CHAPTER 4, C. Dischargeability of Nonpriority Taxes for Late-Filed Tax Return

• Jurisdiction: United States

C. Dischargeability of Nonpriority Taxes for Late-Filed Tax Return

ABI Journal

September 2019

John N. Tedford, IV

Danning, Gill, Diamond & Kollitz, LLP

Los Angeles

Priority tax claims are nondischargeable. Whether a nonpriority tax claim is dischargeable largely depends on whether and when the debtor filed a tax return. Unfortunately, it also depends on where the debtor lives because courts cannot agree on the answer to this seemingly simple question: For purposes of § 523(a)(1)(B), what is a "return"?

Dischargeability of Taxes

Since 1966, Congress has sought to balance a debtor's need for a fresh start, policies favoring equitable distributions among unsecured creditors, and the government's need for sufficient time to conduct its auditing, assessment and collection functions. Today, § 523(a)(1)(B) provides that a discharge does not discharge a nonpriority tax

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 petition.

Section 523(a)(1)(B) serves two purposes: (1) It discourages debtors from using bankruptcy as a tax-evasion device; and (2) it gives the government at least two years to audit returns, assess deficiencies and collect taxes or create liens before the taxes may be discharged. It requires only objective analyses, referencing easily discernable facts and requiring no inquiry into the debtor's motives.

Early Decisions

At least at first, courts had little trouble applying § 523(a)(1)(B). The only truly difficult cases arose when debtors argued that returns prepared by the Internal Revenue Service (IRS) under § 6020 of the Internal Revenue Code (IRC), or stipulated judgments entered in tax courts, constituted "returns" for purposes of § 523(a)(1)(B).

When a taxpayer fails to timely file a proper return, the IRS prepares a substitute return under IRC § 6020(a) or (b). Under IRC § 6020(a), a taxpayer provides the IRS with the information needed to prepare the return. Once it is signed, the IRS may accept it as the taxpayer's return. Generally, courts have held that returns prepared under IRC § 6020(a) qualify as "returns" for purposes of § 523(a)(1)(B).¹

Under IRC § 6020(b), the IRS prepares the substitute return using information from third parties. The IRS gives notice of its proposed assessment, and the taxpayer has 90 days to file a petition with the tax court to challenge the proposed assessment.² If no petition is filed, the IRS makes an assessment in the proposed amount.³ Almost universally, courts have held that returns prepared under IRC § 6020(b) do not qualify as "returns."⁴ Similarly, at least one court has held that a settlement resulting in entry of a stipulated tax court decision did not qualify as a "return."⁵

Other than in these situations, courts did not struggle with defining "return." As one put it, "The plain meaning of the word 'return' should be conclusive, as it has a very specific meaning in the world of taxation. Certainly, taxpayers know what it means to have to file a tax return; they do it each year."⁶ A debtor's motives were irrelevant. However, that began to change in 1997 when courts began using the Beard test to determine whether late-filed returns qualified as returns under § 523(a)(1)(B).

The Beard Test

To determine whether a document qualifies as a "return," federal courts follow the "Beard test" formulated by the U.S. Tax Court in 1984 from two depression-era Supreme Court cases.⁷ Under the Beard test:

(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 penalty of perjury.

After formulating the test, the Beard court discussed "[t]he most recent Supreme Court reaffirmation of the test": Badaracco v. Commissioner.⁸ In that case, taxpayers filed fraudulent returns, but later filed nonfraudulent amended returns. The Supreme Court ruled that "the original returns ... purported to be returns, were sworn to as such, and appeared on their faces to constitute endeavors to satisfy the law."⁹ Thus, although indisputably fraudulent, the documents were returns.

Beard involved a taxpayer who, in protest, tampered with his Form 1040. The tax court held that the impermissibly modified form was not a return. Badaracco and Beard illustrate how the third prong of the Beard test should be applied. Instinctively, a taxpayer who files a fraudulent return has not made an "honest and reasonable attempt to satisfy the requirements of the tax law." However, Badaracco shows that this instinct is wrong. The third prong should be determined by reference to the face of the document, not to the filer's motive.

Post-Assessment Approach

The Beard test went mostly unnoticed in bankruptcy cases until 1997. In In re Hindenlang, the IRS prepared substitute returns under IRC § 6020(b), sent deficiency notices to which the debtor did not respond, and assessed taxes. After the taxes were assessed, the debtor filed returns. More than two years later, he filed for bankruptcy. Applying the Beard test, the bankruptcy court held that the taxes were discharged because returns were filed more than two years pre-petition.¹⁰

The Sixth Circuit reversed, holding that a purported return filed too late to have any effect under the IRC cannot, as a matter of law, constitute an "honest and reasonable attempt to satisfy the requirements of the tax law."¹¹ Because the debtor could not identify any tax purpose for his late-filed Form 1040s, the court ruled that they were not "returns," therefore the taxes were nondischargeable.

In a similar case, the Fourth Circuit reached the same result, but for a different reason: "Simply put, to belatedly...