Is the One Day Late Interpretation of Bankruptcy Code 523 Finally Headed to the Supreme Court?

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After the passage of the 2005 amendments to the bankruptcy code an issue developed concerning the discharge of taxes on late filed returns.  The 2005 amendments resulted from the appointment of a commission in 1994 to look into needed changes to the bankruptcy code after almost two decades of experience with the code.  The commission appointed a subcommission to look into the tax issues impacting bankruptcy matters.  The commission and the subcommission did excellent work fairly quickly and turned their recommendations over to Congress.  Congress struggled to come to closure on the recommendations stemming from this effort.  Finally, in 2005, about eight years after the recommendations came forward, Congress passed comprehensive legislation reforming the bankruptcy code.  One of the big issues on the tax piece of the recommendations concerned the need to address the many taxpayers who filed bankruptcy seeking relief but who had neglected to file their tax returns over numerous years.

Congress addressed the delinquent return filing in numerous code sections including a new and unnumbered code section at the end of BC 523(a) concerning the discharge of taxes for non-compliant taxpayers.  For some reason it chose not to put a number or a letter before this paragraph but simply stuck the new paragraph onto the end of 523(a).  Having made life difficult for everyone seeking to cite to the new material, Congress went further by making this unnumbered and unnamed subparagraph difficult to understand.  I have written numerous blog posts on the interpretation of this section including one last October.  For a sampling of the posts, see here, here, here and here.  In some I predicted that this issue would be resolved in the Supreme Court if Congress did not fix the language of the statute.  Since no one expects Congress to fix anything, this means it’s up to the Supreme Court to resolve the language.  In the recent decision of Massachusetts Department of Revenue v. Shek, — F.3d __ ( D.C. Docket Nos. 5:18-cv-00341-JSM; 6:15-bkc-08569-KSJ) (11th Cir. Jan. 23, 2020) a perfect conflict case has arisen.  The opportunity for a Supreme Court resolution seems quite possible though by no means certain.

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The Massachusetts Department of Revenue (MA DOR) is now the litigant in cases before the First and the Eleventh Circuits with the circuits reaching opposite conclusions.  Five years ago, in the case of Fahey v. Massachusetts Department of Revenue, 779 F.3d. 1 (1st Cir. 2015), the First Circuit interpreted the last paragraph of BC 523(a) to mean that if a taxpayer filed a return late, even one day late, the taxpayer could never discharge the tax liability for that year.  In reaching this conclusion the First Circuit joined two other circuits in holding that the plain language of the statute required this result.

Since the Fahey case, other circuits have demurred when given the opportunity to adopt the one-day rule.  No decision has yet reached the Supreme Court.  The Eleventh Circuit’s decision creates a clear conflict.  It not only specifically considers and directly rejects the decisions of three circuit courts but does so with a plaintiff who was also the litigant in the First Circuit’s decision. 

MA DOR filed a claim in the bankruptcy of Mr. Shek for unpaid taxes for a year in which he did not timely file his state tax return.  MA DOR did not receive full payment of its claim in the bankruptcy case and instituted collection action against Mr. Shek after the lifting of the stay and the granting of the discharge.  Mr. Shek opposed the collection action of MA DOR, arguing that the discharge eliminated the liability and that the actions of MA DOR violated the discharge injunction.  MA DOR countered that he filed his tax return late for the period at issue and BC 523(a) excepted this liability from discharge because of the late filed return.  The litigation started in the bankruptcy court and has now moved on to a circuit court decision.

The Eleventh Circuit looked carefully at the language of the paragraph added in 2005 to determine if it could find a meaning different than the meaning of the three circuits and to find a meaning consistent with the language of BC 523(a)(1)(B).  With the help of an amicus brief from University of Michigan law professor John Pottow, the Eleventh Circuit found a way to interpret the new paragraph in a way that did not result any late filing automatically creating an exception from discharge.

The language added in 2005 sought to provide a definition of the term “return” which was not previously defined in the tax code or the bankruptcy code.  The Eleventh Circuit described the new language as follows:

In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”), which for the first time added a definition of “return” to the Code. The definition states:

For purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or similar State or local law.

11 U.S.C. 523(a)(*).

The Eleventh Circuit described the dispute as follows:

The dispute in this case concerns the first sentence of the hanging paragraph’s definition of “return”, which provides that a “return” for purposes of § 523 means “a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” DOR raises two arguments in an attempt to demonstrate that Shek’s putative return, which was filed seven months late, does not qualify as a “return” under § 523(a)(*). First, DOR argues that the return did not satisfy “applicable filing requirements” because it did not comply with Massachusetts’ April 15th tax return deadline. Second, and relatedly, DOR argues that the “applicable nonbankruptcy law” here is Massachusetts law, and that Massachusetts defines a “return” by reference to its timeliness. We address each argument in turn.

In analyzing this argument, the Eleventh Circuit conceded that MA DOR’s argument had some merit:

DOR’s syllogism—a return must comply with “applicable filing requirements,” and a filing deadline is an “applicable filing requirement,” so a return that does not meet its deadline has not complied with “applicable filing requirements”—has some force to it….  We do not, however, agree that the phrase “applicable filing requirements” unambiguously includes filing deadlines….  But it is not obvious that this is the interpretation Congress intended in drafting the hanging paragraph. Notably, this understanding of the word “applicable” would add little to the phrase “applicable filing requirements” that the phrase “filing requirements,” standing alone, would not already encompass. We must strive, if possible, to give meaning to every word of the Code.

The Court then turned to the argument made by Professor Pottow:

He notes that the Supreme Court, in interpreting a different section of the Code, has described “applicable” as meaning something different from “all”; it requires an analysis of context and typically means “appropriate, relevant, suitable or fit.”….  The amicus argues that the “appropriate, relevant, suitable or fit” filing requirements are those concerning what constitutes a return. For example, “applicable” filing requirements could refer to considerations like a return’s form and contents—aspects of the putative return that have a material bearing on whether or not it can reasonably be described as a “return”—but not to more tangential considerations, like whether it was properly stapled in the upper-left corner, or whether it was filed by the required date. This approach makes common sense; in a definition of what constitutes a “return,” it makes sense that the term “applicable” would relate to matters that are relevant to the determination of whether the document at issue can reasonably be deemed a “return.”

The Court describes both the MA DOR and the amicus arguments as plausible interpretations of the language of the statute.  Given that both are plausible, the argument made by the amicus makes the most sense because it provides the most harmony with the other parts of BC 523.  The Court points out that the MA DOR makes BC 523(a)(1)(B)(i) almost a legal nullity and that as a practical matter almost no factual situations exist that prevent this outcome because so few taxpayers agree to the substitute for return by creating a 6020(a) return.  The court had previously analyzed that the only way the MA DOR argument really worked was in situations in which the taxpayer filed a form 6020(a) return.  The court also noted that the IRS did not agree with MA DOR’s interpretation of the statute.  The court concluded:

We think it is deeply implausible that Congress intended § 523(a)(1)(B)(ii) to apply only in such a handful of cases despite no such limitation appearing in that provision itself. It would be a bizarre statute that set forth a broad exclusion for discharge of tax return debts, but limited the application of that exclusion via an opaque and narrow definition of the word “return.” It would be even stranger to enact the broad exclusion in § 523(a)(1)(B)(ii), only to later amend the statute, not by changing the text of § 523(a)(1)(B)(ii) itself, but with a different definitional provision that would cabin § 523(a)(1)(B)(ii) into applying only to the “minute” number of § 6020(a) returns. If Congress had intended this result, it could have achieved it in a much less abstruse manner simply by stating in § 523(a)(1)(B)(ii) itself that that section applied only to § 6020(a) returns.

I agree with the Eleventh’s Circuit’s interpretation of the correct way to read the statute.  After it disposed of the main argument, the Court still had to deal with an argument based on the statutes in Massachusetts.  While acknowledging that this also was a close case, the court rejected the specifics of the Massachusetts statute as a basis for not excepting the liability from discharge.

So, will MA DOR take this case to the Supreme Court and if it will, what will the Supreme Court do?  MA DOR may decide to stick with the bird in the hand.  It has the decision it wants in the First Circuit where the vast majority of persons owing MA DOR reside.  If it files a cert petition, it risks losing the argument and losing a major legal source for keeping open its assessments after a bankruptcy discharge.  Because of this possibility, MA DOR may take a pass on the opportunity to go to the Supreme Court.  The upsides do not outweigh the possible downsides.

On the other hand, many Massachusetts taxpayers live outside of Massachusetts.  Allowing the decision to stand allows these persons to discharge their taxes when persons still living in the state (or at least in the First Circuit) remain liable.  Massachusetts may feel that it is best to have a definitive answer.  If Massachusetts did file a cert petition, it is very possible that the solicitor general would lend a voice to granting cert because of the impact of this issue on the IRS (and potentially other parts of the federal government.)  Those living in circuits in which the issue is already decided will have their own views as well.  People in the Ninth Circuit will not want to roll the dice on the chance that the Supreme Court could reverse their current situation.

Comments

  1. Lavar Taylor says

    This attorney in the Ninth Circuit wants the issue resolved by the Supremes. Right now, any attorney worth their salt in the Ninth Circuit who provides advice to clients who filed late returns has to prepare a CYA memo about what could happen if a state tax agency in the
    Ninth Circuit prevails on the “one day late” argument at the Circuit level or if the Supremes grant cert on this issue. The uncertainty is itself a problem. Let’s get an answer from the Supremes.

    Also, I feel confident about the taxpayers/debtors prevailing on this issue in front of the Supremes.

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