To Discharge or Not to Discharge: Tax Is the Question

• Publication year: 2016

To Discharge or Not to Discharge: Tax Is the Question

Ryan G. Saharovich

TO DISCHARGE OR NOT TO DISCHARGE: TAX IS THE QUESTION

Abstract

Prior to Congress passing BAPCPA in 2005, an individual was able to discharge debt related to a tax return filed after April 15th as long as that individual satisfied the Beard test and certain statutory requirements. Courts applied the Beard test, which consists of four factors, to determine when a document qualified as a valid tax return. Of these four factors, the fourth factor, which requires that the debtor make an honest and reasonable attempt to comply with the tax law, led to disputes among courts. All circuit courts adopted the Beard test, and the major issue prior to the 2005 amendments turned on whether an individual can satisfy the fourth factor of the Beard test if that individual failed to file a tax return until after the IRS had already filed a tax return on that individual's behalf

In an attempt to clarify the language of the Bankruptcy Code, Congress defined the term "return" in its 2005 amendments. The definition appears in the hanging paragraph of § 523(a). Importantly, Congress stated that a document is a return if the document "satisfies the requirements of applicable bankruptcy law (including applicable filing requirements)." In 2012, the Fifth Circuit found in In re McCoy that the date on which a tax form is filed is one of the "applicable filing requirements" that Congress was referencing in the hanging paragraph. Thus, the Fifth Circuit created the "one-day-late rule" when it held that a tax form filed one day late is not a valid tax return because the filer has failed to satisfy applicable filing requirements. The result of the one-day-late interpretation is that an individual who files a tax form late cannot receive a discharge of debt stemming from that late-filed form. The Tenth and First Circuits subsequently adopted the Fifth Circuit's interpretation.

Conversely, the Ninth Circuit, bankruptcy courts, academics, and the IRS oppose the one-day-late interpretation and have offered an alternative viewpoint. Courts opposing the one-day-late rule are concerned with the harsh impact that the one-day-late interpretation has on honest debtors who file tax forms late for reasons beyond the debtor's control. While various courts opposing the one-day-late rule have interpreted the hanging paragraph in

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slightly different ways, the common theme among these opinions is that a late-filed tax form can still qualify as a return if the filer satisfied the Beard test and statutory requirements. Courts opposing the one-day-late rule maintain that Congress did not intend for the hanging paragraph to displace the Beard test.

This Comment argues that Congress intended to codify the Beard test through the BAPCPA amendments. Under this interpretation, the fourth element of the Beard test requires that a court must always review a late-filed tax form and make a subjective determination as to whether that form is a return. The court must evaluate all relevant factors, including when the form was filed, why it was filed late, and whether the IRS has filed a substitute return on behalf of the individual who failed to file a timely return. This interpretation allows the debtor an opportunity to show a reason for filing late tax forms, and gives the court the opportunity to make a determination as to the validity of the debtor's reasoning. Ultimately, this interpretation allows debtors to receive a fresh start without compromising the IRS's ability to collect taxes.

Introduction

April 15th, also known as "Tax Day" to most Americans, has been the date by which individuals earning an income are expected to file their income tax returns since 1955. Depending on whom you ask, Congress changed tax day from its original February date to March, and finally April, in an effort to either spread out the IRS's workload or as a means of avoiding paying interest on tax returns.¹ While April 15th is technically tax day, this date is often not the final date by which an individual must file his or her tax return without penalty. The IRS has moved tax day for various reasons including extensions, natural disasters, and holidays,² and the IRS has the discretion to waive penalties related to late-filed tax forms.³ Whether an individual does so

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strategically, unintentionally, or out of desperation, the late-filing of tax forms are a common occurrence in America.⁴ Since Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA") in 2005, the question of whether debt arising from these late-filed tax forms is dischargeable in chapter 7 has become an issue.

This Comment will analyze the one-day-late rule, which states that tax debt arising from a late-filed tax form is nondischargeable in bankruptcy.⁵ Further, this analysis will show that the one-day-late rule is a flawed interpretation of § 523(a) of the Bankruptcy Code (the "Code"). Section 523(a) states: "A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt—for a tax . . . with respect to which a return, or equivalent report or notice, if required—was not filed or given."⁶ This issue, therefore, turns on whether a late-filed tax form can be considered a valid tax return because an individual can only receive a discharge for tax debt if the individual filed a valid tax return.

Prior to the passage of BAPCPA, the term "return," as used in § 523(a), was left undefined by the statute.⁷ Inconsistencies regarding various courts' definitions of "return" led to the development of the four-part Beard test.⁸ The Beard test classified a document as a return when the document: "(1) purported to be a return; (2) [was] executed by the debtor under penalty of perjury; (3) contain[ed] sufficient data to allow calculation of the tax; and (4) represented] an honest and reasonable attempt to satisfy the requirements of the tax law."⁹ Of these factors, the fourth factor was the most important, leading to disputes among the circuit courts.¹⁰ Although courts reached varying conclusions on

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what constituted "an honest and reasonable attempt" to satisfy the tax law requirements, all circuits adopted the Beard test for determining when a chapter 7 debtor's late-filed tax forms were a return.¹¹

Congress's decision to define the term "return" in the BAPCPA amendments, however, threatened the future of the Beard test.¹² This definition appears after § 523(a)(19)(B), and the majority of courts refer to the definition as the "hanging paragraph."¹³ The hanging paragraph states:

For purposes of this subsection, the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar state or local law.¹⁴

Although Congress did not clarify which filing requirements are "applicable," debtors who have outstanding tax debt at the time they file a chapter 7 petition are the parties that this legislation has truly affected.¹⁵

Congress's definition of "return" led courts to reach two different conclusions when interpreting what constitutes a return for dischargeability purposes. The courts following the Fifth Circuit's holding in McCoy v.

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Mississippi State Tax Commission (In re McCoy)¹⁶ found that a tax debt resulting from a tax form filed even one day late is not dischargeable because timely filing is a part of the "applicable filing requirements" discussed in the hanging paragraph.¹⁷ Proponents of the one-day-late rule are not concerned with the reason that the debtor filed his tax forms late because, under this view, a late-filed tax form can never be a valid return for dischargeability purposes unless the form is "prepared pursuant to section 6020(a)."¹⁸ A § 6020(a) return is a late-filed tax form prepared by the IRS with the assistance of the individual who failed to file a timely return.¹⁹ Unlike a § 6020(b) return, which is prepared by the IRS without assistance from the filer and will be discussed later, Congress stated in the hanging paragraph that § 6020(a) forms are still valid despite the fact that they are always filed after April 15th.²⁰ Additionally, the IRS has full discretion to allow or deny an individual the opportunity to file a return under § 6020(a) if that individual has failed to file a timely return.²¹

The practical result of the one-day-late rule is that an individual cannot receive a discharge on any tax debt resulting from a late-filed tax form unless the IRS chooses to allow the individual to file a § 6020(a) return.²² While the First, Fifth, and Tenth Circuits have all issued opinions subscribing to this view, the logic behind the one-day-late rule has led to questions about the seemingly harsh impact that this policy has on many debtors.²³ For example, in Mallo v. IRS (In re Mallo), the Tenth Circuit specifically held that courts do not need to evaluate whether a debtor made an honest and reasonable attempt to satisfy the requirements of the tax law because filing deadline dates are part

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of the applicable filing requirements that Congress discussed in the hanging paragraph.²⁴ While Congress never mentioned displacing the Beard test in the BAPCPA amendments, the one-day-late rule is, in effect, a complete departure from the Beard test.²⁵

The second group of courts, which includes the Ninth Circuit, various district courts, and bankruptcy courts, have held that a late-filed tax form can be a return, and the debt can be dischargeable as long as the Beard test and applicable Code requirements have been met.²⁶ Two further...