No Reasonable Cause Shown for Bankruptcy Trustee's Untimely Filed Returns; IRS's Claim for Penalties as Administrative Expense Disallowed.
(Parker's Federal Tax Bulletin: August 14, 2013)

Because a bankruptcy trustee did not show reasonable cause for late filing of the bankruptcy estate's S corporation tax returns, late-filing penalties were upheld; however, the penalties did not constitute a priority administrative claim under Bankruptcy Code Section 503(b)(1)(A), and the case was remanded to see if the penalties qualified as an administrative expense for other reasons. In re 800Ideas.Com, Inc., 2013 PTC 222 (B.A.P. 9th Cir. 7/22/13).

In January 2007, 800Ideas.Com, Inc., an S corporation, filed a Chapter 7 bankruptcy petition. Richard Kipperman was appointed as the bankruptcy trustee. The corporation's liabilities exceeded its assets, and its main asset was a potential right in an excise tax refund for 2006. In March 2007, Richard asked the debtor's prepetition accountant to prepare the 2006 tax return. He was advised that the return would be completed by April 2008. However, the return was not completed and filed until January 2010. The IRS processed the return and disallowed $1,950 of the $38,197 claimed refund. The bankruptcy estate received the refund in June 2011. In July 2011, a second accountant completed and filed the debtor's 2007, 2008, 2009, and 2010 returns. The 2008 and 2010 returns stated that the debtor had zero tax liability. After processing the returns, the IRS assessed penalties against the debtor for 2008 and 2010 failing to timely file its returns.

The IRS filed a Request for Payment of Internal Revenue Taxes in bankruptcy court based on the 2008 and 2010 late-filing penalties and asserted that the penalties were an administrative priority expense. Richard objected to the claim, arguing that his failure to timely file the debtor's tax returns was due to reasonable cause. The bankruptcy found that Richard had no reasonable cause to delay filing the returns at issue while waiting for the excise tax refund and allowed the IRS's claim for penalties as an administrative expense. Richard timely filed a notice of appeal of the bankruptcy court order.

Code Sec. 6037 provides that an S corporation must file a return each tax year. When a corporation files for bankruptcy, it is the trustee's duty to file the corporation's tax returns. A penalty is imposed under Code Sec. 6699 if an S corporation fails to timely file a return unless the failure was due to reasonable cause. The penalty is $195 a month times the number of S shareholders. If the corporation has no assets or income, the trustee may ask the IRS to be relieved of the reporting obligation by following the procedure in Rev. Proc. 84-59.

Administrative expenses of a bankruptcy estate are given second priority under Bankruptcy Code Section 507 and include the actual, necessary costs and expenses of preserving the estate under Bankruptcy Code Section 503.

Richard argued that the penalties were not based on any unpaid tax incurred by the bankruptcy estate, and the claim should be treated as a subordinated penalty claim.

The IRS contended that Richard had an obligation to file 800Idea.com's tax returns, and the corporation's insolvency did not constitute reasonable cause to excuse the assessed penalties. The IRS also argued the penalties were entitled to administrative expense priority as an actual and necessary cost and expense of preserving the estate.

The Bankruptcy Appellate Panel affirmed the bankruptcy court holding that Richard failed to show that he had reasonable cause for his delay in filing 800Idea.com's tax returns. Richard's claim that the late filing was based on his mistaken belief that the debtor's insolvency automatically relived him of the obligation to file the returns was rejected because he showed no factors that were beyond his control in filing the returns. The court noted that Richard's lack of diligence in supervising the accountants, deliberate decision to delay filing the returns, and failure to pursue the IRS procedure which may have relieved him of the burden of filing the returns provided ample basis to find no reasonable cause and sustain the assessment of penalties.

The court looked to case law in Abercrombie v. Hayden Corp., 139 F.3d 755 (9th Cir. 1998), which found that, for an administrative expense to be actual and necessary, the claim must have arisen from a transaction with the debtor in possession and must directly and substantially benefit the estate. The court noted that the primary goal of a bankruptcy case was to minimize costs to preserve limited assets of the bankruptcy estate for the benefit of unsecured creditors. The penalties were not incurred in the operation of the business and did not benefit or preserve the bankruptcy estate. Since Richard was not operating the corporation's business, to allow administrative expense priority to the IRS's claim would be detrimental to the unsecured creditors. Therefore, the penalties were not eligible for administrative expense priority. However, the court remanded the case to the bankruptcy court to determine if the penalties qualify as an administrative expense for other reasons.

For a discussion of the penalty for failing to file an S corporation return, see Parker Tax ¶36,540.

Parker Tax Publishing Staff Writers

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