Can a Taxpayer who Filed a Tax Return After the Filing Deadline Eliminate the Tax Debt in Bankruptcy?

Certainly a taxpayer could file a Chapter 13 bankruptcy case and discharge the tax debt by paying the tax liability through the repayment plan.  The real question is whether a taxpayer who files a tax return after the filing deadline could file a Chapter 7 bankruptcy case and discharge the tax debt without paying the tax liability.

Until recently, the issue appeared clear that the tax debt could be discharged in Chapter 7 if the taxpayer waited to file bankruptcy at least two years after the date the tax return was filed (assuming all other factors being satisfied). The prior court cases usually related to whether the document filed with the IRS was a “return” or some other document filed with the IRS (e.g. protest letter or something less than a statement as to gross and net income).  Another issue related to whether the return was filed by the taxpayer after the IRS had already prepared a substitute for return (aka “SFR”), which rendered a taxpayer’s later-filed return moot.

Now the issue is whether any return filed after the tax filing deadline is deemed NOT A RETURN for bankruptcy purposes solely because it was filed after the tax filing deadline—even one day late.  That issues was addressed by the U.S. Court of Appeals for the First Circuit in In re Fahey, 779 F.3d 1 (1st Cir. 2015).

In Fahey, the court was confronted with taxpayers who had failed to file their Massachusetts income tax return before the deadline imposed by the state statute.  The taxpayers filed their returns late and then waited two years before filing bankruptcy.  The taxpayers sought to discharge their tax obligations by filing Chapter 7.  The Massachusetts Department of Revenue objected arguing that the tax debt was non-dischargeable because 11 U.S. C. §523(a)(1)(B) excepts from discharge any tax obligation relating to a return that “was not filed or given.”  The Department then argued that the late-filed returns were not deemed “returns” for bankruptcy purposes even though the same returns would be considered “returns” for tax purposes.

The Fahey court agreed with the Massachusetts Department of Revenue, holding that the late-filed tax returns could not be deemed “returns” for bankruptcy purposes.  Therefore, the tax obligations would not be discharged in the Chapter 7 bankruptcy because 11 U.S. C. §523(a)(1)(B) excepts from discharge any tax obligation relating to a return that “was not filed or given.”

This case is very bad for taxpayers seeking bankruptcy protection. The only good news is that the U.S. Court of Appeals that incorporates the Chicagoland area has not ruled on the issue. Hopefully, the 7th Circuit Court of Appeals would render a contrary holding and create a conflict between the circuits so the U.S. Supreme Court would decide the issue once and for all.

Practice Pointer: File all tax returns and perform all other filing obligations on a timely basis. The Fahey case may not be limited to filing obligations. It could be interpreted expansively to apply to all tax obligations other than payment obligations. So, a taxpayer seeking to discharge tax debts in a Chapter 7 bankruptcy should file all returns on a timely basis and then file bankruptcy after the two-year waiting period has expired (plus satisfy all other Section 523 requirements).

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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