Category Archives: 2-Year Filing Rule

Can a Merchant Discharge Unpaid Sales Taxes by Filing Bankruptcy?

We all have paid sales taxes when purchasing consumer items.  But where does that money go?

In most states, a merchant selling consumer products is required to collect sales tax from customers and hold that money in trust for the government.  Periodically, the merchant is required to report the amount of sales taxes collected and to tender the tax money to the government.

However, some merchants fail to tender the money to the government when business is bad and use the trust fund money as a cash infusion to keep the business afloat.  It’s a terrible idea from a bankruptcy attorney’s point of view, but merchants struggling to keep their doors open sometimes grab any life-line they can reach.

Such was the case in Cooper v. Miss. Dep’t of Revenue (In re Cooper), 2015 Bankr. LEXIS 3261, (Bankr. S.D.MS 2015).  Cooper was audited by the Mississippi Department of Revenue for a three year period and assessed almost $60,000 in unpaid sales taxes.  MDOR filed a lien to secure its claim and started collection efforts against Cooper.

Two years later, Cooper responded by filing Chapter 13 bankruptcy and then initiated an adversary proceeding alleging the sales tax debt was dischargeable.  However, the court noted that Cooper failed to site any Bankruptcy Code sections or case law supporting Cooper’s position. MDOR filed a motion for summary judgment asserting that there are no factual issue in dispute and MDOR is entitled to a judgment that the sales tax debts are non-dischargeable.  MDOR’s claim had increased with interest to approximately $70,000.

The Court granted MDOR’s motion and held that the sales tax debts were non-dischargeable pursuant to 11 U.S.C. §§523(a)(1)(A) and  507(a)(8)(A).  The court’s reasoning for nondischargeability was limited to a one paragraph declaration.  Interestingly, MDOR did not allege that the taxes were nondischargeable pursuant to § 507(a)(8)(C), which would have been harder to discharge.  But MDOR’s attack on a  §507(a)(8)(A) basis opened a dischargeability door for Cooper to walk through, but Cooper failed to take advantage of this strategic opening and had to suffer the consequences of having $70,000 worth of tax debts rendered non-dischargeable.

Practice Pointer:   The taxpayer missed an opportunity to discharge the sales tax debt.  According to the Cooper court, the sales taxes were a §507(a)(8)(A) tax.  This type of debt could have been discharged if the taxpayer had waiting the required time periods set forth in 11 U.S.C. §§523(a)(1)(A) and  507(a)(8)(A).  Cooper should have considered before filing bankruptcy  the 3-year due date rule, 2-year filing date rule, and the 240-day assessment rule.  But Cooper failed to time the filing correctly, which resulted in Cooper not discharging the $70,000 claim.  Cooper should have made the investment and paid a little more to acquire expert legal advice.

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

Follow Robert Schaller on social media Join Robert V. Schaller on Facebook Join Robert V. Schaller on Linkedin

Taxpayers can discharge income tax liability relating to late-filed returns by filing Chapter 7 bankruptcy.

A Chapter 7 bankruptcy general discharge eliminates a debtor’s obligation to pay debts.  11 U.S.C. §727.  However, income tax debts relating to an unfiled tax return are excepted from the general discharge and survive the bankruptcy.  11 U.S.C. §523(a)(1)(B)(i).  The issue in Biggers was whether an IRS Form 1040 can be considered a “return” for bankruptcy purposes when filed after the due date and after the IRS unilaterally assessed a tax.

The Biggers court noted that courts across the country are divided regarding the issue of discharging tax obligations relating to late-filed tax returns.  Some courts have concluded that a late-filed tax return can never be a “return” for bankruptcy purposes solely because the return was filed after the tax filing deadline – even one day late.  See, e.g., In re Fahey, 779 F.3d 1 (1st Cir. 2015).  These courts rely on the Bankruptcy Code’s definition of “return” contained in 11 U.S.C. Section 523(a)(*), which states the term “return” means a return that satisfies the requirements of “applicable nonbankruptcy law”-including applicable filing requirements.

However, the Biggers court reached a different conclusion and rejected Fahey’s rational and held that a late-filed return can be deemed a “return” for bankruptcy purposes if it meets the definition of “return” as set forth in Beard v. Commissioner, 82 T.C. 766, 1984 WL 15573 (1984), affirmed 793 F.2d 139 (6th Cir. 1986).  The Beard test determining whether an IRS Form 1040 is a “return” has four prongs: (1) it must purport to be a return; (2) it must be executed under penalty of perjury; (3) it must contain sufficient data to allow calculation of tax; and (4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law.   

The Biggers court agreed with those decisions that define the phrase “applicable non-bankruptcy laws” of 11 U.S.C. Section 523(a)(*) as the pre-BAPCPA Beard test and found a Form 1040 is a “return” if it satisfies the Beard test. The court rejected the idea that the reference to “applicable non-bankruptcy laws” relates narrowly to the filing deadline imposed by the taxing authority per statute.

The Biggers court then applied the Beard test, noting that the taxpayers had filed multiple returns after the filing deadline and after the IRS had already assessed the tax.  The court found that the late-filed returns served no purpose on all but one return because the tax liability disclosed on the late-filed return was less than the amount assessed by the IRS and therefore did not “represent an honest and reasonable attempt to satisfy the requirements of the tax law,” as required by the fourth prong of the Beard test.  However, the court allowed the discharge of income tax relating to the one late-filed return that disclosed liability greater than the amount assessed by the IRS.  The Court allowed the discharge as to the tax liability that exceeded the IRS’ assessed liability that return.  Although not addressed in the opinion, it appears the Biggers court would have discharged all of the tax liability had the returns been filed after the filing deadline but before the IRS had assessed the tax.

Can Bankruptcy Discharge Income Taxes Filed More Than 2 Years Before the Bankruptcy Filing?

Short Answer:  Yes, income taxes can be discharged in bankruptcy if the taxpayer satisfies all of the bankruptcy requirements.  One of the contested issues is whether tax liability relating to a late-filed return can ever be discharged.  Another issue is whether the paper filed with the taxing authority is deemed a “return” for bankruptcy purposes.  These issues were addressed in In re McBride, 534 B.R. 326 (Bankr. S.D.OH 2015).

Facts: The taxpayer filed multiple city tax returns for taxes imposed by the City of Kettering, Ohio (“City”).  Some returns were filed on a timely basis and at least one return was filed after the due date. The tax liability due on these returns was calculated in relation to the IRS tax liability.  This liability was dramatically understated as a result of the taxpayer’s scheme to minimize tax liability through a now discredited “abusive trust arrangement.”  The US Tax Court found taxpayer’s self-reported returns dramatically deficient and increased the tax liability substantially, which caused the City tax liability to be increased proportionately.

Argument: In response, taxpayer filed chapter 7 bankruptcy to discharge the tax liability more than 2 years after the original City returns were filed. Taxpayer then filed an adversary proceeding to determine the dischargeability of the tax and filed a motion for summary judgment to obtain a judgment.  City objected asserting that the taxes owed are nondischargeable under 11 U.S. C. §523(a)(1)(B)(i) because the taxpayer never filed qualifying “returns.”  City argued the documents filed do not constitute “returns” because one return was untimely and all of the tax documents significantly under-reported the taxpayer’s income.

Analysis: The McBride court was forced to resolve the issue. There, the court addressed the two competing arguments regarding whether a late filed return can ever be a “return” for bankruptcy purposes.  The McBride court noted that the hanging paragraph in §523(a)(*) attempts to define the term “return.”  However, the court found the statute’s definition unclear and begged the question “Is §523(a)(*) pointing to the definitional provisions in state or local tax law to define the term ‘return’ for §523(a) purposes or, instead, must the document satisfy all aspects of the relevant nonbankruptcy ta law, including filing requirements, in order to be a ‘return’?” (Emphasis added).

The McBride court considered and rejected City’s bright-line test adopted by the Fifth Circuit in McCoy v. Miss. State Tax Comm’r (In re McCoy), 666 F.3d 924 (5th Cir. 2012) and followed by the Tenth Circuit in Mallo v. Internal Revenue Service (In re Mallo), 774 F.3d 1313 (10th Cir. 2014) and the First Circuit in Fahey v. Mass. Dept. of Revenue (In re Fahey), 779 F.3d 1 (1st Cir. 2015).  This test looks strictly at the tax statute’s filing deadline and would render taxes nondischargeable if the return was filed even one day late.

Instead, the McBride court applied the simplest meaning to §523(a)(*)’s definition of “return” as it relates to the nondischargeability of income taxes. The court held that §523(a)(*) required the court to look to relevant nonbankruptcy law to determine what qualifies as an acceptable return under that law. The court believed that if a document filed with the federal, state, or local taxing authority meets the applicable tax code’s DEFINITION of an acceptable return, then it is a return under §523(a)(*) even if the document does not fully comply with all aspects of the relevant tax code.

When a formal definition of return in the applicable tax statute is absent, the court must look to another source for determining whether the taxpayer’s tax documents qualify as a return.  The Sixth Circuit applied a four-part test to determine whether a tax form qualifies as a tax “return” for bankruptcy purposes: (1) it must purport to be a return; (2) it must be executed under penalty of perjury; (3) it must contain sufficient data to allow calculation of the tax; and (4) it must represent an honest and reasonable attempt to satisfy the requirements of tax law.  See Beard v. Commissioner, 82 T.C. 766 (1984) adopted by United States v. Hindenlang (In re Hindenlang), 164 F.3d 1029 (6th Cir. 1999).

The McBride court applied its analysis to the case and bar and concluded that questions of fact existed and these facts had to be determined before the Beard test could be applied.  Therefore, the court denied the taxpayer’s motion for summary judgment and allowed the parties to present evidence to determine if the tax returns filed with the City were “returns” for bankruptcy purposes.

Practice Pointer: File all tax returns and perform all other filing obligations on a timely basis.  Wait the two years after filing the tax returns (and meet all other requirements) before filing bankruptcy.  Then expect to battle the taxing authority if the returns were filed late or substantially understated the tax liability.

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

Can a Taxpayer who Files a Tax Return After the IRS Assesses the Tax Eliminate the Tax Debt in Bankruptcy?

A Chapter 13 debtor could discharge the tax debt by paying the tax liability through the repayment plan.  However, most people are interested in the dischargeability of the tax debt in a Chapter 7 bankruptcy case without any payment to the IRS.

In In re Mallo, 774 F.3d 1313 (10th Cir. 2014), the taxpayers filed a Chapter 7 bankruptcy case to discharge tax debt relating to an IRS assessment made prior to the taxpayers filing the bankruptcy petition.   The taxpayers failed to file the returns for 2000 and 2001.  The IRS issued statutory notices of deficiencies pursuant to 26 U.S.C. §§ 6212 and 6213 for those years.  The IRS began collection efforts in 2006.  In response, the taxpayers filed joint Form 1040s for the missing years in 2007.

The Mallo court defined the issue as follows: whether an untimely 1040 Form, filed after the IRS has assessed the tax liability, is a tax return for purposes of the exceptions to discharge in 11 U.S.C. §523(a)(1)(B)(i) of the US Bankruptcy Code. The Court began its analysis by examining the Bankruptcy Code’s definition of “return,” which states a return “means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).”  Id at 1318.

Second, the Mallo court noted that prior to the BAPCPA amendments of 2005  most courts determined whether a document qualified as a tax return by following the four-pronged test approved in Beard v. Commissioner, 793 F.2d 139 96th Cir. 1986).  This Beard test consisted of: (1) there must be sufficient data to calculate tax liability; (2) the document must purport to be a return; (3) there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and (4) the taxpayer must execute the return under penalties of perjury. The majority of courts have held that tax forms filed after the IRS assesses the taxpayer’s liability have no valid purpose and therefore cannot satisfy the 3rd prong of the Beard test— there being no honest and reasonable attempt to satisfy the requirements of the tax law.  See In re Payne, 431 F.3d 1055 (7th Cir. 2005).

The Mallo court side-stepped the Beard test and held that 11 U.S.C. §523(a)(*) of the US Bankruptcy Code excludes late-filed Form 1040s from the definition of “return” because the “applicable filing requirement” includes filing deadlines—and late-filed returns do not satisfy applicable filing deadlines.  The court rejected the taxpayers’ argument that the “applicable filing requirements” refer not to the filing time, but to whether a tax form qualifies as a return upon form and content per the Beard test.  Apparently, the Mallo court would hold that no late-filed tax returns would ever be deemed a “return” for bankruptcy purposes.

Consequently, the Mallo court held that the taxpayer’s liability was excepted from the general Chapter 7 discharge order after finding the taxpayers’ Form 1040s were not “returns” for bankruptcy purposes of 11 U.S.C. §523(a)(1)(B)(i).

Practice Pointer: File all tax returns and perform all other filing obligations on a timely basis. There appears to be a growing trend to side-step the Beard test and find that late-filed tax returns can never be deemed a “return” and therefore can never be discharged in a Chapter 7 bankruptcy case.  The US Court of Appeals for the Seventh Circuit has not ruled on this issue directly. But read In re Payne, 431 F.3d 1055 (7th Cir. 2005).  The 7th Circuit covers all of Illinois, Indiana, and Wisconsin.

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

A Taxpayer Can Eliminate Tax Liability Relating to a Late-Filed Tax Return

The courts are divided regarding the dischargeability of tax obligations relating to a late-filed tax return.  An earlier blog discussed the First Circuit’s conclusion that a late-filed tax return is deemed NOT A RETURN for bankruptcy purposes solely because it was filed after the tax filing deadline.  See In re Fahey, 779 F.3d 1 (1st Cir. 2015).

However, a different conclusion was reached by the bankruptcy court in In re Biggers, 528 B.R. 870 (Bankr. M.D.TN 2015).  In Biggers, the court rejected Fahey’s rational and ruled that a late-filed return can be deemed a “return” if it meets the definition of “return” as set forth in Beard v. Commissioner, 82 T.C. 766, 1984 WL 15573 (1984), affirmed 793 F.2d 139 (6th Cir. 1986).  In order for a Form 1040 to qualify as a “return” pursuant to the Beard test: (1) it must purport to be a return; (2) it must be executed under penalty of perjury; (3) it must contain sufficient data to allow calculation of tax; and (4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law.  In re Biggers, 528 B.R. 870, 872 (Bankr. M.D.TN 2015).

The Biggers court agreed with the IRS and those decisions that define “applicable non-bankruptcy laws” (11 U.S.C. Section 523(a)(*)) as the pre-BAPCPA Beard test and found a Form 1040 is a “return” if it satisfies the Beard test. The court rejected the idea that the reference to “applicable non-bankruptcy laws” relates to the filing deadline imposed by the taxing authority per statute.

In Biggers, the taxpayers had filed multiple returns AFTER the filing deadline and AFTER the IRS had already assessed the tax.  The court found that the late-filed returns served no purpose on all but one return because the tax liability disclosed on the late-filed return was less than the amount assessed by the IRS and therefore did not “represent an honest and reasonable attempt to satisfy the requirements of the tax law,” as required by the fourth prong of the Beard test.  However, the court allowed the discharge of tax relating to the one late-filed return that disclosed liability greater than the amount assessed by the IRS.  The Court allowed the discharge as to the tax liability that exceeded the IRS’ assessed liability that return.

Practice Pointer: File all tax returns and perform all other filing obligations on a timely basis. It is a risky landscape on this issue.  The courts are split and no definitive ruling exists for Illinois taxpayers. 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.

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.