Complications from Extensions and Unprocessible Returns

Bob Probasco returns today with an important alert on overpayment interest. Christine

A few months ago, Bob Kamman flagged a number of surprising phenomena he’d observed recently, one of which related to refunds for 2020 tax returns.  Normally, when the IRS issues a refund within 45 days of when you filed your return, it doesn’t have to pay you interest.  That’s straight out of section 6611(e)(1).  Yet, taxpayers were getting refunds from their 2020 returns within the 45 day period and the refunds included interest.  As Bob explained, that was a little-known benefit of COVID relief granted under section 7805A.  Not only were filing and payment dates pushed back but also taxpayers received interest on refunds when they normally would not have.

On July 2, 2021, the IRS issued PMTA 2021-06, which raised two new wrinkles—one related to returns that were not processible; the other related to returns for which taxpayers had filed extensions.  How do those factors affect the results Bob described?


Interest on Refunds Claimed on the Original Return

The general rule is that the government will pay interest from the “date of the overpayment” to the date of the refund.  Normally the “date of the overpayment” will be the last date prescribed for filing the tax return, without regard to any extension—April 15th for individuals—unless some of the payments shown on the return were actually made after that date.  But there are three exceptions applicable to refunds claimed on the original return: 

  • Under section 6611(b)(2), there is a “refund back-off period” of “not more than 30 days” before the date of the refund, during which interest is not payable.  In practice, this period is significantly less than 30 days.  See Bob Kamman’s post and the comments for details.
  • Under section 6611(b)(3), if a return is filed late (even after taking into account any extension), interest is not payable before the date the return was filed.
  • Under section 6611(e)(1), no interest is payable if the refund is made promptly—within 45 days after the later of the filing due date (without regard to any extension) or the date the return was filed.

Section 6611(b)(3) and (e)(1) affect when overpayment interest starts running, while section 6611(b)(2) affects when it ends.

Other Code provisions, however, may adjust this further.

When Is the Return Considered Filed?

This is where “processible” comes in.  Section 6611(g) says that for purposes of section 6611(b)(3) and (e), a return is not treated as filed until it is filed in processible form.  As the PMTA explains, a return that is valid under Beard v. Commissioner, 82 T.C. 766 (1984), may not be processible yet, because it omits information the IRS needs to complete the processing task.  IRM gives an example of a return missing Form W-2 or Schedule D.  Those are not required under the Beard test, but the return cannot be processed “because the calculations are not verifiable.”  The PMTA also mentions a return submitted without the taxpayer identification number; still valid under the Beard test but the IRS needs the TIN to process it.

As a result, under normal conditions, if a valid but unprocessible return is filed timely, and a processible return is not filed until after the due date, the latter is treated as the filing date for purposes of section 6611(b)(3) and (e).  The return is late, so the taxpayer is not entitled to interest before the date the (processible) return was filed.  And the 45-day window for the IRS to issue a refund without interest doesn’t start until the (processible) return was filed.

And Now We Add COVID Relief

The previous discussion covered normal conditions, but today’s conditions are not normal  As we all recall, the IRS issued a series of notices in early 2020 that postponed the due date for filing 2019 Federal income tax returns and making associated payments from April 15, 2020, to July 15, 2020.  The IRS did the same thing for the 2020 filing season, postponing the due dates from April 15, 2021, to May 17, 2021.  (Residents of Oklahoma, Louisiana, and Texas received a longer postponement, to June 15, 2021, as a result of the severe winter storms.)

This relief is granted under authority of section 7508A(a)(1), responding to Presidential declarations of an emergency or terroristic/military actions.  For purposes of determining whether certain acts were timely, that provision disregards a period designated by Treasury—in effect, creating a “postponed due date.”  The acts covered are specified in section 7508(a) and potentially, depending on what relief Treasury decides to grant, include filing returns and making payments.  For the 2019 filing season, the IRS initially postponed the due date for payments and then later expanded that relief to cover the due date for filing tax returns.

(Yes, the section 7508A provision for Presidentially declared emergencies piggybacks on the section 7508 provision for combat duty.  As bad as the disruptions caused by COVID have been, I prefer them to serving in an actual “combat zone.”  Hurricane Ida, which I am also thankful to have missed, may be somewhere in between.  All get similar relief from the IRS.)

Section 7508A(a)(2) goes beyond determining that acts were timely.  It states that the designated period, from the original due date to the postponed due date, is disregarded in calculating the amount of any underpayment interest, penalty, additional amount, or addition to tax.  No penalties or underpayment interest accrue during periods before the postponed due date, just as they don’t accrue (in the absence of a Presidentially declared emergency) before the normal due date. 

That’s the right result, and section 7508A(a)(2) is necessary to reach it.  Section 7508A(a)(1) simply says that the specified period is disregarded in determining whether acts—such as payment of the tax balance due—are timely.  It doesn’t explicitly modify the dates prescribed elsewhere in the Code for those acts.  The underpayment interest provisions, on the other hand, don’t focus on whether a payment was timely.  Section 6601(a) says underpayment interest starts as of the “last date prescribed for payment” and section 6601(b) defines that without reference to any postponement under section 7508A.

What about overpayment interest on a refund?  Section 7508A(c) applies the rules of section 7508(b).  That provision tells us that the rule disregarding the period specified by Treasury “shall not apply for purposes of determining the amount of interest on any overpayment of tax.”  Great!  We won’t owe interest for that designated period—April 15, 2020 to July 15, 2020 for the first emergency declaration above—on a balance due, but we can potentially be paid interest for that period on a refund.

Section 7508(b) also states that if a postponement with respect to a return applies “and such return is timely filed (determined after the application of [the postponement]), subsections (b)(3) and (3) of section 6611 shall not apply.”  That certainly sounds reasonable with respect to 6611(b)(3); it’s a de facto penalty of sorts for filing late, but if you filed your 2019 tax return by July 15, 2020, that should be treated as though you had paid by the original due date of April 15, 2020. 

Section 6611(e)(1) is a little bit different.  It’s not a de facto penalty for late filing; it’s essentially (1) a recognition that processing returns and issuing refunds takes some minimal amount of time and (2) possibly a small incentive for the IRS to do that expeditiously.  But when Treasury grants relief after a Presidentially declared emergency, any refund issued from a timely return will include interest, unless some other provision overrides it.  That’s what Bob Kamman’s Procedurally Taxing post pointed out and explained. 

And Now, the PMTA

It appears that the PMTA is correcting earlier analysis.  I haven’t been able to track down any earlier guidance, but the PMTA refers to “our previous conclusions” and those differed from the conclusions in the PMTA.  The conclusions in the PMTA seem correct.  Summarized:

  1. If the IRS determined a postponed due date under section 7508A, a return filed by the postponed due date means section 6611(b)(3) and (e) do not apply.  The return need only be valid under the Beard test to be timely and trigger the provisions of section 7508A; it doesn’t need to be processible.  This is what the “previous conclusions” got wrong, apparently thinking that whether a return was timely for purposes of section 7508A depended on whether it was processible.  But section 6611(g) defines “timely” only for purposes of section 6611(b)(3) and (e), not section 7508A.  It doesn’t matter whether the return was timely filed for purposes of 6611(b)(3) and (e); section 7508A negated them.  The default rules below don’t apply.  Interest will run from the date of the overpayment and there is no exception for a prompt refund.
  2. If the IRS determined a postponed due date under section 7508A, but a valid return is not filed by the postponed due date, it doesn’t meet one of the requirements for sections 7508A(c)/7508(b)—that the return is timely filed by the postponed due date—so the default rules below apply. 

Default rules, if there was no section 7508A relief from Treasury, or the taxpayer did not file a valid return by the postponed due date.  Sections 7508A(c)/7508(b) have no effect, so sections 6611(b)(3) and (e) are in effect and the return is “filed” only when it is processible pursuant to section 6611(g).  Thus:

  • If a processible return is filed by the original due date (or extended due date if applicable) it is not late under section 6611(b)(3), so interest runs from the date of the overpayment.  If it is filed after the original due date (or extended due date if applicable) it is late under section 6611(b)(3), so interest runs from the date the processible return was filed.
  • Whether or not the processible return is filed late, no interest is payable at all if the IRS makes a prompt refund under section 6611(e).  The 45-day grace period starts at the later of the original due date (even if the taxpayer had an extension) or the date the return is filed. 

Note that a return filed after the postponed due date (July 15, 2020) but on or before the extended due (October 15, 2020, if the taxpayer requested an extension) is not timely for purposes of section 7508A.  As a result, sections 6611(b)(3) and (e) are not disregarded.  But it is timely for purposes of 6611(b)(3).  Interest runs from the date of the overpayment rather than the date the return is filed, but the taxpayer may still lose all interest if the IRS issues the refund promptly.

Although the PMTA doesn’t mention it, the “refund back-off period” of section 6611(b)(1) will apply in all cases.  That rule is not dependent on whether a return is processible or filed timely, and it is not affected by a Presidentially declared emergency.

Two Final Thoughts

First, I think the PMTA is clearly right under the Code.  That the IRS originally reached the wrong conclusion, in part, is a testament to the complex interactions of the different provisions and the need for close, attentive reading.  I double-checked and triple-checked when I worked my way through the PMTA.  This was actually a relatively mild instance of a common problem with tax.  Code provisions are written in a very odd manner.  They’re not intended to be understandable by the general public; they’re written for experts and software companies, and sometimes difficult even for them.  I suspect that people who work through some of these complicated interpretations would fall into two groups: (a) those who really enjoy the challenging puzzle; and (b) those who experience “the pain upstairs that makes [their] eyeballs ache”.  My bet is that (b) includes not only the general public and most law school students but also a fair number of tax practitioners.  Which group are you in?

Second, that (relative) complexity leads to mistakes.  I assume that these interest computations have to be done by algorithm.  There are simply too many returns affected to have manual review and intervention for more than a small percentage.  An algorithm is feasible but will require re-programming every time there’s a section 7508A determination, with changes from year to year.  Even when the law is clear, there is a lot of opportunity for mistakes to creep in.  (We’re seen some of those recently in other contexts, e.g., stimulus payments and advanced Child Tax Credit.)  Whether by algorithm or manual intervention, particularly given the change from the original conclusions, there’s a good chance that some refunds were issued that are not consistent with the correct interpreation and may not have included enough interest.  Is the IRS proactively correcting such errors?  If the numbers are big enough, it might be worth re-calculating the interest you received—it’s easier than you may think—and filing a claim for additional interest if appropriate.

Questioning the Portal: Why the Beard Test Matters

A few months ago, Nina Olson wrote What is this thing called portal?, in which she analyzed the IRS non-filer portal under the Beard test for determining when a submission to the IRS is considered a tax return.

After that post was published, the IRS confirmed what the screenshots in Nina’s post show – that functionally, the portal e-files a 2019 federal income tax return reporting $1 of interest income. Because many people who used the portal actually should have filed a full tax return instead, the IRS created a process for people to file their real 2019 tax return and signal to the IRS that they had mistakenly used the portal, via a submission which the IRS calls an “Amended EIP Return”. The IRS website states:

Tax Professionals please note that returns labeled “Amended EIP Return” will be processed as superseding returns if submitted before July 15 or, with a valid extension, before Oct. 15.

So we know that practically, the IRS computer system is treating a portal submission as a 2019 tax return. But is the legal question settled? A recent post by Gina Ahn on the ABA Tax Section’s listserv for the Pro Bono & Tax Clinics community highlights one taxpayer’s predicament and reminds us why the legal question matters.


The facts presented are roughly as follows:

A domestic violence survivor fled her husband to live in a shelter, where among other services she connected with an LITC with the goal of seeking innocent spouse relief for her 2018 joint tax debt. The client’s husband runs a sole proprietorship and the 2018 joint liability consists of his unpaid self-employment taxes.

The husband and wife are both in touch with the tax professional who prepared their past joint tax returns and had been hired to prepare their 2019 tax returns. The spouses had arranged with the preparer to file Married Filing Separate returns for both of them for 2019.

At some point after the CARES Act passed, the tax preparer told the spouses that he could use the nonfiler portal for them to “get the stimulus checks faster,” and they all agreed he should do this.

The preparer later tried to e-file the wife’s MFS tax return for 2019, but the IRS rejected the e-file submission as a duplicate, due to the previous nonfiler portal submission.

The LITC attorney learns these facts in August. 

What advice would you give?

Before we go further, remember that Treasury Regulation § 1.6013-1(a)(1) provides:

For any taxable year with respect to which a joint return has been filed, separate returns shall not be made by the spouses after the time for filing the return of either has expired.

The IRS interprets “the time for filing the return” to mean the due date of the return without regard to any extension of time to file. (See e.g. PMTA 2020-17.) So, although we do not know if an extension was filed for either spouse, it probably does not matter.

If a valid joint return was filed before July 15, the spouses in our scenario are stuck with a joint tax return for 2019. They would need to file an amended return if they wanted to report their actual 2019 income and tax liability. This likely means that at some point down the road, the wife will be requesting innocent spouse relief from the husband’s 2019 self-employment tax liability.

However, if the portal submission was not a joint return, then the spouses are free to file separate returns for 2019 as they had originally planned. These would need to be submitted on paper, but they would be legally valid separate returns.

Was the Portal Filing a Valid Joint Return?

As Nina explained, “In Beard v. Commissioner, the Tax Court outlined the basic requirements of what constitutes a valid return for statute of limitations purposes:

First, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury.”

Nina then applied the Beard test to the portal, and concluded that the test is probably met. “If it walks like a duck, and quacks like a duck, maybe it actually is a duck.” I recommend viewing the screenshots in her post to see what she means.

If the nonfiler portal could be a return when completed by the taxpayer, does it still qualify as a return given that the taxpayers here never laid eyes on the portal or their purported joint return?

It’s worth mentioning that the nonfiler portal is not set up for tax preparers or any other assister to use on behalf of an individual. There is no option to enter your PTIN. In fact, the Form 1040 generated by the portal specifically says “Not for use by paid preparer” and “self-prepared” on the second page.

It seems to me that the analysis should come out differently in this case, than in Nina’s hypothetical case of a taxpayer using the portal for himself. The wife (and maybe also the husband) in our scenario always intended to file a separate tax return for 2019. She did not know that allowing the tax preparer to use the portal meant that, practically speaking in the e-filing system of the IRS, she was filing a joint 2019 tax return. She did not use the portal herself, see the jurat or the final 1040 that the portal generated, or have any basis to question whether the preparer’s suggestion was appropriate.

A tax administrator might not like that subjective analysis, but it’s not too far off from the analysis employed when one spouse contests the joint status of a return filed by the other. For example, in a 2017 summary opinion Judge Wherry explained:

Whether an income tax return is a joint return or a separate return of the other spouse is a question of fact. Harrington v. Commissioner, at *8 (citing Heim v. Commissioner, 27 T.C. 270 (1956), aff’d, 251 F.2d 44 (8th Cir. 1958)). The focus of our inquiry is whether [the nonsigning spouse] intended to file and be bound by the return in question. See Shea v. Commissioner, 780 F.2d 561 (6th Cir. 1986), aff’g in part, rev’g in part T.C. Memo. 1984-310.

The courts have considered various factors in determining whether a nonsigning spouse intended to file a joint return, including (1) whether the returns were prepared pursuant to an established practice of preparing and filing a joint return, (2) whether the nonsigning spouse failed to object to the filing of a joint return, (3) whether an affirmative act was taken indicating an intention to file other than jointly, (4) whether one spouse entirely relied on the other spouse to file returns, (5) whether the spouse examined returns presented for a signature, (6) whether separate returns were filed, (7) whether the returns included the income and deductions of the nonsigning spouse, and (8) and whether the nonsigning spouse was aware of the contents of the purported returns. See, e.g., Estate of Campbell v. Commissioner, 56 T.C. at 12-13; Howell v. Commissioner, 10 T.C. 859 (1948), aff’d per curiam, 175 F.2d 240 (6th Cir. 1949); Boyle v. Commissioner, T.C. Memo. 1994-294; Evans v. Commissioner, T.C. Memo. 1982- 700; Crew v. Commissioner, T.C. Memo. 1982-535.

Here, the tax preparer essentially played the role of the signing spouse. The tax preparer in this case should have known better than to use the portal for taxpayers who had 2019 filing requirements. We do not have enough facts to understand why the preparer thought this would cause the EIP to arrive sooner.

This case also highlights another pitfall of the nonfiler portal – the only filing statuses allowed are Single and Married Filing Jointly. If Married Filing Separately had been available, this taxpayer’s dilemma might have been avoided.

Procedure Grab Bag: CCAs – Suspended/Extended SOLs and Fraud Penalty

My last post was devoted to a CCA, which inspired me to pull a handful of other CCAs to highlight from the last few months.  The first CCA discusses the suspension of the SOL when a petition is filed with the Tax Court before a deficiency notice is issued (apparently, the IRM is wrong on this point in at least one spot).  The second touches on whether failing to disclose prior years gifts on a current gift tax return extends the statute of limitations for assessment on a gift tax return that was timely filed (this is pretty interesting because you cannot calculate the tax due without that information).  And, finally, a CCA on the imposition of the fraud penalty in various filing situations involving amended returns.


CCA 201644020 – Suspension of SOL with Tax Court petition when no deficiency notice

We routinely call the statutory notice of deficiency the ticket to the Tax Court.  In general, when a taxpayer punches that ticket and heads for black robe review, the statute of limitations on assessment and collections is tolled during the pendency of the Tax Court case.  See Section 6503(a).  What happens when the petition is filed too soon, and the Court lacks jurisdiction?  Well, the IRM states that the SOL is not suspended.  IRM states, “If the petition filed by the taxpayer is dismissed for lack of jurisdiction because the Service did not issue a SND, the ASED is not suspended and the case must be returned to the originating function…”  But, Chief Counsel disagrees. Section 6503(a) states:

The running of the period of limitations provided in section 6501 or 6502…shall (after the mailing of a notice under section 6212(a)) be suspended for the period during which the Secretary is prohibited from making the assessment or from collecting by the levy or a proceeding in court (and in any event, if a proceeding in respect of the deficiency is placed on the docket of the Tax Court, until the decision of the Tax Court becomes final), and for 60 days thereafter. (emph. added).

Chief Counsel believes the second parenthetical above extends the limitations period even when the Tax Court lacks jurisdiction because no notice of deficiency was issued.   The CCA further states, “Any indication in the IRM that the suspension does not apply if the Service did not mail a SND is incorrect.”  Time for an amendment to the IRM.  I think this is the correct result, but the Service likely had some reason for its position in the IRM, and might be worth reviewing if you are in a situation with the SOL might have run.

CCA 201643020

The issue in CCA 201643020 was whether the three year assessment period was extended due to improper disclosure…of prior gifts properly reported on prior returns.  In general, taxpayers making gifts must file a federal gift tax return, Form 709, by April 15th the year following the gift.  The Service, under Section 6501(a) has three years to assess tax after a proper return is filed.  If no return is filed, or there is not proper notification, the service may assess at any time under Section 6501(c)(9).

In the CCA, the Service sought guidance on whether a the statute of limitations was extended where in Year 31 a gift was made and reported on a timely filed gift tax return.  In previous years 1, years 6 through 9, and 15 prior gifts were reported on returns.  On the year 31 return, however, those prior gifts were not reported.  That information was necessary to calculate the correct amount of tax due.

Section 6501(c)(9) specifically states:

If any gift of property the value of which … is required to be shown on a return of tax imposed by chapter 12 (without regard to section 2503(b)), and is not shown on such return, any tax imposed by chapter 12 on such gift may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. The preceding sentence shall not apply to any item which is disclosed in such return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item.

Chief Counsel concluded that this requires a two step analysis.  Step one is if the gift was reported on the return.  If not, step two requires a determination if the item was adequately disclosed.  Counsel indicated it is arguable that the regulations were silent on the omission of prior gifts, but that the statutory language was clear.  Here, the gift was disclosed on the return, and the statutory requirements were met.  The period was not extended.  I was surprised there was not some type of Beard discussion regarding providing sufficient information to properly calculate the tax due.

CCA 201640016

Earlier this year, the Service also released CCA 201640016, which is Chief Counsel Advice covering the treatment of fraud penalties in various circumstances surrounding taxpayers filing returns and amended returns with invalid original issue discount claims.  The conclusions are not surprising, but it is a good summary of how the fraud penalties can apply.

The taxpayer participated in an “Original Issue Discount (OID) scheme” for multiple tax years.  The position take for the tax years was frivolous.  For tax year 1, the Service processed the return and issued a refund.  For tax year 2, the Service did not process the return or issue a refund. For tax year 3, the return was processed but the refund frozen.  The taxpayer would not cooperate with the Service’s criminal investigation, and was indicted and found guilty of various criminal charges.  Spouse of taxpayer at some point filed amended returns seeking even greater refunds based on the OID scheme, but those were also frozen (the dates are not included, but the story in my mind is that spouse brazenly did this after the conviction).

The issues in the CCA were:

  1. Are the original returns valid returns?
  2. If valid, is the underpayment subject to the Section 6663 fraud penalty?
  3. Did the amended returns result in underpayments such that the penalty could apply, even though the Service did not pay the refunds claimed?

The conclusions were:

  1. It is likely a court would consider the returns valid, even with the frivolous position, but, as an alternative position, any notice issued by the Service should also treat the returns as invalid and determine the fraudulent failure to file penalty under Section 6651(f).
  2. To the extent the return is valid, the return for which a refund was issued will give rise to an underpayment potentially subject to the fraud penalty under Section 6663. The non-processed returns or the ones with frozen refunds will not give rise to underpayments and Section 6663 iis inapplicable.  CC recommended the assertion of the Section 6676 penalty for erroneous claims for refund or credit.
  3. The amended returns did not result in underpayments, so the Section 6663 fraud penalty is inapplicable, but, again, the Service could impose the Section 6676 penalty.

So, the takeaway, if a taxpayer fails to file a valid return, or there is no “underpayment” on a fraudulent return, the Service cannot use Section 6663.  See Mohamed v. Comm’r, TC Memo. 2013-255 (where no valid return filed, no fraud penalty can be imposed).  In the CCA, Counsel believed the return was valid, but acknowledged potential issues with that position.  Under the Beard test, a return is valid if:

 four requirements are met: (1) it must contain sufficient data to calculate tax liability; (2) it must purport to be a return; (3) it must be an honest and reasonable attempt to satisfy the requirements of the tax law; and (4) it must be executed by the taxpayer under penalties of perjury. See Beard v. Comm’r,  82 T.C. 766 (1984). A return that is incorrect, or even fraudulent, may still be a valid return if “on its face [it] plausibly purports to be in compliance.” Badaracco v. Comm’r, 464 U.S. 386 (1984).

The only prong the CCA said was at issue was the third prong, that the return “must be an honest and reasonable attempt to satisfy the requirements of the tax law.”  As the taxpayer had been convicted of Filing False Claims with a Government Agency/Filing A False Income Tax Return, Aiding and Abetting, and Willful Attempt to Evade or Defeat the Payment of Tax, it is understandable why you would question if the returns were “an honest and reasonable attempt to satisfy the requirements of the tax law.”  Further, the Service had imposed the frivolous filing penalty under Section 6702, which only applies when the return information “on its face indicates that the self-assessment is substantially incorrect.”

The CCA notes, however, it is rare for courts to hold returns as invalid solely based on the third prong of Beard, but clearly there would be a valid argument for the taxpayers in this situation.  The CCA acknowledges that by stating “[t]o guard against the possibility that the returns are not valid, the Service should include the Section 6651(f) fraudulent failure to file penalty as an alternative position,” so the taxpayer could pick his poison.

As to the underpayment, Counsel highlighted that overstatements of withholding credits can give rise to an underpayment under the fraud penalty.  The definition was shown as a formula of Underpayment = W-(X+Y-Z).  W is the amount of tax due, X is the amount shown as due on the return, Y is amounts not shown but previously assessed, and Z is the amount of rebates made.  Where the refund was provided, the penalty could clearly apply.  In “frozen refund” situations, the Service has adopted the practice of treating that amount as a sum collected without assessment, which can cancel out the X and Y variables so no underpayment for the fraud penalty will exist.

But, as shown above, even if the fraud penalty may not apply, the Section 6651 penalty will likely apply if the return is invalid, or the frivolous position penalty under Section 6702 may apply.

New Developments in the Cases Involving Discharge of Late Filed Returns

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.


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.

Ninth Circuit Rules in Smith Case but Passes on Addressing the One Day Late Discharge Issue

A copy of the 9th Circuit’s opinion issued today in the Smith case can be found here:  Smith v. United States.  We will have commentary about the opinion in coming days.  Like the recent opinion from the 11th Circuit, the 9th Circuit goes back to pre-2005 law to decide the case and passes on the opportunity to address the one day late rule.  Because the IRS does not argue the one day late rule and because the debtor will never argue for that rule, it requires affirmative action by the Court as the 10th Circuit took in Mallo to raise the issue.

Bankruptcy Discharge Regarding Late Filed Return Moves Forward in Third Circuit

I have previously written on several occasions, here, here, here, here, and here, about the interpretation of the bankruptcy code concerning the discharge of taxes related to tax years for which the taxpayer files a late return.  Three Circuits have ruled that when a taxpayer files a late return, even a moment late though that is rarely the case, the taxes related to that return can never be discharged because of the language added to Section 523(a) of the Bankruptcy Code in 2005.  Though the IRS does not yet agree with the determination of the Circuit courts, its representative has stated that it may have to reconsider that position if more Circuits adopt the strict reading of Section 523(a).  At present, taxpayers living outside the 1st, 5th or 10th Circuits can generally discharge their federal taxes even if they have filed a late return as long as they did not cause the IRS to prepare a substitute for return (SFR) with respect to the period.  If the IRS had to go to the trouble of preparing an SFR, it will take the position that any tax liability for the period is excepted from discharge.

Enter the next case in this saga.  On June 29, 2016, the District Court for the District of New Jersey, which is within the 3rd Circuit, entered an order certifying the issue to the 3rd Circuit from the bankruptcy court.


Mr. Davis filed a Chapter 7 petition on July 24, 2012.  He listed the IRS as a creditor for just over $100,000.  Before he filed his Chapter 7 petition, the IRS prepared SFRs for him for 2005 and 2006 since he had not had time to prepare his own tax returns.  After the IRS prepared the SFRs, sent the notice of deficiency, waited for the 90-day period to file a petition in Tax Court to run and assessed the liabilities for these two years, Mr. Davis freed up some time and filed Forms 1040 for each of the years on January 28, 2010.  The Forms 1040 he filed reduced the liability by small amounts in each year.  He waited more than two years after filing the Forms 1040 before filing his Chapter 7 bankruptcy petition.  The IRS treated the 2005 and 2006 liabilities as excepted from discharge for the reasons discussed in the prior blog posts and not because of a strict reading of Section 523(a) of the Bankruptcy Code.

Probably because the Chapter 7 case did not get Mr. Davis where he wanted to be with respect to his federal tax obligations, he filed a Chapter 13 petition on August 11, 2014.  Seems like he could have saved a lot of time and trouble by filing his returns on time or even working with the IRS when it undoubtedly began a long chain of correspondence with him about the unfiled returns, but that’s not what happened.  The IRS filed a proof of claim for over $60,000 of which a small portion was secured, a small portion was priority (for a later year) and the largest portion was general unsecured.  Mr. Davis disputed the debt from 2005 and 2006 arguing that it was discharged in his prior bankruptcy.  The bankruptcy court granted his motion.  The bankruptcy court relied on an earlier decision in the bankruptcy courts of New Jersey, In re Maitland, 531 B.R. 516 (Bankr. N.J. 2015) which had rejected the decisions of the three Circuit courts.  The Davis court also rejected the IRS argument that the Forms 1040 filed after an SFR did not cause the exception to discharge to apply.  Finding Maitland persuasive, the bankruptcy court held that “there is no timeliness requirement when determining if a filing constitutes a return for purposes of discharge” and ruled that the late filed Forms 1040 filed more than two years before the first bankruptcy petition met the requirements of Section 512(a)(2)(ii) for purposes of meeting the requirements of returns to be discharged.  The IRS filed a notice of appeal to the district court and Mr. Davis moved for certification for direct appeal to the Third Circuit.

Normally, a decision of a bankruptcy court gets appealed to the local district court; however, 28 U.S.C. 158(d)(2) provides that a litigant may appeal the decision of a bankruptcy court directly to a Circuit court if the district court certifies (1) that the matter “involves a question of law as to which there is no controlling decision of the court of appeals for the circuit or of the Supreme Court of the United States or involves a matter of public importance; (2) the judgment order, or decree involves a question of law requiring resolution of conflicting decisions, or (3) an immediate appeal from the judgment, order, or decree may materially advance the progress of the case or proceeding in which the appeal is taken”

The IRS opposed the certification which surprises me from the perspective that getting this issue resolved will reduce its exposure for a large drawer full of potentially discharged cases on which it is violating the discharge injunction.  It is certainly not clear that a resolution would result in a holding that the IRS is violating the discharge injunction on a wholesale basis but since that is, at least, a possibility, I would think that the IRS would want to resolve this issue as quickly as possible and seek certification in as many cases as possible.  The IRS opposition to certification points to exactly the problem with the position it has taken since Hindenlang.  It argues here that the issue is not a purely legal issue and that’s the rub because the IRS bankruptcy specialists sure want to treat it as if it is a purely legal issue to which they can apply mechanical tests.  The IRS seems to argue to the district court that the discharge issue here is “heavily dependent on the particular facts of the case.”  Why it would want to make such an argument is mind boggling.  Does it think that its bankruptcy specialists are making case by case decisions?  Does it want them to do so?  The IRS should be desperately seeking a legal decision.  It has tens of thousands of these cases to review and cannot possibly make a heavily dependent factual determination.  I did not go and read the IRS brief but only the characterization of its position.  The district court says that the IRS characterized the bankruptcy court’s decision as fact dependent.  Maybe that is the distinction between my concerns and its arguments but it should want the court to treat it as a legal decision rejecting its argument.

Because this case is between the IRS and the debtor, the issue of the one moment late rulings of the three circuit courts will not necessarily be argued to the 3rd Circuit.  The 3rd Circuit, however, will not be blind when it starts researching this issue and when it reads the last paragraph of the district court order.  In the Mallo case the 10th Circuit got to the one moment late issue even though only the IRS was before it.  The Third Circuit will quickly discover that there is a very simple way to dispose of this case that does not turn on intent or the bankruptcy court’s view of the timeliness requirement vis a vis SFRs.  So, this may be the next case to address the issue regarding the late filing of a tax return and the discharge of the liabilities for the year(s) when the returns are filed late.

The 11th Circuit Bypasses the Chance to Rule of the Late Return Issue

In Justice v. United States, the 11th Circuit had the chance to become the fourth Circuit Court to rule on the impact of the unnumbered paragraph, aka (*) paragraph, at the end of B.C. 523(a).  It passed on the opportunity and went back to the roots of this issue before siding with the majority of Circuit Courts that addressed this issue based on the pre-2005 law.  Mr. Justice loses because the majority of Circuit Courts deciding the issue prior to 2005 held that debtors filing a Form 1040 in circumstances similar to his were not filing a tax return under the Beard test.  I think everyone loses because the opinion just defers to another day the resolution of the (*) paragraph problem.  I have written about this issue on numerous occasions and the last post has links to the earlier ones.


The Justice case provides a nice review of the law as it existed when Congress tried to fix the problem in 2005. Because the Court essentially ignores, or leaves for another day, the 2005 legislation, those following this issue simply have another opinion that follows the way the case law was developing prior to the legislative change. By deciding the case based on pre-2005 law, the 11th Circuit did a disservice to those concerned about this issue including debtors and the various taxing authorities trying to decide how to deal with this discharge provision. Both sides need a speedy resolution to a problem that has persisted for 18 years since the Sixth Circuit decided Hindenlang.

Resolution of the issue is important for debtors because so many individuals fail to timely file their returns. These individuals need to know if their failure to timely file the return means that they are forever barred from using bankruptcy to discharge the taxes or have some hope for relief that seems to exist in B.C. 523(a)(1)(B)(ii). The taxing authorities need to know because every day they must make a decision on whether to discharge a debtor in these circumstances. The longer the uncertainty lingers, the more debtors that have what may ultimately turn out to be a wrongful discharge determination and the more trouble the taxing authorities will have unwinding the situation. The IRS continues to resist applying the harsh discharge rule as interpreted by three Circuit Courts but it has no obligation to continue to do so in the face of continuing uncertainty and given the certainty that the harsh rule provides.

The problem with the pre-2005 state of the law and the problem that the Justice opinion prolongs is the difficulty of administering a law concerning discharge based on a case by case factual determination of whether the late for 1040 represents a meaningful attempt to file a return under the Beard test, there by resulting in a discharge, or does not represent a good faith attempt to file, thereby resulting in an exception to discharge. The IRS has offered a post-2005 alternative which provides certainty, viz., if the debtor does not file the return until after the IRS makes an assessment based on an SFR then the debt is always excepted from discharge because it is not a return and if the debtor files the late return before an assessment based on an SFR then the two year rule applies. The IRS offered up this outcome to the 11th Circuit but it was not buying what the IRS was selling. So, it sticks the parties with the factual determination test.

To its credit the 11th Circuit seems to choose the “best” of the factual determination cases – Moroney out of the 4th Circuit but Moroney is still a factual determination case at its heart although one in which the debtor will almost always lose making it easy for the IRS to administer and for debtors to predict the outcome. The application of the Moroney rules will almost always create the same result the IRS seeks in its post-2005 argument for a legal test but it does not quite get all the way to the legal test.

Last week I was working on a case in the clinic that demonstrates the problems with the application of the harsh (*) rule and cries out for a simple solution. The individual owes for three years and has a total liability over $60,000. For each of the three years he was running a small business and requested an extension of time to file his return. He clearly filed two of the three returns on time but he may have filed the third year late by a week or two. The year is old and I am trying to get a definitive answer on when the return was filed because it is so critical. The individual has a very low income now but has recently married someone with a good income. Because of her income, I do not think he can obtain an offer in compromise without a very high payment. He is someone who has always filed. With the possible exception of the one year where I am trying to find out if the return was timely filed or filed shortly after the extended due date, he has always filed timely. The IRS did not impose a late filing penalty on him and would have abated the penalty based on its first time abate rules if it had imposed the late filing penalty. Yet, if it turns out he did not timely file, he cannot discharge this debt in bankruptcy because he lives in the First Circuit. Because he got married to someone with a good and stable income, he also cannot obtain an offer unless his new spouse is willing to pay off his long outstanding and substantial tax debt. Understandably, she is not excited about paying off his old tax debts and the situation is putting a strain on their relationship. So, he may end up waiting out the statute of limitations on collection and putting pressure on his marriage.

This is a wasteful policy dilemma. Section 523(a)(1)(B)(ii) set up a system to allow late filers to still obtain a discharge if they waited extra time. In the case of my client, who, if he filed late, did so immediately after the due date, would not even have to wait extra time because of the timing of his filing. Yet, he appears to be prevented from obtaining a discharge for this year. By demurring on the correct interpretation of (*) the 11th Circuit sentences those seeking to know the answer to a longer wait. No matter which way it ruled, having the opinion of the 11th Circuit on (*) would have helped to move the issue to resolution faster.

Les’ post discussing how  filing within 10 days of an e-file rejection will still result in a timely return.  This work around will not present itself often but is worth remembering for those situation where your client has tried and failed to timely file their return electronically.

9th Circuit Bankruptcy Appellate Panel Decision on Unfiled Returns Takes Issue Back to the Future

I have written several times, here, here, here, here and here, on the case law that has developed after the 2005 amendments to section 523 of the bankruptcy code addressing the ability to discharge taxes when the taxpayer files the return late.  In 2015 two circuit courts, Mallo in the 10th and Fahey in the 1st, followed In re McCoy in the 5th and held that when an individual taxpayer files a return late, even one day late, the tax liabilities related to that return can never qualify for discharge.  These courts reach this result based on a literal interpretation of the unnumbered paragraph added to the end of 523(a)(hereinafter 523(a)(*)) in 2005.

A 9th Circuit bankruptcy panel, in the case of Martin v. United States examines and rejects the emerging case law applying a literal interpretation to 523(a)(*).  The court not only works its way through the literal interpretation argument but addresses and rejects the IRS’ current position resulting in an opinion that essentially finds the law unchanged by the 2005 legislation.

Before discussing the opinion, it is worth pausing for a moment to discuss bankruptcy appellate panels so that the opinion can have some context as it relates to the three circuit level opinions that currently exist. Bankruptcy courts reside beneath federal district courts in the pecking order for precedent.  Without getting into the constitutional issues created by the 1978 Bankruptcy Code and the resolution of those issues, it is safe to say that bankruptcy judges are not Article III judges and that their opinions, when appealed, go to the district court before going to the circuit court and then to the Supreme Court.  In 1978 Congress gave circuits the option of creating bankruptcy appellate panels as a place to appeal the decision of a bankruptcy judge.  In 1994 Congress said all circuits would have such panels.  The bankruptcy appellate panels consist of three bankruptcy judges.  The decision of the bankruptcy appellate panel goes to the appropriate circuit court.  There is more that could be said about these panels but for purposes of this discussion, I simply want to place them on the map of federal courts for those not familiar with bankruptcy procedure.  So, the opinion that this post will discuss will now go to the 9th Circuit if appealed and does not itself create a conflict among the circuits.


The opinion has an interesting format because it leads off talking about misguided nature of the opinions holding that a return filed one day late must forever be denied a discharge. After the clear statement in the opening paragraphs, the court circles back to the facts before working its way through the legal arguments.  Because I very much agree with the views of the BAP regarding the literal reading of the 2005 amendment, the opening paragraphs made for enjoyable reading.

The facts of the case essentially mirror those of all cases of this genre. The taxpayers did not file returns for several years.  The IRS sent them notices about that fact.  They did not act in response to the notices.  The IRS eventually sent the Martins notices of deficiency for the years at issue.  The notices of deficiency inspired them to go to a preparer and get the returns prepared; however, they defaulted on the notices allowing the IRS to assess the liabilities.  The Martins then filed the missing returns and the IRS abated its assessments to reflect the liabilities reported on the late filed returns.  The Martins waited two years after filing the late returns and filed a chapter 7 bankruptcy.  They sought a determination that the liabilities on the late returns were discharged.  The IRS objected.

In deciding the case the BAP looked at three possible bases for reaching the correct conclusion. First, it examined the interpretation of discharge developed by the three circuits making the literal interpretation of 523(a)(*).  Second, it examined 9th Circuit law that had developed prior to 2005 on the issue of unfiled returns and finally, it addressed the argument advanced by the IRS regarding the effect of an assessment prior to the filing of the late return – an argument developed post 2005.

As mentioned above the BAP rejected the literal reading of 523(a)(*). I t found that such a reading did violence to the statutory scheme of discharge developed in 1978 with the passage of the bankruptcy code.  In addition, it found that the literal interpretation did not make sense even within the new paragraph added in 2005 and that the literal interpretation of that paragraph could not be resolved with the language of 523(a)(1)(B).  The opinion provides a roadmap for those who disagree with the literal interpretation provided by the three circuit courts.  If the case is appealed and if the 9th Circuit follows the BAP, a clear conflict will exist among the circuits which might create a path for resolution of this issue.

After knocking down the literal argument, the BAP turned its attention to the controlling precedent of its circuit. It found that the controlling precedent relied on the Beard test for determining “what is a return?”  The BAP held that the 2005 amendment sought to codify the Beard test and prior 9th Circuit precedent.  This aspect of the decision is also important.  I disagree with the BAP on its interpretation of the goal of the 2005 language because the effort to change the code sprang not from an effort to codify the case law imposing the Beard test but to creating an easily administrable rule.  The Beard test involves a fact intensive look at the circumstances of each case.  The taxing authorities do not want this both because it requires more resources than they want to devote to this issue and it makes the issue one which will require frequent litigation to resolve the fact intensive question.  This result is not what the taxing authorities sought in pushing for the amendment but may be what they got if the literal language is rejected.

Finally, the court looked at the argument the IRS now pushes. This is an easily administrable position and one which is much more lenient than the literal language argument but one that the BAP did not buy.  The IRS argues that once it has made an assessment of the tax for a year, any return filed after that assessment is not a return for purposes of triggering the two year rule in 523(a)(1)(B)(ii).  The BAP rejected this because it did not agree that the trigger point is the assessment date.  The liability goes back to the end of the tax year and does not start with the assessment.  The assessment of the tax, almost always done in these cases after the issuance of a notice of deficiency to a taxpayer who has refused to filed the return, does not have any special meaning in the statutory scheme of 523.  The IRS position has the attraction of easy administrability and the opportunity for a taxpayer to correct the unfiled return situation long after the close of the tax year, but it is hard to find support for the position in the language of the statute.

So, the BAP takes us back to the pre-2005 legislation on this issue with the only impact of the legislation, in the opinion of the BAP, being the codification of the position the 9th Circuit had previously staked out (along with several other circuits.)  If the BAP position prevails, taxpayers are clear winners vis a vis the literal interpretation test because they have time to fix their failure to file and still obtain the benefit of a discharge.  In pre 2005 cases most taxpayers who waited for the IRS to make an assessment before filing a late return lost in their attempt to get the liability discharged.  Taxpayers will still lose their discharge cases under the BAP opinion in most cases where they wait until after assessment to file the late return but the clear losers if the BAP opinion prevails are the tax administrators who must do more fact investigations and face more litigation when trying to resolve the discharge issue created by a late filed return.