I have written before here, here, here, and here on the issue of discharging the tax liability when a taxpayer files the return late. Three circuit courts have interpreted the language added in the 2005 amendments to the Bankruptcy Code (see the unnumbered paragraph at the end of section 523(a)) to prohibit discharge of taxes if a taxpayer files a return even one day late. The Supreme Court denied cert in the first of these three decisions, In re McCoy cert denial, a couple of years ago. The Solicitor General urges the Court to deny cert in Mallo, while the First Circuit denied rehearing in Fahey v. Massachusetts Department of Revenue in late April 2015 (no petition for cert has been filed at this time).
This post seeks to update readers on the position of the United States in case anyone needs to closely follow this issue. I will briefly recap the issue and then link in the Solicitor’s brief on behalf of the United States requesting that the Court deny cert.
read more...As described before, the issue started back in the late 1990s with a 6th Circuit case, Hindenlang, in which that court held that a Form 1040 filed after the IRS made an assessment using the IRC 6020(b) procedures did not qualify as a return for the purposes of triggering the running of the two year waiting period set out in B.C. 523(a)(1)(B)(ii). Section 523 enumerates about 20 types of debts excepted from discharge, i.e., not discharged. At issue in Hindenlang was a provision excepting from discharge returns filed late. The rule regarding late returns allows discharge where the late return arrives at the IRS more than two years before the filing of the bankruptcy petition. After the IRS went to the trouble of assessing Mr. Hindenlang using the substitute for return provisions, he decided to file a return and wait to years and then file bankruptcy. For some reason, he also decided to file a Form 1040 containing information identical to the information on the substitute for return prepared by the IRS. The 6th Circuit, applying the Beard test developed by the Tax Court for determining whether a document is a return, found that Mr. Hindenlang’s Form 1040 did not meet the test to qualify as a return and, therefore, did not start the two year period running.
While the outcome was favorable to the IRS the fact intensive nature of the Beard test did not work well with the procedure the IRS used for processing discharged taxes. So, the IRS pressed for a change in the bankruptcy code in order to obtain a clear, easily administrable rule. In 2005, Congress passed what three circuits have found to be a clear rule and one that is easily administrable, so far so good, but one that clashes with another bankruptcy section as interpreted by these circuits and creates an extremely harsh result the IRS does not embrace.
The Mallo case, the third of the trilogy of clear but harsh circuit opinions interpreting the new discharge language finds the taxpayers seeking cert to overturn the result which has left them liable and unable to discharge all of the taxes on the late filed years. The circuit cases create one rule, the pre-2005 circuit decisions create another rule looking to the fact intensive Beard test and the IRS argues for a third rule, as set forth in its 2010 Chief Counsel Notice stating that if the late return comes after the IRS has assessed the taxes for that year the late return provides no benefit in determining the discharge of the taxes. This mess of differing positions between the courts, the states and the federal government has left the discharge of taxes when the taxpayer files a late return – something that happens hundreds of thousands of times each year – in disarray. The uncertainty causes different governments to keep or remove taxes in different ways and will have a lasting impact for the duration of the statute of limitations on collection unless the governments have carefully marked these cases to allow a quick fix once the dust settles on the issue.
Rather than argue that the law is a mess that needs correcting, the Solicitor General argues that the taxpayer in Mallo would have lost his case under any of the theories and, therefore, the Supreme Court should not accept the case for cert. In its brief the Solicitor states:
“The court of appeals’ judgment is correct, does not implicate any conflict among the courts of appeals, and does not warrant further review. The court below held that, if a Form 1040 is filed late, the tax debt is non-dischargeable under Section 523(a)(1)(B)(i). The court reasoned that a late-filed Form 1040 is not a “return,” as defined by Section 523(a)(*), because it does not satisfy “applicable filing requirements.” Every other court of appeals to consider the issue has reached the same conclusion.
The IRS has interpreted Section 523(a)(*) in a somewhat more forgiving manner, so that the late filing of a Form 1040 will preclude discharge only if the IRS has already assessed the tax debt by the time the form is submitted. That disagreement has no impact on the disposition of this case, however, because the court of appeals’ judgment is correct under either approach. Petitioners did not merely file their Forms 1040 late. They filed their forms “long after the IRS had determined liability, provided notices of deficiency and assessed the taxes.” Pet. App. 80a. The courts of appeals and the IRS agree that a tax debt cannot be discharged in that circumstance. Further review is not warranted.”
See the full brief here.
The Solicitor’s position concerning the case correctly states the situation but, if accepted by the Court, will leave the mess to continue until some future date when Congress fixes the problem, a conflict in the Circuit court decisions occurs or the specific rule applied drives a different outcome. We will continue to follow the cases.
I am probably repeating myself, but it seems to me that, if a Form 1040 filed late can trigger the running of the three years statute of limitations on making audit assessments under section 6501 and can serve as the basis for a criminal prosecution for filing a false return under section 7206, that Form 1040 should be treated as a “return” for purposes of discharging the tax liability associated with that Form 1040 in a bankruptcy case.
Thanks for the update, Keith!
I agree. In addition, refusing to allow a discharge of taxes based on a substitute return after which the taxpayer filed its own original return undermines one of the fundamental policies behind the bankruptcy code: a fresh start. I do not think that a tax debt based on a return filed by the taxpayer after the IRS filed a substitute return is on the same level as trust fund taxes; debts induced thru fraudulent behavior, debts resulting from willful or malicious injury to another or other similar debts all of which are exempt from discharge. I just do not put this sort of thing in the same category.
https://www.irs.gov/pub/irs-ccdm/cc_2010_016.pdf
What happens when the IRS disagrees with the Courts as it has in the OCC’s notice in 2010? Does the Court simply ignore the IRS’s interpretation and refuse to discharge the tax debt?
The IRS is administratively following the position set out in the 2010 notice and IRM 5.9.17.7.1. It will discharge the taxes of someone who files their return late if the taxes for that year otherwise meet the criteria for discharge that the IRS has established. In litigation, the IRS is bound by circuit authority and would recognize that authority. In a specific case, like Mallo, where the court has determined the debt to be excepted from discharge, I believe the IRS will treat the debt as excepted from discharge and continue to collect on that debt. Because I am not practicing bankruptcy and do not have clients in the 1st, 5th and 10th circuits you might seek out a practitioner in one of those circuits to tell you what the IRS is doing with respect to their clients where the return was filed late but would otherwise meet the IRS criteria for discharge.