When a Return Is Not a “Return”

Posted by NCBRC - October 15, 2021

A tax return filed four years after it was due and one year after the IRS completed its own independent tax assessment is not dischargeable under section 523(a) because it does not meet the “honest and reasonable” standard set forth in the Beard test for what constitutes a “return.”  IRS v. Starling, Nos. 20-7478, 20-7954 (S.D.N.Y. Sept. 16, 2021).

When the debtor failed to file his 2002 federal tax return, the IRS, in 2005, sent a notification of delinquency informing the debtor that it had performed its own assessment on his behalf and providing instructions for the debtor to file his own return, contest the one completed by the IRS, or take other action. Upon receiving no response from the debtor, the IRS finalized its assessment in 2006. In 2007, the debtor filed a return for the 2002 taxes which mirrored the assessment conducted by the IRS.

The debtor then petitioned for chapter 13 bankruptcy and the IRS filed a claim for the delinquent taxes. Upon completion of his plan and discharge, the debtor had paid off only a portion of the 2002 taxes. The IRS, and its private collection agency, ConServe, continued to dun him for the remaining tax debt until the statute of limitations rendered the debt uncollectible. The debtor then filed a motion in the bankruptcy court seeking sanctions against the IRS and ConServe for violation of the discharge order, asserting that the tax debt had been discharged in his bankruptcy. The bankruptcy court agreed, In re Starling, 617 B.R. 208 (Bankr. S.D.N.Y. 2020), and, after the court denied its motion for reconsideration, the IRS and ConServe appealed to the district court.

The appeal centered on whether the tax debt was discharged under section 523(a)(1)(B), which provides that “an individual debtor” is not discharged “from any debt . . . for a tax . . . with respect to which a return, or equivalent report or notice, if required . . . was not filed or given.” The decisive issue was whether the debtor’s 2007 filing could be deemed a “return.”

The district court began its discussion with the four-prong test set forth in Beard v. Comm’r, 82 T.C. 766 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986) (per curiam). That test says that to be a “return” for purposes of section 523(a)(1), 1) the filing must contain sufficient data to calculate tax liability 2) it must purport to be a return, 3) the taxpayer must execute the document by signing it under penalty of perjury; and 4) it must be an honest and reasonable attempt to satisfy the requirements of the tax law. Resolution of the issue typically turns on the fourth prong of the test with the majority view, represented by United States v. Hindenlang (In re Hindenlang), 164 F.3d 1029, 1034-35 (6th Cir. 1999), considering a variety of outside factors, including timing, to determine whether a tax debtor’s filing constituted an “honest and reasonable” attempt to comply with tax laws. Representing a minority view, the Eighth Circuit in Colsen v. Internal Revenue Serv. (In re Colsen), 446 F.3d 836, 840 (8th Cir. 2006), also applied the Beard test when it held that timing was irrelevant and that the only factor to consider in determining whether a debtor made an “honest and reasonable attempt” to satisfy the tax laws was whether the tax document filed was objectively accurate on its face.

Congress ostensibly clarified the issue in 2005 when it amended section 523(a) to include a hanging paragraph providing:

“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 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.”

After that, decisions split into three primary camps: 1) the “one-day-late” approach, where the “applicable filing requirements” language in the hanging paragraph is read to include the original tax filing deadlines and  any filing that does not comply with the filing deadline cannot be deemed a “return;” 2) continued application of the Beard majority test; 3) the view propounded by the IRS that once the IRS completes its own independent tax assessment, any filing by the debtor can no longer be considered “honest and reasonable.”

The district court here found that the debtor’s tax filing did not satisfy any of the three approaches. It was filed nearly four years after it was due, and more than a year after the IRS independently assessed his tax liability. The district court concluded that even under the Beard test majority view, the debtor, by filing late and ignoring numerous notices by the IRS giving him the opportunity to rectify the situation, did not make an “honest and reasonable” attempt to satisfy the requirements of the tax law.

In so holding, the court specifically rejected the reasoning in Colson, upon which the bankruptcy court relied, finding that use of that standard misapplied the test set forth in Beard and was an error of law. Specifically, the court found that Colson’s narrow interpretation which looks only at the face of the purported return, “waters down” the element of honesty, and eliminates the element of reasonableness. In fact, the court called into question whether even the Eighth Circuit would have found the debtor’s filing reasonable in this case. The district court noted that other courts out of the Eighth Circuit have declined to apply Colson post-BAPCPA, and that even the Colson court considered the fact that the debtor there provided additional information in his filing that the IRS did not already have. Here, the court stated: “Unlike in Colsen, Starling’s late-filed Form 1040 appears to have simply reiterated the tax assessment the IRS had already performed, and although this effort may have been an “honest” attempt to satisfy his obligations under the tax law, it was hardly “reasonable” to ignore multiple notices and only file years late with the same number the IRS had already come up with on its own.”

Concluding that the tax debt was not discharged in the debtor’s bankruptcy, the court reversed the bankruptcy court’s order holding the IRS and ConServe in contempt for violation of the discharge order.

Starling SD NY Sept 2021


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