Notification to State Tax Board of Federal Tax Reevaluation is Return “Equivalent”

Posted by NCBRC - February 8, 2021

A state-mandated notification with the state taxing authority of a change in the taxpayer’s federal taxes is a “return, or equivalent report or notice,” which, if not filed by the taxpayer, renders the state tax debt nondischargeable under section 523(a)(1)(B). Berkovich v. Calif. Franchise Tax Bd., No. 20-1025 (B.A.P. 9th Cir. Oct. 5, 2020).

This case involved the interplay between California Revenue and Taxation Code (RTC), section 18622(a), which provides that when the IRS alters a taxpayer’s federal tax liability that taxpayer must report the change to the California Franchise Tax Board (FTB), and section 523(a)(1)(B) of the Bankruptcy Code, which provides that a tax debt for which the debtor failed to file a “return, or equivalent report or notice,” is excepted from discharge.

Here the taxpayer/debtor filed federal and state tax returns for the years 2003, 2004, and 2005. In 2008, the IRS reevaluated the debtor’s tax liability and assessed an additional $145,000 in taxes for those years. The debtor failed to file a report of the change with the FTB as required by RTC section 18622(a). After learning of the federal tax increase from the IRS, the FTB assessed the debtor additional $45,000 in state taxes for those years.

The debtor filed for chapter 13 bankruptcy and, after completion of his plan under which he paid 0.9% to unsecured nonpriority creditors including the FTB, the FTB sought a ruling by the court that the state tax debt was non-dischargeable because the debtor failed to file an “equivalent report or notice” as required by section 18622(a). The bankruptcy court granted summary judgment in favor of the FTB. The debtor appealed.

On appeal to the Ninth Circuit Bankruptcy Appellate Panel, the debtor argued that the required notification to the FTB did not constitute a “return” within the meaning of section 523(a)(1)(B) and, therefore, his failure to submit the notification did not implicate the non-dischargeability provision. The panel disagreed.

The BAP began with section 1328(a) which excludes from discharge the kind of debt specified in section 523(a)(1)(B). Prior to 2005, a tax debt for which a debtor failed to file a “return” was excepted from discharge. In 2005, Congress expanded the scope of the exception to a “return, or equivalent report or notice.” In a hanging paragraph to that section, Congress explained that “the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).”

The panel turned to whether the required notification under the California tax reporting requirement fell within the type of document which would be excepted from discharge under section 523(a)(1)(B) upon failure to file. Section 18622(a) provides:

“(a) If any item required to be shown on a federal tax return, including any gross income, deduction, penalty, credit, or tax for any year of any taxpayer is changed or corrected by the Commissioner of Internal Revenue or other officer of the United States or other competent authority, or where a renegotiation of a contract or subcontract with the United States results in a change in gross income or deductions, that taxpayer shall report each change or correction, or the results of the renegotiation, within six months after the date of each final federal determination of the change or correction or renegotiation, or as required by the Franchise Tax Board, and shall concede the accuracy of the determination or state wherein it is erroneous.”

Section 18622(c) mandates that the taxpayer provide notification that is “sufficiently detailed to allow computation of the resulting California tax change and shall be reported in the form and manner as prescribed by the Franchise Tax Board.” The regulations effectuating this provision instruct the taxpayer to provide an original or copy of the final determination renegotiation agreement to the FTB without regard to whether the taxpayer believes the federal tax action will affect his state taxes.

Taking these provisions as a whole, the panel found that the state notification requirement met the definition of “other equivalent report or notice” of section 523(a)(1)(B). The panel pointed to the case of Maryland v. Ciotti (In re Ciotti), 638 F.3d 276 (4th Cir. 2011), which dealt with a state tax requirement similar to the California reporting requirement here. In Ciotti, the court applied a four-part test for determining whether a particular tax reporting requirement was an equivalent report or notice under section 523(a)(1)(B): “[I]n order for a document to be considered a ‘return,’ under either the bankruptcy or the tax laws, it must (1) purport to be a return; (2) be executed under penalty of perjury; (3) contain sufficient data to allow calculation of tax; and (4) represent an honest and reasonable attempt to satisfy the requirements of the tax laws.” The Ciotti court found the report required under Maryland law had the earmarks of a “return” in that it required truthfulness the lack of which would be punishable, and required the taxpayer to provide a copy of the federal audit which would provide the additional information necessary to assess state tax liability. The Ciotti court rejected the taxpayer’s argument that state tax law was satisfied when the IRS forwarded the information to the state tax board, finding that state law specified that the taxpayer provide the information.

The panel agreed with the holding in Ciotti. It found that “[t]he report required under RTC section 18622(a) furnishes the state tax authority with information needed to ascertain the taxpayer’s state tax liability. For purposes of § 523(a)(1)(B), the report is equivalent to a return, and the failure to file such a report excepts the tax debt from discharge.”

The panel was unpersuaded by the debtor’s argument that anything not labeled a “return” cannot fall within the meaning of section 523(a)(1)(B). The panel found that when Congress added “equivalent report or notice,” to the language of that provision in 2005, it expanded its reach beyond tax returns. Like the court in Ciotti, the panel also rejected the debtor’s argument that he satisfied the requirements of section 523(a)(1)(B) when the IRS notified the FTB of the reevaluation of his taxes. Here, as in Ciotti, the state statute places the burden of notification on the taxpayer.

The panel affirmed.

Berkovich 9th BAP Oct 2020

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