Another Circuit Weighs in on the Discharge of Unfiled Returns

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We have discussed how courts, IRS and debtors are struggling with Bankruptcy § 523(a) and its infamous hanging paragraph. Addressing exceptions to discharge that language states the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). A number of courts have held that unless a return is filed by the appropriate due date, the tax liability is not eligible for discharge; other courts have pushed back on the one-day rule.

In Giacchi v. United States, the Third Circuit continued a trend away from the one-day rule and held that the debtor’s taxes were non-dischargeable based on the application of the Beard test.  Following the pattern of other recent cases on this issue discussed here and here, the Third Circuit stated that it did not need to reach the one-day rule because it found that the Forms 1040 filed by Mr. Giacchi after the IRS had already assessed the taxes based on IRC 6020(b) determination of the liability and a failure by Mr. Giacchi to petition the Tax Court in response to a statutory notice of deficiency were not a genuine effort to file a tax return but were simply forms filed to qualify Mr. Giacchi for discharge.  Of course, the Court could have avoided having to make the determination based on the valid return issue if it had decided based on the one-day rule.  So, the decision, like the recent decisions in other circuits, serves as an implicit repudiation of the one-day rule even though the Third Circuit does not directly take on the statutory language and seek to resolve the issue directly.

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As discussed before, the resolution of the issue in the manner in which the Third Circuit resolves this case does little to fix the problem the IRS has of administering discharges to determine when it may write off tax liabilities.  The Court did not adopt the bright line rule sought by the IRS that would make any Form 1040 filed after the IRS makes an IRC 6020(b) assessment unqualified to meet the test of a return; however the Court comes about as close as you can come to setting out that conclusion without explicitly doing so.  The case presents a strong victory for the IRS and will prevent just about any taxpayer in the Third Circuit from getting a discharge once the IRS makes an IRC 6020(b) assessment.

The facts of this case follow the normal fact pattern for someone filing a late return and seeking discharge.  He failed to file returns for 2000, 2001, and 2002.  In 2004, the IRS prepared substitute returns for 2000 and 2001, sent him a statutory notice of deficiency, he defaulted on that notice and then filed the Forms 1040 for 2000 and 2001 about one month after the IRS assessed the taxes based on the defaulted notice.  The only thing unusual about these facts is how quickly he filed the returns after the assessment.  The assessment would have triggered a notice and demand letter but he should also have received several letters leading up to and including the notice of deficiency.  So, it is not clear why the notice and demand letter would have prompted action.  The IRS went through the same process for the unfiled 2002 return.  It ended up assessing that liability in 2005 and he filed the delinquent Form 1040 in 2006.  He filed a chapter 7 bankruptcy in 2010.  When the IRS did not remove the tax liabilities for these three years, he then brought an adversary proceeding against the IRS seeking to have the court determine that the taxes were discharged.  The bankruptcy court and the district court held the taxes were excepted from discharge.

Mr. Giacchi made three arguments which the court rejected in relatively short order.  First, he argued that the filing of the returns represented an honest attempt to comply with the tax law.  In rejecting this argument, the Third Circuit specifically declined to follow the Eighth Circuit decision in Colsen v. United States, 446 F.3d 836 (8th Cir. 2006).  This repudiation of Colsen definitely benefits the IRS as it tries to consolidate the Circuit court opinions and the reasoning, similar to the Fourth Circuit’s decision in In re Moroney, 352 F.3d 902, 905-6, leaves little room for any taxpayer who files a Form 1040 after an IRC 6020(b) assessment.

Second, Mr. Giacchi argued that because his late filed Forms 1040 showed less taxes than the amounts assessed by the IRS and the IRS abated the taxes down to the amounts on the late filed returns, the documents had meaning and should be treated as returns.  This situation almost always arises when taxpayers file the late Forms 1040.  The court noted that he should not benefit just because the IRS made an imprecise estimate of his liability (and because it abated his liabilities in response to the late filed Forms 1040.)

Lastly, Mr. Giacchi argued that he should be excused because of his emotional state during the years.  The Court did not describe his emotional state.  In effect, Mr. Giacchi seeks an IRC 6511(h)-like suspension of the time to file due to his incapacitating emotional condition.  The Court suggested that under the right circumstances someone might be able to demonstrate a good faith effort to comply with the tax laws but his emotional state did not fit the bill.

Unless Mr. Giacchi succeeds in convincing the Supreme Court to take his case, the circuit split between the three “one-day rule” circuits, the Eighth Circuit in Colsen and the five or so relatively pure Hindenlang circuits will persist.  Look at earlier posts here, here, and here for a greater discussion of this issue.

Almost immediately after the Giacchi decision, a bankruptcy court in the Northern District of California cited to the Giacchi decision favorably in the case of Van Arsdale v. Internal Revenue Service.  Mr. Van Arsdale, whose facts were essentially similar to the Giacchi facts, argued that he panicked because he did not have enough money to pay his taxes for the year at issue and then he stuck his head in the sand until after the IRS made the assessment.  In citing to Giacchi, the bankruptcy court found that this explanation, without more, simply did not help.  The Ninth Circuit decision in In re Smith, 828 F.3d 1094 (2016) sets up a test similar to the one adopted by the Third Circuit.  The decision in Van Arsdale was very predictable based on circuit precedent but shows continuing attempts to seek discharge even in circuits that have recently made pronouncements on this issue.

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