First Circuit Dodges Late-Filed Tax Return Issues

Posted by NCBRC - December 2, 2022

Faced with the question of whether the debtor’s tax debt based on a late-filed tax return was excepted from discharge, the circuit declined to reexamine its holding in Fahey where it applied the strict “one day late” rule, found the debtor waived his argument in support of an objective test that does not consider timing of filing, and instead, held the debtor’s late-filed tax return did not meet Beard’s subjective test for a “return.” In re Kriss, 21-1206 (1st Cir. Nov. 22, 2022). After the debtor failed to pay taxes for the years 1997 and 2000, the IRS conducted an independent assessment of his taxes, interest, and penalties from those years and concluded that he owed almost $80,000. Later, the debtor filed an IRS form 1040 relating to those years’ taxes. In 2012, the debtor filed for chapter 13 bankruptcy and obtained a discharge in 2017. The debtor and IRS then sought guidance from the bankruptcy court as to whether his tax liabilities were discharged along with his other debts. The bankruptcy court found the tax debts had not been discharged, and the district court affirmed. The debtor appealed to the First Circuit.

Section 523(a)(1)(B)(i)-(ii) excepts from discharge a tax liability: “with respect to which a return, or equivalent report or notice, if required—(i) was not filed or given; or (ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition.”

In an effort to clarify this exception to discharge, Congress in 2005, hung a paragraph at the end of section 523(a) defining a “return” as “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, . . . 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.”

In In re Fahey, 779 F.3d 1 (1st Cir. 2015), the First Circuit dealt with an issue similar to the one here. In that case, the debtor sought to discharge a state tax debt after he had filed his state tax return late. The court found the nonbankruptcy “applicable filing requirements” referred to state filing laws which set a specified filing date for returns. Because the debtor failed to meet that deadline, his purported return did not fall under the definition of “return” set forth in the hanging paragraph to section 523(a).

The debtor here argued that the court should reject the inflexible “one day rule” applied in Fahey in favor of the objective test set forth in In re Colsen, 446 F.3d 836 (8th Cir. 2006). The Colsen court held that to be a “return” within the meaning of section 523(a), a return need only fulfill the requirements of the form itself without regard to extraneous factors like the deadline for filing.

The court found it did not have to consider the “cogent arguments well-marshalled” by the debtor in favor of rethinking Fahey, because the debtor’s argument that his return qualified as a “return” within the meaning of section 523(a)(*) failed without regard to the continued validity of Fahey.

Nor did the court have to decide whether the Eighth Circuit’s objective test was a more fitting approach, because it found the debtor waived that argument by failing to rely on it in the bankruptcy court.

Instead, the debtor relied on the subjective four-part test set forth in Beard v. Comm’r, 82 T.C. 766 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986). Specifically, the debtor argued in the bankruptcy court that his return met all the requirements of the Beard test including the fourth requirement that the purported return represented an honest and reasonable attempt to satisfy the requirements of the tax law.

Having limited the debtor to the arguments he made before the bankruptcy court, the court here found the debtor failed to show that his failure to file a timely return was justified under Beard’s “honest and reasonable” standard. The court rejected his assertion that he relied on his wife’s representation that she had filed the returns, finding that the debtor did not dispute that he and his wife filed separate returns. In addition, the court found no excuse for the debtor’s having ignored notices from the IRS that his returns had not been filed.

The court affirmed, leaving for another day the question of whether it would be willing to reexamine its holding in Fahey, and, if so, whether it would settle on the objective Colsen approach, or return to the pre-BAPCPA Beard test. The court also left open the question posed by the IRS of whether a return filed by the IRS based on its own assessment and without participation of the tax debtor can ever be a “return” for exception-to-discharge purposes.

Kriss 1st Cir Nov 2022

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