Experienced Tax
Accountant –The Court
of Appeals for the First Circuit has held that, except with respect to returns
prepared with the assistance of IRS under Code Sec. 6020(a), debts for unpaid
taxes from late-filed tax returns are not dischargeable in bankruptcy. In so
doing, it came to the same conclusion as the Fifth and Tenth Circuits.
Background. 11 USC
727(b) provides for the discharge of all debts that arose before the date of a
bankruptcy discharge order, except as provided in 11 USC 523. 11 USC 523(a)(1)
excludes from discharge any debt for a tax “... (B) with respect to which a
return..., if required (i) was not filed or given; or (ii) was filed or given after
the date on which such return, report, or notice was last due, under applicable
law or under any extension, and after two years before the date of the filing
of the petition...”
11 USC 523(a)(1) also
provides in flush language to that section (in what the First Circuit called
“the hanging paragraph”) that, “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 Code Sec. 6020(a)..., but does not
include a return made pursuant to Code Sec. 6020(b).” The hanging paragraph was
added to the Code in 2005, well after the rest of 11 USC 523(a)(1).
Code Sec. 6020(a) refers
to a return prepared by IRS with the assistance of the taxpayer, and Code Sec.
6020(b) refers to a return prepared by IRS without the assistance of the
taxpayer. Code Sec. 6020(a) returns are allowed only at IRS's request; returns
filed under Code Sec. 6020(b) may involve willful fraud.
To qualify as a return
under the Beard four-pronged test: (1) a document must purport to be a return;
(2) it must be executed under penalty of perjury; (3) it must contain
sufficient data to calculate tax liability; and (4) there must be an honest and
reasonable attempt to satisfy the requirements of the tax law. (Beard, (1984)
82 TC 766)
Facts. The taxpayers all
failed to timely file their Massachusetts income tax returns for multiple years
in a row. They also failed to pay (either timely or otherwise) their taxes to
the Massachusetts Department of Revenue. Eventually, each debtor filed his late
tax returns, but still failed to pay all taxes, interest, and penalties that
were due. More than two years later, they filed for Chapter 7 bankruptcy.
First Circuit says “no
discharge.” The Court ruled that the plain meaning of the hanging paragraph,
when read together with the language of the applicable Massachusetts law, which
itself was very similar to the applicable Code section, meant that a Massachusetts
tax return filed after the due date for that return is not a “return” for
purposes of 11 USC 523(a)(1) and thus debt with regard to such a return is not
dischargeable.
The Court said that,
looking solely at the non-hanging paragraph part of 11 USC 523(a)(1), and using
a common notion of what a “return” is, one could easily conclude that any
return filed after the due date but more than two years before a bankruptcy
filing would place the tax due under that return outside the 11 USC 523(a)(1)
exception, and thus within the broad category of dischargeable debts. Prior to
2005, courts nevertheless attempted to fashion a definition of “return” that
prevented debtors from relying on “bad faith” returns, or returns filed only
after the taxing authority actually issued an assessment for taxes due in the
absence of a tax return. (In re Moroney, (CA 4 2003) 92 AFTR 2d 2003-7381)
In 2005, Congress
decided to define “return” on its own when it passed the Bankruptcy Abuse
Prevention and Consumer Protection Act, which included the hanging paragraph.
It provided that, to be a return, a document must satisfy the “applicable
filing requirements.”
Like Code Sec. 6072, the
relevant Massachusetts statute provided that income tax returns “shall be filed
on or before” a given date. And, the Court said, like the Tenth Circuit in
Mallo, (CA 10 2014) 114 AFTR 2d 2014-7022, and like the Fifth Circuit in McCoy
v. Mississippi State Tax Commission, (CA 5 2012), 666 F3d 924: a) where the
language of the statute is plain, it must be interpreted in accordance with the
usual and natural meaning of the words, b) here the language of the statute is
plain, and c) the phrase “shall be filed on or before” a particular date is a
classic example of something that must be done with respect to filing a tax
return and therefore is an “applicable filing requirement.”
The taxpayers and a
dissenting judge had made a series of arguments to the effect that the 11 USC
523(a)(1) language was not “plain,” all of which the Court rejected.
First, the Court said
that the dissent relied on the accurate premise that, when a statute states
that the universe of X “includes” Y, one normally presumes that Y is merely an
example of what is in X, and that X includes more than Y. The Court said that
the dissent erred, though, in claiming that the Court's interpretation fails to
satisfy this premise. The dissent made this error by presuming that the
universe defined by the statute is “late-filed returns that count as returns,”
and that Code Sec. 6020(a) returns (and “similar” state or local law returns)
are therefore simply examples of a wider array of permitted late filed returns.
The statute neither says nor implies any such thing. Rather, the statute
provides that a “return” includes a “return prepared pursuant to Code Sec.
6020(a). . . or similar State or local law.” So one presumes only that a
“return” includes more than these few types of returns. And it plainly does: it
includes all sorts of returns that satisfy their respectively applicable filing
requirements.
Second, the Court said,
the dissent erred in claiming that the Court's reading of the statute “means
that, conversely, a Code Sec. 6020(b) return would be the only type of return
that is not a return.” This is plainly not so—any type of return not filed in
accord with applicable filing requirements is not a "return" under
the Court's reading of the statute. The returns at issue in this case were a
notable demonstration that Code Sec. 6020(b) returns are not the only ones that
are not returns under the statute.
Third, the taxpayers
pointed to the language of 11 USC 523(a)(1)(B)(ii) (“the two-year provision”),
which they said clearly implies that there can be a “return” that is filed
within two years “after the date on which such return . . . was last due.” They
said that this means that the hanging paragraph cannot be read as entirely
excluding the possibility that a late return can also be a “return.” The
taxpayers contended that the Court's interpretation would “vitiate in its
entirety” the two-year provision, rendering it “superfluous,” thus violating a
standard rule of statutory interpretation.
The Court said that the
defect in this argument is that the hanging paragraph itself carves out an
exception from its general rule, deeming one type of late return to be a
return. It specifies that “a return prepared pursuant to Code Sec. 6020(a). . .
or similar State or local law” qualifies as a “return,” while those prepared
pursuant to Code Sec. 6020(b) do not. Code Sec. 6020(a) and Code Sec. 6020(b)
can both be invoked when a taxpayer "fails to make" a proper return,
including situations where the taxpayer is late in filing a return to IRS
Therefore, a late tax return, if prepared in compliance with Code Sec. 6020(a)
and filed within two years of the bankruptcy petition, is still a return (and
the tax due thus dischargeable), notwithstanding its failure to meet the
otherwise "applicable filing requirement" of a mandatory deadline.
The fact that a late-filed Code Sec. 6020(a) return can still qualify as a "return"
for 11 USC 523(a) purposes means that the two-year provision still has a role
to play if the hanging paragraph's plain meaning controls.
Fourth, the dissent
deemed it "absurd" to think that Congress would allow a discharge of
taxes due with respect to a Code Sec. 6020(a) return prepared years after the
due date, but not with respect to any other return that is one day late. The
Court said that it saw no absurdity. Code Sec. 6020(a) is a tool for IRS,
invoked solely at its discretion, when it decides obtaining help from the late
filing taxpayer is to IRS's advantage. That Congress left IRS a carrot to offer
a taxpayer in such infrequent cases does not mean that it was absurd for
Congress not to extend this carrot categorically to large numbers of other late
filers.
Finally, the taxpayers
argued that the Court's reading of the hanging paragraph still renders
unnecessary its last clause, i.e., the clause that states that the term
"return" does not include "a return made pursuant to Code Sec.
6020(b)." The Court said that the taxpayers were correct on this point.
Nevertheless, the Court said that it did not see this as the type of redundancy
that invokes any effective application of the doctrine that a court try to read
statutes so that no section is superfluous. Here, in context, it simply appears
that in creating an exception for Code Sec. 6020(a), the drafters made clear
(desiring a belt and suspenders) that they were not including its companion
Code Sec. 6020(b). Whatever one thinks of this redundancy, it offers too little
to parry the force of the observation that a requirement to file on time is a
filing requirement.
References: For denial
of discharge of taxes in bankruptcy where no return was filed or the return was
filed late, see FTC 2d/FIN ¶ V-7364 ; United States Tax Reporter ¶ 68,734.01
; TG ¶ 72009 .
If you would like more details about these or any other aspect
of the law, please do not hesitate to call. I look forward to hearing from you. Click this link to
view our YouTube video http://youtu.be/EYJdQtbPZAI
Amare
Berhie
(651)
621-5777, (952) 583-9108, (612) 224-2476, (763) 269-5396
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