We have reported on numerous occasions regarding the issue of whether a taxpayer who files a return late may discharge the taxes owed on the late-filed returns in bankruptcy. See prior posts here, here, here, and here. The recent case of Biggers v. Internal Revenue Service decided by the District Court in the Middle District of Tennessee on September 9, 2016, demonstrates yet again the difficult administrative position that IRS put itself in by embarking on this argument almost 20 years ago. In Biggers, the District Court reversed the bankruptcy court and determined that the application of the Beard test requires a subjective determination of the taxpayer’s intent in filing the late return. The case has other interesting facets which I will discuss below.
Additionally, some new developments in the 3rd and 9th Circuits on this issue deserve mention for those following this line of cases. In the 3rd Circuit, an attempted appeal to the Circuit Court bypassing the district court or Bankruptcy Appellate Panel has been turned back. In the 9th Circuit, a case on which we reported previously has requested cert.read more...
I will start with the Biggers case. Mr. and Mrs. Biggers did not timely file tax returns for the years 2001 through 2004 for reasons that the court does not explain. The IRS prepared substitute returns for Mr. Biggers for each of these years, sent him notices of deficiency on which he defaulted, and then assessed the taxes. After the IRS had assessed taxes through this process for all of the years, Mr. and Mrs. Biggers filed joint Forms 1040 for each of these years on February 15, 2007. On three of those returns, the reported liability decreased from the amount previously assessed; however, on the return for 2002, the joint return reported an increased liability of about $15,000. The Biggers then waited slightly more than two years and filed a joint chapter 7 petition in December of 2009 after which they received a discharge three months later.
The IRS conceded that the discharge relieved Mrs. Biggers of liability for the four years. It also conceded that the discharge relieved Mr. Biggers of the $15,000 increase in tax reported on the Form 1040 for 2002 but not for the amount assessed through the substitute for return process. For the other three years the IRS abated the taxes down to the amount shown on the late filed Forms 1040 but argued that the bankruptcy petition did not relieve Mr. Biggers of the liability because it had prepared the substitute returns first and made assessments before he filed the Forms 1040. The bankruptcy court agreed with the IRS citing to the seminal case in this area, United States v. Hindenlang, 164 F.3d 1029 (6th Cir. 1999) as controlling circuit precedent. On appeal, the district court took a different tack.
Before I get to what the district court decided, I need to pause to point out what the district court said that the IRS argued. The principal argument of the IRS focused on the prior assessment through the substitute for return process. The argument of the IRS did not exactly mirror the holding in Hindenlang, the controlling circuit authority. Hindenlang adopted a subjective test based on the Tax Court’s Beard case and found that Mr. Hindenlang, whose return filed subsequent to the preparation of the substitute return, matched the substitute return exactly. That, said the 6th Circuit, was not a good faith attempt to file a return, and good faith is one of the Beard elements. The IRS primary argument morphed the Hindenlang argument into an essentially per se rule that once the IRS has assessed based on a substitute for return any Form 1040 filed thereafter can never meet the Beard test and lead to discharge. This is standard stuff in these cases; however, the district court reports that the IRS went further. Alternatively, it argued that if the court did not want to adopt its primary argument, the court should adopt the position of the three circuits holding that for bankruptcy cases filed after the 2005 amendments the language in the handing paragraph of B.C. 523(a) means that a late return can never satisfy the discharge requirements because it does not meet the additional statutory requirements in the hanging paragraph.
The district court noted that this argument by the IRS represented a change in its position from other cases. It does. This argument goes directly against the Chief Counsel Notice giving guidance on this issue. It is unclear if the alternative argument the IRS appears to have made in Biggers represents an unannounced shift in the IRS position, a disagreement between Chief Counsel’s office and the Tax Division on this issue or merely a rogue argument by the Tax Division attorney arguing this case. Unless making this argument represents a mistake by the trial attorney in the heat of battle, the ground seems to have shifted in these cases from a situation in which only certain states argue for the per se rule that filing a return one day late forever prevents it from receiving a discharge to one where the IRS will also make this argument. If it will make this argument, it will change the way it administratively processes these cases upon discharge. This change comes as quite a surprise.
The district court did not adopt the per se rule argued by the IRS as its lead argument or its alternate argument of the one day late rule. It concluded “that ‘applicable bankruptcy law’ as used in section 523(a)(*) includes pre-BAPCA [the 2005 legislative amendments to the bankruptcy code] case law, which encompasses the Beard test, as well as any other non-bankruptcy law as to requirements for a return.” So, the district court finds that in deciding whether a document filed as a tax return satisfies the test for being a tax return requires a look at Beard and other case law deciding what constitutes a return. The court cited a Tax Court case, Swanson v. Commissioner, 121 T.C. 111 (2003) which carefully examined the debtor’s intent before deciding that the taxpayer in that case did not have an intent to file a return. Imagine IRS bankruptcy examiners doing that in every case. Impossible. The IRS cannot administer the subjective test which explains why it has morphed to its own form of per se rule when it has made an assessment pursuant to a substitute for return.
The district court also went back to a long standing anomaly in the IRS argument concerning how it treats taxpayers in bankruptcy cases versus offer in compromise cases. In bankruptcy cases, it says that Forms 1040 filed after the IRS has made an assessment based on a substitute for return exist only as claims for abatement; however, in offer cases, it requires taxpayers to file Form 1040 even where it has already made an assessment based on a substitute for return. The district court found the IRS treatment of taxpayers in the offer context suggestive of the continued possibility that Forms 1040 filed in this context could meet the Beard test or otherwise meet the statutory requirement necessary for consideration as returns. As a result, the district court remanded the case to the bankruptcy court for it to look into the subjective intent of Mr. Biggers in filing the late Forms 1040 in order to determine if they might, in fact, be returns. If the district court’s analysis of the applicable test holds up, the IRS must carefully investigate the taxpayer’s intent in each of these late file return cases and have courts second-guess its conclusions in hearings involving the violation of the discharge injunction. Because the IRS cannot handle such a test, I suspect it will seek to appeal this decision.
Meanwhile, a petition for cert has been filed in the Smith case out of the 9th Circuit which we blogged here. The petition, partially written by Professor John Pottow at University of Michigan, does an excellent job of explaining the state of the law and the various splinters into which it has broken over this issue. The Supreme Court has denied cert on this issue before, but I do not think that it has previously received a request of this quality. Whether the Smith case provides the best vehicle for cert is something about which parties will disagree. Those in the 9th Circuit which averted the per se rule in Smith may prefer to live with Smith rather than face the possibility of the McCoy per se rule, but Mr. Smith can choose to seek cert if he wishes. Will the IRS, which declined to seek cert before when it had the chance after the creation of the first circuit split based on the decision of the 8th Circuit not to follow Hindenlang, join in this request or will it continue to find that the current state of the law provides it the best avenue for administering the discharge of late-filed returns? The brief cites to the importance to individual debtors to have consistency in the law across the country. Will the IRS also find administrative importance in the need for consistency? Does the alternative argument it made in Biggers signal a new litigating strategy that will play out in its response to the cert request?
Another, meanwhile, concerns the Third Circuit. We posted previously on a case headed to that circuit; however, it appears that the Third Circuit has turned down the direct appeals, meaning that it will be longer before that circuit joins the parade of circuits weighing in on this issue.