAP noted the inconsistency of the other circuits' literal approach with the definition's inclusion of a substitute for return prepared by the IRS under Sec. 6020(a).
[T]hus, under the literal construction ... a debtor taxpayer who is one month or one day or even one hour late in filing his or her return will have his associated tax debt excepted from discharge, whereas a debtor taxpayer who never bothers to file his or her own return can discharge his or her associated tax debt if the IRS fortuitously prepares a return on that person's behalf. [Martin, slip op. at 17—18]
In rejecting the IRS's argument that the definition excludes returns filed after an assessment, the BAP noted (quoting its prior opinion in Nunez, 232 B.R. 778, 782 (B.A.P. 9th Cir. 1999)) that "Congress could have conditioned discharge of tax debt on whether a return was filed prior to an assessment. As correctly noted by the [bankruptcy] court, Congress used assessment as a trigger for other time periods in the [Bankruptcy] Code, for example, the priority qualifications found in Section 507(a)(8)(A)(ii)."
For these reasons, the BAP determined that the BAPCPA amendments to the Bankruptcy Code did not change previous law on this point. The BAP did, however, remand the case for the Bankruptcy Court to apply the correct legal standard for determining the honesty and the reasonableness of the Martins' efforts to comply with the tax laws, by also considering the number of missing returns, the length of delay, the reasons for the delay, and other relevant circumstances.
- Martin, No. EC-14-1180 (B.A.P. 9th Cir. 12/17/15)
—By Mark M. Sharf, Esq., a bankruptcy litigator with Merritt, Hagen & Sharf LLP in Woodland Hills, Calif.