Circuit Split Emerging on Dischargeability of Late Returns

There is an emerging circuit split as to whether late filed tax returns can ever be considered to be “returns.”   The issue arises because BAPCPA included a paragraph stating that a return “means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements.”    This is known as the hanging paragraph of section 523(a) because it appears following section 523(a)(19) without any other designation.

A Hanging Paragraph

The hanging paragraph was added by BAPCPA to address the situation where the IRS files a return for the debtor.   Its full text is:

For purposes of this subsection, the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).   Such return includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local tax law, or a written stipulation to a judgment or a 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.

 Section 6020(a) addresses the situation where the taxpayer does not file a return but the IRS files one for her with the taxpayer's active participation.   Section 6020(b) arises where the IRS prepares a return without the taxpayer's cooperation.   The hanging paragraph should have made it easier to discharge a tax because it allowed the taxpayer credit for two instances in which the taxpayer did not actually file a return.   These are where the government filed a return for the taxpayer with the taxpayer's cooperation or where the debtor entered into a written stipulation to a judgment.   In both of these instances, the taxpayer participated in determination of the tax even if the taxpayer did not file a formal return.

A Split Arises

 McCoy v. Miss. State Tax Comm'n (In re McCoy), 666 F.3d 924 (5th Cir. 2012), cert. den. 2012 U.S. LEXIS 6632 (2012) was the first circuit case to address the issue after the adoption of BAPCPA.   The Court relied on the definition of “return” as a return filed in accordance with applicable non-bankruptcy law.   Because non-bankruptcy law required a return to be filed within a specific period of time, a late return was not a return at all and could not be discharged. I strongly criticized the McCoy decision when it came out (which you can read here) and Mrs. McCoy employed me to file a petition for cert.   Unfortunately, I was not successful.

 The First Circuit and the Tenth Circuit followed suit, although the First Circuit case drew a vigorous dissent.   Fahey v. Mass. Department of Revenue (In re Fahey), 779 F.3d 1 (1st Cir. 2015); Mallo v. IRS (In re Mallo), 774 F.3d 1313 (10th Cir. 2014), cert. den., 135 S.Ct. 2889 (2015).   In the Mallo case, Prof. Ronald Mann filed the petition for cert.

 A second line of cases rejects the one day late rule and follow an earlier four part test, which includes whether the document is an “honest and reasonable attempt to satisfy the requirements of the tax law.”    The Ninth and Eleventh Circuits follow this approach along with district courts in several states.   Smith v. United States IRS (In re Smith), 2016 U.S. App. LEXIS 12859 (9th Cir. 2016); Justice v. United States (In re Justice), 817 F.3d 738 (11th Cir. 2016); Biggers v. IRS, 2016 U.S. Dist. LEXIS 123219 (M.D. Tenn. 2016).

A Matter of Interpretation

The difficulty with the cases that follow McCoy is that they read section 523(a)(1)(B)(ii) out of the Code.   Prior to BAPCPA, there were three ways that a tax could be non-dischargeable.   First, if it was a priority tax under section 707(a)(3) or (a)(8) it could not be discharged.   Second, a tax could not be discharged if the return was not filed or if it was filed late, the return was filed less than two years before the petition date.   Finally, the tax could be non-dischargeable if the debtor made a fraudulent return or willfully attempted to evade or defeat the tax.   

The cases that follow McCoy overlooked both the amendment's purpose and the existing language of section 523(a)(1)(B)(ii) which allowed discharge of taxes where the return was filed late but at least two years prior to the petition date.   Instead, they focused on the words "including applicable filing requirements."    They interpreted "applicable filings requirements" to have a temporal condition, that is, was the return timely filed.   However, section 523(a)(1) already had a temporal condition, that is, was the return filed at least two years before the petition date.   Therefore, the better reading is that applicable filing requirements should refer to the act of filing the return as well as whether it was filed on the proper form.   For example, a letter to the governor stating that a person was being unfairly persecuted by the taxing authorities would not constitute a return while a form 1040 filed with the IRS would. 

A New Hope? 

 Although the Supreme Court has denied cert twice on this issue, now that there is a clear circuit split, the Court may be persuaded to take up the issue.