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All Late-Filed Taxes Now Nondischargeable?!

posted by Jason Kilborn

Tax formSometimes a tax return is not a tax return. As a result, bankruptcy is becoming a less effective response to back tax woes in the US. Yesterday, the 1st Circuit joined the 5th and 10th in holding that old income tax debts are nondischargeable if the taxpayer-debtor filed the related tax returns late. This is the latest negative impact of BAPCPA and an oddly worded statute with an even odder citation.

Section 523(a)(1)(A) of the Bankruptcy Code has long made nondischargeable recent income tax debts, for taxes for which the return was due within three years before the bankruptcy filing. But older tax debts might also survive the discharge thanks to section 523(A)(1)(B)(i). That section renders taxes nondischargeable if the taxpayer-debtor failed to file a return. Not surprising. What is surprising is a recent revision and its expansive interpretation, which have created a vast new category of nondischargeable tax debts.

In yet another BAPCPA "hanging paragraph" at the very end of section 523(a), generally cited 11 USC § 523(a)(*), the term "return" is oddly defined now as a return "that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements)." In Fahey, the 1st Circuit joined several other courts, including the 5th (McCoy) and 10th (Mallo) in interpreting "applicable filing requirements" to include the filing deadline. That is, a return filed so much as one day past the filing deadline does not satisfy applicable filing requirements and so is not subject to discharge in bankruptcy, no matter how old.

Notwithstanding the majority's "plain language" insistence in Fahey, this is not an uncontroversial interpretation of the provision. The IRS doesn't view it this way, for example. It takes the historical approach of regarding a return filed after the IRS has  made an involuntary assessment (or filed a 6020(b) return) as not a good faith attempt to comply with tax law and therefore not a return. But a late-filed return filed before an assessment (the IRS apparently moves somewhat slowly) is a "return," and the tax debt for such a return can be discharged. This still leaves many old taxes nondischargeable because their "returns" were filed late (and were not, therefore, "returns"), but it's a much narrower exception than the McCoy-Mallo-Fahey approach. I admit that I was surprised at the metaphysics of "returns" even on this historical IRS test, but many courts (4th, 6th, 7th, 9th and a slew of lower courts) have adopted this position.

Attorneys advising potential bankruptcy clients with old back tax debts, beware! Even the Chapter 13 discharge does not encompass these "no-return" tax debts!  [11 USC § 1328(a)(2)]  If this approach expands to other circuits, BAPCPA will have silently ushered in a substantial new category of nondischargeable tax debts.

1040 tax return image courtesy of Shutterstock


Excuse me from turning this post into a Wellness International prediction/rebuttal but the future of consumer bankruptcy is affected by tax cases and Wellness.

I predict Wellness will restrict bankruptcy court authority to decide most everything except uncontested debt. All other disputes related to contested debt, contracts, sales, etc. must be decided in an Article III or State Court. Obviously that is what all bankruptcy practitioners are afraid of. Bankruptcy becomes a wounded duck where the bird only lives if everyone stops hunting.

In such a world notice and consent become a critical issue. The Court’s notice that the debtor has filed bankruptcy MUST be allowed to put creditors on notice that if they do nothing they consent to everything - that is informed knowing consent is sufficiently implied if solicited.

That is why the Court was so interested during oral arguments in which issue was more important - consent or authority to decide.

It takes Herculean denial and blind prejudice to expect differently.

Consumer bankruptcy support groups will be stressed to the max defending the few rights remaining for individual debtors; corporations (debtors and creditors alike) on the other hand will enjoy and be able to afford the litigious Article III gamemanship.

Did I just say this is a Class issue?

I think your prediction is way off. I think the Court is virtually unanimous on holding the bankruptcy court could decide the claim in Wellness. However, some Justices see the consent issue as more important, and recognize that Wellness's holding on Stern's scope is an outlier, so they'd like to reach consent first if they could. That's why the Court was so interested in which issue was more important to decide. The fact that they're even asking almost presupposes that the petitioners could and probably would win on the question of Stern's scope; if they lost on that issue, you'd HAVE to reach consent, and there would be no question of which issue was more important.

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