Discharging Late Filed Returns – A Novel but Unsuccessful Approach

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I have discussed the issue of late filed returns and bankruptcy discharge too much. See the most recent post, capturing all prior posts, here.  Despite many discussions of this issue, the debtor in Nilsen v. Massachusetts Dept of Revenue, a recent bankruptcy in Massachusetts, a state in the 1st Circuit where controlling circuit law requires the strict interpretation that any late return is excepted from discharge, made a novel argument worthy of a brief post.

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The debtor failed to timely file returns for almost every year between 2000 and 2010. In August of 2010 he late-filed for all of the years except 2010 and he submitted that return in March of 2012.  He then waited until March of 2015 to file a chapter 7 petition.  At the time of filing the bankruptcy petition, he owed the IRS over $200,000 and the state about $28,000.  His chapter 7 case was a no asset case and he received a discharge in about three months.

He then filed a complaint to determine dischargeability knowing that taxing authorities would treat his debts as excepted from discharge due to the late filing and the controlling circuit law. Both government entities filed motions for judgment on the pleadings.  With respect to the IRS it bears noting that it does not agree with the 1st Circuit but follows the law of the circuit rather than its own more lenient position on the issue when it is litigating in one of the three strict interpretation circuits.

The debtor objected to the motions filed by the government entities. The court allowed the debtor to place the returns into the record and treated the motions as motions for summary judgment because it admitted the factual material.  The debtor did not argue that the late Forms M1 (the state tax return form) and Forms 1040 he filed were returns but rather than but rather that they were “equivalent reports” as that term is used in bankruptcy code section 523(a)(1)(B).

Section 523(a)(1)(B) provides that “(a) A discharge under section 727, 1141 1228(a), or 1328(a) of this title does not discharge an individual debtor from any debt – (1) for a tax or customs duty – (A) 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.”

By recasting the title given to the tax return forms debtor hoped to avoid the application of the controlling circuit precedent. A footnote in the controlling 1st Circuit case noted that the debtors in that case had initially made an argument similar to the one Mr. Nilsen makes here but they abandoned it so this argument was not considered by the 1st Circuit in its opinion on the application of the discharge provision.  Essentially, his argument is that “A document which is not a return within the meaning of section 523(a)(*) solely due to its tardiness, constitutes an equivalent report where it satisfies the non-bankruptcy definition of return in all other respects, is treated as a return for non-bankruptcy purposes and serves the same function as a timely filed return.”

The IRS argued that some states use the term equivalent report but that no such term exists with respect to federal taxes. Federal law only requires the filing of “returns.”  The IRS also argued that “the plain language of section 523(a)(1)(B) and (a)(*) indicate that a late filed Form 1040 is not an equivalent report or notice…. Accordingly, it concludes that whether a document constitutes an equivalent report or notice for purposes of 523(a)such a document must be equivalent to a return as defined by section 523(a).”

Both the IRS and Massachusetts argued that In re Ciotti made clear that the language in 523(a) adding “or equivalent report or notice” expanded the prerequisites for obtaining a discharge and did not diminish them.  The court found the reasoning in Ciotti compelling as well as the reasoning in the controlling 1st Circuit opinion.  In addition, the court found that even if it simply applied the Beard test as the debtor seemed to want the debtor would still lose based on the pre-2005 law that had developed on this issue.  I doubt the debtor was shocked at this outcome and I expect that the debtor was advised before filing bankruptcy that the taxes were likely to survive the bankruptcy because of the circuit in which he resided.  The case shows the creativity that can come into play in the face of very long odds.

Comments

  1. Barry Goldwater says:

    What if he moved to a friendlier Circuit before filing for bankruptcy? Would they be discharged then?

    • There some venue issues that prevent moving at the last moment to get a different result. Former baseball commissioner Bowie Kuhn can take credit for those provisions because he moved to Florida a couple of decades ago to take advantage of the generous homestead provisions available in that state. My response assumes no problems with venue.
      Aside from the three jurisdictions that hold any late return creates an exception to discharge, he probably still loses on these facts but the case becomes factual rather than just legal. Not all circuits have ruled on the issue. The circuits that ruled before 2005 mostly held that courts should apply the Beard test developed in the Tax Court to determine if the document was truly intended to be a return. Of the Circuits applying that test the taxpayer only prevailed in the 8th Circuit in the Colson case. The federal government makes a new argument now that it was not making before about 2010 and that argument is that a Form 1040 filed after the IRS has made a 6020(b) assessment cannot be a return. Not many courts have bought this argument and no circuit courts have bought it. So, his best bet at the moment is to move to the 8th Circuit long enough before filing bankruptcy to establish venue. Since he needs to wait for two years after filing the late return before filing bankruptcy, establishing venue should not be a problem if he moves when he decides to file the late return. The federal and state government may still contest dischargeability but this is the best place to be at the moment. The more the late return differs from the substitute for return, the better his chances.

  2. When “Barry” and Keith discuss how an individual can avoid Mr. Nilsen’s bankruptcy fate with a residency change, I wonder:

    Whatever happened to the Constitutional requirement, in Art. I, § 8, cl. 4, that we the people shall have “uniform Laws on the subject of Bankruptcies”?

  3. Barry Goldwater says:

    What do you expect from the federal government?

    I don’t expect anything other than the pigsty we live in.

    This never would have happened had 1964 turned out differently.

    • Bob Kamman says:

      Barry’s son Michael probably wouldn’t have filed for bankruptcy in 2013, had 1964 turned out differently.

      Since it’s not baseball season, but the TV season has brought us a series on the Trial of the Century, it might be more appropriate when discussing a bankruptcy move to Florida to cite OJ Simpson, not Bowie Kuhn (whose initials are more respectable).

  4. Marques Lipton says:

    I represent Mr. Nilsen in this matter (appeal pending) and I also represented two of the four debtors in the 1st Circuit Fahey decision. The “equivalent report” argument was actually raised by another attorney represented who represented another of the debtors in the consolidated Fahey case. He actually thought of the argument for the first time the day before the hearing and raised it for the first time that day. The panel quickly noted that he hadn’t briefed it and refused to consider it. A foot note in the Fahey decision left open the possibility that the “equivalent report” argument was viable so gave it a shot the first chance I had. The outcome was not surprising however. Ironically, Nilsen has since moved within the 9th Circuit where his late filed returns are dischargeable.

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