Taxes Shown on Belated Tax Filings Don't Qualify for Discharge in Bankruptcy

(Parker Tax Publishing December 2022)

The First Circuit affirmed a district and bankruptcy court and held that a taxpayer's tax liabilities had not been discharged in bankruptcy and he was thus liable for the deficiencies and penalties assessed by the IRS. In reaching its conclusion, the court addressed what it called "a particularly puzzling section of the Bankruptcy Code" dealing with the definition of a "return" and determined that the taxpayer's much belated tax filings did not qualify as returns under 11 U.S.C. Section 523(a)(), thus precluding their discharge in bankruptcy. In re Kriss, 2022 PTC 370 (1st Cir. 2022).

Background

Terrence Kriss failed to file income tax returns when due for 1997 and 2000. Nor did he pay the taxes that were owed. In March of 2003, without the benefit of a return (or any other help from Kriss), the IRS assessed the tax believed to be due, including penalties and interest, for tax year 1997, in the amount of $30,568. Six months later, it calculated -- again on its own -- $46,344 in tax, penalties, and interest due for tax year 2000. The IRS thereafter undertook unsuccessful collection efforts. Subsequently, in 2007, Kriss filed Forms 1040 for years 1997 and 2000, but did not pay the long-overdue taxes. Five years later, Kriss filed a chapter 13 petition for bankruptcy.

After he received a discharge in bankruptcy in 2017, Kriss and the IRS disagreed on whether his discharge covered his debts to the IRS for the taxes due for 1997 and 2000. In In re Kriss, 2019 PTC 505 (Bankr. N.H. 2019), a bankruptcy court cited the First Circuit's decision in In re Fahey, 779 F.3d 1 (1st Cir. 2015), in holding that Kriss's tax liabilities had not been discharged, and a district court, in 2021 PTC 421 (D. N.H. 2021), affirmed. In Fahey, the First Circuit heard four bankruptcy appeals which posed a single question of statutory interpretation: whether a Massachusetts state income tax return filed after the date by which Massachusetts requires such returns to be filed constituted a "return" under 11 U.S.C. Section 523(a) such that unpaid taxes due under the return could be discharged in bankruptcy. The First Circuit concluded that it did not.

Kriss appealed the district court's decision to the First Circuit, arguing his case should turn on the application of the four requirements of the Beard test, which he claimed to have met.

Under Bankruptcy Code 11 U.S.C. Section 523(a)(1)(B)(i)-(ii), a discharge in bankruptcy does not discharge an individual debtor from any debt for a tax or a customs duty with respect to which a return, or equivalent report or notice, 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 debtor's bankruptcy petition. Until 2005, the Bankruptcy Code did not define "return" for purposes of this provision. Thus, in determining whether a filing constituted a "return," courts predominantly employed the test developed in Beard v. Comm'r, 82 T.C. 766 (1984), aff'd, 793 F.2d 139 (6th Cir. 1986). Under the Beard test, for a document to constitute a "return" (1) it must contain sufficient data to calculate tax liability; (2) it must purport to be a return; (3) the taxpayer must execute the document by signing it under penalty of perjury; and (4) it must evidence the taxpayer's honest and reasonable attempt to satisfy the requirements of the tax law.

In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) added an unenumerated subsection to the Bankruptcy Code, denoted as Section 523(a)() and often referred to as the "hanging paragraph." Under 11 U.S.C. Section 523(a)(), the term "return" means a return that satisfies the requirements of applicable non-bankruptcy law (including applicable filing requirements) and includes a return prepared pursuant to Code Sec. 6020(a) (i.e., prepared by the IRS on the basis of information provided by the taxpayer), or similar state or local law, or a written stipulation to a judgment or a final order entered by a non-bankruptcy tribunal. However, a "return" for this purpose does not include a return made pursuant to Code Sec. 6020(b) (i.e., prepared by the IRS based on the IRS's own knowledge or information), or a similar state or local law.

Post-BAPCPA, courts have taken different approaches to the question of whether a late-filed Form 1040 constitutes a "return" within the meaning of the statute. Some courts, including the Third, Ninth, and Eleventh Circuits, have continued to apply the Beard test. Other courts, such as the First, Fifth, and Tenth Circuits, have applied a more stringent test, reading the hanging paragraph's mandate that a return satisfy requirements of applicable non-bankruptcy law (including applicable filing requirements) to include the original filing deadline. These courts therefore apply a bright-line rule that a late-filed Form 1040, even if filed only one day after the deadline (i.e., the "one-day-late" rule), cannot be a "return" for purposes of Section 523(a) and, thus, the associated tax liability cannot be discharged in bankruptcy.

Analysis

The First Circuit affirmed the district court and held that Kriss's tax debts had not been discharged in bankruptcy. The court noted that resolution of the dispute turned on the interpretation of what the First Circuit called "a particularly puzzling section of the Bankruptcy Code, 11 U.S.C. Sec. 523(a)(1)(B)(i)-(ii)." According to the court, Section 523(a)() required it to decide whether Kriss's returns satisfied the requirements of applicable non-bankruptcy law (including applicable filing requirements). The court noted that its decision in Fahey looked at a similar inquiry and the court decided the case based on provisions in Massachusetts state law since the debtor owed Massachusetts income tax. That law, the court noted, included a requirement that returns be filed by a specified date and, because the debtor's return was filed after that specified date, the First Circuit held that the return was not a "return" within Section 523(a)().

At least on its face, the First Circuit stated, Fahey did not directly control Kriss's appeal because Kriss's debt arose under federal law and not Massachusetts law. However, the court said, one might nevertheless think that distinction easily erased because, after all, Kriss was required by Code Sec. 6072 to file his returns before he did. Nonetheless, the court noted, the United States makes clear that it regards many late-filed federal returns to be returns within the meaning of Section 523(a)().

The court addressed Kriss's argument that he met the requirements under the Beard test and should therefore be considered as having filed a "return" for purposes of Section 523(a)(). While the court agreed that Kriss satisfied the first three requirements of the Beard test, it concluded that he failed to meet the fourth test which required evidence of a taxpayer's honest and reasonable attempts to satisfy the requirements of the tax law. The court noted that cases cited by Kriss adopted a "subjective" test that looked at the taxpayer's conduct and beyond the return itself. Under this test, the court said, a failure to file a timely return, at least without a legitimate excuse or explanation, evinces the lack of a reasonable effort to comply with the law. And, the court noted, the only explanation Kriss provided for his very belated filings was that his wife falsely assured him that she had filed the returns for him. The court did not find that to be a meaningful excuse in light of the fact that Kriss and his wife were filing separate returns. Thus, the court concluded, Kriss's belated tax filings did not qualify as returns and his tax deficiencies were not discharged in bankruptcy.

For a discussion of discharges of taxes in bankruptcy, see Parker Tax ¶16,160.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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