If It Looks Like a Duck, Swims Like a Duck, and Quacks Like a Duck, It Is Probably a Duck! Whether Late-filed Tax Returns Constitute 'Returns' for Purposes of Discharge under s. 523.

• Author: Sutton, Kristi R.

ABSTRACT

When Congress amended the Bankruptcy Code in 2005, courts grappled with the irreconcilable language of the newly-added hanging paragraph in [section] 323(a). When faced with the question of whether a chapter 7 debtor may discharge liability arising from a late-filed tax return, courts diverge into four distinct groups. Some courts follow a strict "one-day-late rule" under which the return loses its purpose and no longer qualifies as a "return" for discharge purposes if the debtor fails to file timely. Courts at the opposite end of the spectrum wholly refuse to entertain timeliness as a legitimate factor when ruling on what qualifies as a return for purposes of discharge. This article argues that the best approach looks solely to the tax return itself to find whether the debtor acted "honestly and reasonably," which allows courts to avoid the draconian one-day-late rule, disregard the Internal Revenue Service assessment, and avoid a judicially inefficient totality-of-the-circumstances test. Further, given the lack of discernable congressional intent concerning how to apply the hanging paragraph, the test proposed here is the most faithful to sound bankruptcy policy because it neither justifies superfluous language nor creates an internal inconsistency within [section] 523.

1. INTRODUCTION

   Today, the lifestyle of the average American is dynamic and hectic. Often we equate routine with the "hobgoblin of [a] little mind." (1) Notwithstanding this modern day penchant for risk and adventure, three things remain certain: death, taxes, and bankruptcy. This study focuses on two of those certainties, taxes and bankruptcy. Failing to adhere to the stodgy routine of filing timely tax returns is a sure-fire way to wind up in bankruptcy. Even in bankruptcy, a debtor's ability to shed tax debt when he has filed late returns is murky. Section 523(a)(1) (2) renders certain tax debts nondischargeable when the tax return has not been filed or was filed late. This article explores a pertinent legal issue vexing nearly all U.S. circuit courts of appeal today: whether late-filed tax returns constitute a "return" for purposes of discharge under [section] 523 of the Bankruptcy Code.

   In answering this question, courts generally diverge into four branches. First, some courts find that a return filed even one day late disqualifies it from being defined as a return for discharge purposes. (3) Other courts take a second path, finding that after a tax is assessed, a late-filed return serves no purpose and is not a "return" for discharge purposes. (4) Yet a third analysis demands more fact-finding to determine whether debtors acted "honestly and reasonably" when filing their late tax returns. (5) Finally, some courts simply refuse to investigate the subjective intent of the debtor, choosing instead to examine the tax return itself to determine if the debtor acted honestly and reasonably. (6) This article explores case law, statutory text, legislative intent, and bankruptcy policy to conclude that the best option is the last one. Courts should examine only the tax form itself to decide whether it qualifies as a return, regardless of the filing delinquency, to determine whether the debtor acted honestly and reasonably, consistent with the tax court's seminal analysis in Beard v. Commissioner. (7)

   This study first explores why some debtors file late and how the Internal Revenue Service ("IRS'") handles late-filed returns. We next review how courts have interpreted and applied the Code to late-filed returns before passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"). (8) Finally, we investigate post-BAPCPA jurisprudence in light of the hanging paragraph of [section] 523 and conclude that the best approach looks to the tax return itself, regardless of delinquency, to analyze whether the document evidences an honest and reasonable attempt to comply with the law.

2. THE PROBLEM OF LATE-FILED RETURNS

   Ideally, every American files his or her tax return on or before April 15. Unfortunately, life is not always ideal, and individual circumstances influence a person's ability to file timely. For various reasons, whether "strategically, unintentionally, or out of desperation, the late-filing of tax forms [is] a common occurrence in America." (9) When tax returns are delinquent, the IRS imposes various penalties and charges, such as "5 percent of the unpaid taxes for each month or part of a month that a tax return is late ... accruing [from] the day after the tax filing [is] due ... not [to] exceed 25 percent of [] unpaid taxes." (10) Further, if the returns are filed beyond sixty days from the due date, "the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax." (11) Notably, the IRS waives the penalty if the taxpayer "can show reasonable cause for not filing or paying on time." (12) In the absence of this showing, the IRS conducts an audit to fix, or "assess," the amount of liability. (13) Absent access to the taxpayer's self-reported income, the IRS implements a deficiency and assessment procedure outlined by the statute (14) and following an audit, issues a "notice of deficiency" to the taxpayer. (15) Once the notice is received, the taxpayer has ninety days to respond by either paying the tax liability or filing a petition in the tax court. (16) If the taxpayer fails to contact the IRS, it issues an assessment and sends a notice of unpaid taxes to the taxpayer with a demand for payment. (17)

   Although taxpayers are encouraged to file on time regardless of whether they can pay the tax liability at the time of filing, the IRS website makes it clear that late-filed returns will be accepted. (18) The IRS provides options to aid filers who are unable to pay the tax in full on filing, including, on request, an additional 60 to 120 days to pay in full and the possibility of paying in installments. (19) Further, the IRS will consider an offer in compromise to allow the taxpayer to pay less than the full liability, depending on the taxpayer's ability to pay, his income, and his expenses. (20) The IRS's willingness to accept late-filed tax returns and to compromise tax debt is notable given that some courts refuse to consider extenuating circumstances when interpreting post-BAPCPA language in the context of what qualifies as a return for discharge purposes. (21)

3. PRE-BAPCPA JURISPRUDENCE

   Before BAPCPA, judges tasked with balancing dischargeable and nondischargeable debts often first looked to the language of [section] 523(a)(1), which provided:

   (a) A discharge under section 727 ... of this title does not discharge an individual debtor from any debt--

   (1) for a tax or a customs duty--

   (A) of the kind and for the periods specified in section 507(a)(2) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed;

   (B) with respect to which a return, if required--

   (i) was not filed; or

   (ii) was filed after the date on which such return was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition; or

   (C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax. (22)

   Because the Code contained no definition of "return," courts often looked to two key Internal Revenue Code provisions. (23) The first, entitled "Returns prepared for or executed by Secretary," addresses (24) preparation of returns by the Secretary of the Treasury when taxpayers fail to timely file returns:

   (a) Preparation of return by Secretary.--If any person shall fail to make a return required by this title or by regulations prescribed thereunder, but shall consent to disclose all information necessary for the preparation thereof, then, and in that case, the Secretary may prepare such return, which, being signed by such person, may be received by the Secretary as the return of such person.

   (b) Execution of return by Secretary.--

   (1) Authority of Secretary to execute return.--If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.

   (2) Status of returns.--Any return so made and subscribed by the Secretary shall be prima facie good and sufficient for all legal purposes. (25)

   Returns prepared by the Secretary under [section] 6020 are known as "substitute returns." (26)

   The second key Internal Revenue Code provision considered by preBAPCPA courts concerns the deadlines for filing returns:

   (a) General rule.--In the case of returns under section 6012, 6013, 6017, or 6031 (relating to income tax under subtitle A), returns made on the basis of the calendar year shall be filed on or before the 15th day of April following the close of the calendar year and returns made on the basis of a fiscal year shall be filed on or before the 15th day of the fourth month following the close of the fiscal year, except as otherwise provided in the following subsections of this section. (27)

   Additionally, because the pre-BAPCPA Code failed to define return for discharge purposes, most courts looked to the Beard test, (28) which was rendered by a tax court in 1984 and affirmed by the Sixth Circuit in 1986. This test dictates when a document purporting to be a return, in fact, is a return: (29)

   (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. (30)

   Based on these foundations, pre-BAPCPA courts developed three distinct analyses for determining whether tax liability was nondischargeable under [section] 523(a)(1): the...