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Equitable Tolling and Bankruptcy Time Periods

Posted on Apr. 27, 2023

Bankruptcy brings out equitable rulings in a way that tax issues do not, but as discussed at the end of the post, remembering the bankruptcy equitable rulings can prove helpful.  The leading case on equitable tolling and bankruptcy in the tax context is United States v. Young, 535 U.S. 43 (2002) where the IRS argued, and the Supreme Court held, that the time period for a tax to retain priority status based on BC 507(a)(8)(A)(i) was equitably tolled based on a prior bankruptcy filing.  In that case the debtor filed a chapter 13 petition and stayed in bankruptcy long enough for the tax period to age out of priority status.  The debtor then dismissed the chapter 13 bankruptcy petition and shortly thereafter filed a chapter 7.  After obtaining a discharge in the chapter 7, the debtor argued that the debt was no longer entitled to priority status and thus discharged due to its age and status.  The Supreme Court said that under these circumstances the IRS time period for having a priority claim was tolled by the first bankruptcy since that bankruptcy prevented the IRS from collecting on the debt.

In Rader v. Internal Revenue Service, No. 3:21-ap-90125 (M.D. Tenn. 2023) the debtor made a similar argument, but this time the parties argued about the period in BC 523(a)(1)(B)(ii) which governs the discharge of taxes for individual taxpayers who file their returns late.  As in the Young case, the IRS prevailed in its equitable tolling argument.

Mr. Radar filed a chapter 13 bankruptcy petition on March 11, 2014. He successfully completed the bankruptcy using the five-year plan option and received his discharge on November 12, 2019. Prior to filing his successful chapter 13 petition, Mr. Radar filed a chapter 13 petition on May 11, 2011, which was dismissed without a discharge on November 7, 2013. During both bankruptcy cases the automatic stay arose at the time of filing the petition and lasted until the dismissal (first case) or the discharge (second case.) While the automatic stay was in effect, the IRS could not take collection action against Mr. Radar and the collection statute of limitations was tolled; however, the time period in BC 523(a)(1)(B)(ii) makes no mention of the effect of a prior bankruptcy.

I have discussed BC 523(a)(1)(B)(ii) in numerous blog posts because this subparagraph comes into play for the courts interpreting the unnumbered paragraph at the end of BC 523(a) which gave rise to the “one-day rule” discuss here and in many preceding posts.  You can find an extensive discussion of the one-day rule in IRS Practice and Procedure at Chapter 16.

The Radar case, however, involves a straight-forward interpretation of this provision. BC 523(a)(1)(B)(ii) provides that a taxpayer who files a return late cannot discharge a tax liability related to that return without waiting for two years after the filing of the late return. This exception to discharge ties back to the priority provisions and to the overall goal of the bankruptcy code to generally give the IRS adequate time to collect on a debt before allowing a debtor to discharge the tax debt in bankruptcy.

Mr. Radar, like many who file for bankruptcy as well as many who do not, failed to timely file his returns for many years. For the years 2002-2009 he filed eight years of past due returns on Mach 15, 2011. He filed his 2010 return on April 2, 2012. He apparently filed the past due returns without remittance or with insufficient remittance.

The timing of the filing of these late returns is not a coincidence. So many debtors were going into bankruptcy with unfiled returns that Congress addressed the situation in the 2005 extensive revisions to the bankruptcy code. Debtors must file past due returns or face dismissal from bankruptcy. In the 2005 legislation Congress enacted BC 1308 entitled “Filing of prepetition tax returns.” This section requires the filing of the four returns due prior to the filing of the bankruptcy petition. By March of 2011, Mr. Radar was probably consulting with a bankruptcy attorney in preparation for the filing of his first bankruptcy petition and knew he needed to file the past due returns.

By filing the past due returns less than two months before he filed his first bankruptcy petition, he did not give the IRS much time to process those returns and begin collection. Because the IRS give past due returns low priority for processing during the filing season and because the past due returns must be paper filed, the returns filed in March of 2011 were probably not processed for several months. Once processed, the IRS would have filed a claim in the bankruptcy case but done nothing else because of the stay.

When Mr. Radar was dismissed from the first bankruptcy case, the IRS could collect; however, only four months separated the first and second bankruptcy cases at which time the IRS had to stop collection and wait for payment through the bankruptcy process. At the time of the second bankruptcy filing, the IRS had only six months of time to collect when the automatic stay did not prevent collection.

After noting that the two-year rule of BC 523(a)(1)(B)(ii) would allow the discharge of all of the years at issue except 2010 if equitable tolling does not apply, the bankruptcy court launched into its analysis of equitable tolling.  It stated:

There is a “rebuttable presumption” that equitable tolling applies to nonjurisdictional federal statutes of limitations. Holland v. Florida, 560 U.S. 631, 645-46, 130 S. Ct. 2549, 2560 (2010) (citation omitted). “It is hornbook law that limitations periods are ‘customarily subject to ‘equitable tolling,’’ unless tolling would be ‘inconsistent with the text of the relevant statute.’” Young v. United States, 535 U.S. 43, 49, 122 S. Ct. 1036, 1040 (2002) (citations omitted).

It is not immediately obvious that the two-year lookback period in §523(a)(1)(B)(ii) is a limitations period. However, in Young, the Supreme Court explained that a similar tax-related three-year lookback period in 11 U.S.C. §507(a)(8)(A)(i), as incorporated by §523(a)(1)(A), was a “limitations period because it prescribes a period within which certain rights (namely, priority and nondischargeability in bankruptcy) may be enforced.”3 Id. at 47.

The Supreme Court noted in Young that the IRS risked older taxes becoming dischargeable if not collected or if a tax lien is not perfected before the three years under that subsection have elapsed, so the IRS was encouraged to act quickly. Id. “Thus, . . . the lookback period serves the same ‘basic policies [furthered by] all limitations provisions: repose, elimination of stale claims, and certainty about a plaintiff’s opportunity for recovery and a defendant’s potential liabilities.’” Id. at 47 (quoting Rotella v. Wood, 528 U.S. 549, 555, 120 S.Ct. 1075 (2000)). The Supreme Court acknowledged that the lookback period was limited in nature since it only barred some, but not all, legal remedies (namely priority and nondischargebilty in bankruptcy), but it held it was, nonetheless, a statute of limitations. Id. at 47-48. So that point regarding the nature of the lookback period as a limitations period is settled by the Young decision.

After the Young decision, Congress amended BC 507(a)(8) in 2005 to specifically addressed, at least in part, the problem of prior bankruptcy cases on the priority of the tax claim by adding an unnumbered paragraph to the end of the section.  In making that change it did not alter BC 523(a).  The bankruptcy court noted that two prior bankruptcy court decisions had addressed the specific question at issue in Mr. Radar’s case: Putnam v. IRS (In re Putnam), 503 B.R. 656 (Bankr. E.D.N.C. 2014), aff’d sub nom. Putnam v. I.R.S., No. 5:14-CV-118-D, 2014 WL 8863125 (E.D.N.C. Sept. 24, 2014); Ollie-Barnes v. IRS (In re Ollie-Barnes), No. 09-82198, 2014 WL 5794866 (Bankr. M.D.N.C. Nov. 6, 2014).

Mr. Radar argued that the failure of Congress to make a change to BC 523 to fix this problem at the time it changed BC 507 showed that the rebuttable presumption for equitable tolling should not apply. The bankruptcy court turned around that argument finding that the change to BC 507 showed that Congress approved of the tolling of time periods such as this and doing so would close a loophole.

Mr. Radar made a second argument regarding equitable tolling based on the facts and circumstances of the case.  He argued:

vehemently and creatively that because equitable tolling is “equitable” relief, the totality of the circumstances should be considered in determining whether it would be equitable to toll the lookback period. Debtor argues for a case-by-case review of the actions of both the debtor and the IRS. If a debtor has acted in good faith and if the IRS perhaps has not, Debtor argues that the lookback period should not be tolled. Debtor contends some actions of the IRS reflect poor conduct or bad faith, such as the way Chapter 13 plan payments were applied to the IRS debt in the earlier case and the pursuit of dischargeable penalties. Accordingly, under Debtor’s approach, all actions of the parties throughout the bankruptcies and the collection process should be considered before imposing any equitable remedy.

Debtor misconstrues the equitable focus when a limitations period is tolled. The focus is on whether the applicable claimant has been prevented in some way from acting within the limitations period. See Robertson v. Simpson, 624 F.3d 781, 783 (6th Cir. 2010) (“The doctrine of equitable tolling allows courts to toll a statute of limitations when ‘a litigant’s failure to meet a legally-mandated deadline unavoidably arose from circumstances beyond that litigant’s control.’”) (citation omitted).

While rejecting this argument as a basis for preventing equitable tolling, the court noted that in the next phase of the trial the IRS behavior in the case could become relevant.

The decision did not surprise me based on the Supreme Court’s analysis in Young and the equities of shielding yourself from collection but wanting the benefit of the ticking clock on IRS collection opportunities. The case indicated that a fair amount of money was at issue. So, an appeal may occur.

I like to see the IRS make equitable arguments and believe that it deserves to make those arguments.  It also deserves to be reminded that it argues in favor of equitable tolling when it benefits the IRS and against it when it favors taxpayers.  Bringing out the cases where it makes these arguments helps in the cases where it seeks to limit equitable tolling.

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