B.A.P. Rejects Literal Interpretation of 523(A) – Dischargeability of Tax “Returns”

By Megan Craig, Bayer, Wishman & Leotta (Los Angeles, CA)

1.

Meet the Martins

The Martins missed the deadline to file their tax returns. With good intentions to file, the Martins were delayed by troubles with their accountant. After the IRS sent notices of the deficiency and filed its own substitute assessment, Kevin and Susan obtained a new accountant and filed their missed tax returns. Two years later they filed a Chapter 7 bankruptcy to discharge the taxes. The IRS objects. Are the taxes dischargeable?

Setting The Stage

Pre-BAPCPA

Prior to the 2005 bankruptcy reform (“BAPCPA”), the Ninth Circuit examined the dischargeability inquiry and held under Section 523(a)(1)(B)(i) that tax debts were excepted from discharge when the debtor taxpayers failed to file a tax return and were required to do so.i Taxes were also nondischargeable when filed untimely and within two years of the debtors’ bankruptcy filing, or when such taxes were fraudulent or evasive.ii

As will be discussed, this is essentially still good law today- with some important case law caveats to explore.

Post-BAPCPA

Congress introduced with BAPCPA the nondischargeability statute as part of the Bankruptcy Code amendments. BAPCPA amendments included 11 U.S.C. § 523(a)(*) – another so-called “hanging paragraph” that defines the term “return” to exclude any taxpayer filing that does not wholly and strictly comply with all applicable return filing requirements, even if the taxing authority itself could and would forgive that noncompliance. Stranger yet, the “return” definition expressly includes some types of returns that the taxing authority prepares on behalf of the taxpayer when the taxpayer never gets around to it.

Martin v. United States

Enter United States v. Martin (In re Martin)iii; an extremely informative case, well researched, and critically written. Martin analyzes and relies on §523(a)(1)(B)(ii)- which existed Pre-BAPCPA- as critical to the court’s decision. It rejects a literal interpretation of the “return” definition under § 523(a)(*) & 523(a)(1)(B)(i) that would render these sections superfluous in construction if not meaningless in content when read together with §523(a)(1)(B)(ii) . First, the latter provision already contains a specific and careful treatment of tax debts associated with untimely-filed returns. Second, the Court explains “it would make no sense for a debtor taxpayer who never bothers to file his or her own tax returns to discharge his or her associated tax debt if the IRS fortuitously prepares a substitute assessment on that person’s behalf.” And, finally, the Supreme Court disfavors major changes in practice absent some discussion in the legislative history.iv

For these reasons, Martin rejects the IRS’ contention that the dischargeability of income tax debts associated with a late-filed tax return should hinge on whether the taxpayer filed the return before or after the IRS made any assessment.

The Beard Test

Martin properly relies on the Beard testv. The Ninth Circuit, ahead of the curve, had already followed Beard in In re Hatton IIvi when it cited In re Hindenlangvii to utilize the Beard test. The Beard test – derived from nonbankruptcy law – determines whether tax debts are dischargeable in bankruptcy. The test examines whether the debtor(s) filed something that:

  1. Purports to be a return;
  2. Is executed under penalty of perjury;
  3. Contains sufficient data to allow calculation of a tax; and
  4. Represents an ‘honest and reasonable attempt’ to satisfy the requirements of the tax law.

Martin opines that Congress intended to codify the Beard test when it enacted BAPCA. And while, for most intensive purposes this is true, such wholehearted reliance would cause the Court’s opinion to depart from its own logic. More likely, Congress simply thought it was creating an easy-to-administer rule. Martin astutely recognizes that Beard is a fact-intensive test (as will be further discussed below), and that Congress typically will not make major changes to the Code without legislative comment.

Nevertheless, Martin shines on the central issue: Prong #4 of the Beard test.

The Honest and Reasonable Attempt

The crux of the ‘honest and reasonable attempt’ inquiry is broad (not narrow) and subjective (not objective) in its scope.viii At its core, the fourth prong of Beard requires an assessment of a totality of the circumstances. That is, a fact-intensive look at each individual case. Factors such as the length of the delay, the reason for the delay, and the number of tax years missed affect the ultimate determination of dischargeability.

The bankruptcy court had failed to consider oral testimony of the Martins attesting to facts which may have been critical to the ‘honest and reasonable attempt’ inquiry. Namely, that the Martins testified to delays caused by sickness and death in family of her former accountant, and to the time it took to reacquire their financial records and obtain a new accountant.

Are the Taxes Dischargeable?

If the B.A.P. opinion prevails, the Martins (and many other debtor taxpayers) will succeed in getting their taxes discharged regardless of whether the IRS filed its own tax assessment against the debtors. In fact, in pushing the issue, the IRS may have caused itself an interminable headache in future case administration. Arguably, the IRS now has a duty to investigate much more deeply into the factual bases for the tax filing delay before asserting nondischargeability. The end result may well be that fewer nondischargeability actions are filed for want of manpower. For now, the dischargeability of tax “returns”.

____________________

[1] Cal. Franchise Tax Bd. V. Jackson (In re Jackson), 184 F. 3d 1046, 1050 (9th Cir. 1999).

[2] See In re Hindenlang, 164 F.3d at 1032; see also 4 COLLIER ON BANKRUPTCY § 523.07[3], [4] (Alan N. Resnick & Henry J. Sommer, eds., 16th ed. rev. 2015).

[3] United States v. Martin (In re Martin), 2015 WL 9252590 (9th Cir. BAP 2015).

[4] See Dewsnup v. Timm, 502 U.S. 410, 419 (1992).

[5] Beard v. Commissioner, 82 T.C. 766, 774-79 (1984), aff’d 793 F.2d 139 (6th Cir. 1986).

[6] United States v. Hatton (In re Hatton), 220 F. 3d 1057, 1060-61 (9th Cir. 2000).

[7] United States v. Hindenlang (In re Hindenlang), 164 F.3d 1029, 1033 (6th Cir. 1999).

[8] See In re Hatton, supra note v.
_____________________

craig megan atty authorMegan Craig is an associate attorney at Los Angeles consumer bankruptcy law firm Bayer, Wishman & Leotta. An alumna of Southwestern Law School, Megan has a true passion for bankruptcy law that is reflected in her scholarly achievements as recipient of the Judge Barry Russell Federal Practice Award, American Bankruptcy Institute Medal of Excellence, and her externships with the U.S. Bankruptcy Court Central District Rules Committee and former Chief Judge Vincent P. Zurzolo. In addition to her academic achievements, she has 10 years of experience with reputable consumer bankruptcy law firms across the country. She is a frequent contributor to The Academy’s e-zine ConsiderChapter13.org.

No Author Biography has been linked to this Article.

Related Articles

October 24, 2021
By Merideth Akers, CPA, PHR, Comptroller for Bradford W. Caraway (Birmingham, AL) I have taught Compensation and Benefits to candidates preparing to take the Professional in Human Resources certification exam. These two topics include a great amount of employment law. So, I know just enough about employment law to be scared… or maybe cautious is a better term. I am...
Members
judgebaxter
August 20, 2023
Passing of Retired Ohio Judge Judge Baxter was appointed United States Bankruptcy Judge for the Northern District of Ohio on December 16, 1985, and served in the Court’s Cleveland, Ohio location until his retirement in 2011. He served as Chief Judge between 2004 and 2008. Click here for obituary.
January 5, 2020
By David Cox,1 Cox Law Group, PLLC (Lynchburg, VA) Overview Filing considerations. Perfect Storm! Pensions going down. Healthcare costs going up. Home Equity high. Medical debts increasing. Limited income. Common considerations. Embarrassment. Many of the elderly are from a generation which regards bankruptcy as an indication of moral failure and shame. Confidentiality. May not want family members, including a spouse,...
Members
February 2, 2020
By The Honorable William Houston Brown (Retired) Class action certification on predominance. The Eleventh Circuit remanded, finding that the District Court had abused its discretion in refusing to certify a class on a predominance theory for former debtors who had obtained discharge of personal liability on residential mortgages and who asserted violations of the FDCPA by a loan servicer. The...
Members
November 21, 2021
By Lawrence R. Ahern III, Brown & Ahern (Nashville, TN) Introduction Following Part 1's review of the December 1, 2021, changes in the Federal Rules of Bankruptcy Procedure, this Part 2 presents a digest of selected judicial decisions of interest for their procedural import arising under Parts I-III of the Federal Rules of Bankruptcy Procedure. Digest of Selected Judicial Decisions
Members
M Joseph Photo 2-1-22
May 8, 2022
Faced with abusive and serial bankruptcy cases,courts have fashioned various sanctions to put a stop to gaming the system. The favored sanction of the majority of courts is to enter an order of dismissal with prejudice under Section 349(a) of the Bankruptcy Code that adds a condition prohibiting refiling another bankruptcy case for a set period of time. See Lundin...
Members
March 7, 2021
By Dynele Schinker-Kuharich, Chapter 13 Standing Trustee (Canton, OH) I vividly remember getting the call that I was to be appointed as a Standing Chapter 13 Trustee (effective October 1, 2018). I was so honored, and humbled, and excited. At the time I was a panel Chapter 7 Trustee, but my heart had always been in Chapter 13. As corny...
Copy of Hildebrand-2016
September 3, 2023
To pay present value to a secured creditor, a reorganization plan may start with a treasury rate and add a risk factor and need not start with a prime rate plus a risk factor.
Members
Merideth Akers
November 6, 2022
“Does wearing these horizontal stripes make me look fat?” My wife, Becky, tells me that clothes with horizontal stripes make one look broad or fat. However, wearing clothes with vertical stripes create the illusion of making one look tall or slim. Smart fashion designers design clothing that creates the illusion that people are something they are not. I must confess...
October 13, 2019
IRS officials announced on 10/8/19 that a new payment option has been added to the private debt collection program to make it easier for those who owe to pay their tax debts. Taxpayers now can choose the convenient option of a preauthorized direct debit to make one payment or a series of payments toward their federal tax debt. With direct...
Members

Looking to Become a Member?

ConsiderChapter13.org offers a forum to advance continuing education of consumer bankruptcy via access to insightful articles, informative webinars, and the latest industry news. Join now to benefit from expert resources and stay informed.

Webinars

These informative sessions are led by industry experts and cover a range of consumer bankruptcy topics.

Member Articles

Written by industry experts, these articles provide in-depth analysis and practical guidance on consumer bankruptcy topics.

Industry News

The Academy is the go-to source for the latest news and analysis in the Chapter 13 bankruptcy industry.

To get started, please let us know which of these best fits your current position: