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More Bad News for Late Filers –Update!

Posted on Apr. 1, 2015

Last Thursday, Keith posted More Bad News for Late Filers, in which he discussed the First Circuit following the Fifth and Tenth Circuit holdings that Bankruptcy Code Section 523 prohibits from discharge any tax liability in which the taxpayer files a late return, no matter the timing of the late return.  The post also discusses In Re Coyle, a 2015 Bankruptcy case out of the Southern District of Florida, which stated the language only prevented discharge when the returns were filed more than two years after the due date.  As Keith notes, this holding is in line with the IRS position on the matter, whereas the Circuit Court holdings are in line with the position being taken by state tax authorities.

On the same day as Keith’s post, the Department of Justice filed a supplemental authority letter (hat tip and thank you to attorney and previous guest blog poster A. Lavar Taylor) in a case before the Ninth Circuit, Smith v. United States.  The letter can be found here.

I would write a summary of the letter, but Mr. Taylor already did that in the comments to Keith’s post, which is superior to what I would have done.  I have reproduced the comment below:

Yesterday, DOJ Tax filed a supplemental authority letter in the Martin Smith case in the 9th Circuit, which involves the issue of the circumstances under which taxes arising from a late filed Forms 1040 can be discharged in a chapter 7 case. That letter alerts the 9th Circuit to the new Circuit Court opinions. Importantly, that letter also states that DOJ continues to disagree with the approach taken in Fahey.

Since the Fahey opinion was issued, I’ve not spoken with anyone in IRS to confirm that they are continuing to disagree with the rule set forth in Fahey. But I would be surprised if the official IRS position is not the same as DOJ’s position.

Nevertheless, it is imperative that private practitioners warn their clients who are considering filing bankruptcy for purposes of discharging federal income tax liabilities associated with late filed returns that they are at risk that the IRS and/or DOJ could change their official position on this issue at any time. Which means that, for clients who filed returns even a day late, it really is a mess. They face uncertainty because no one can properly advise them that they are not at risk that their taxes will not be discharged as the result of filing their Form 1040 late, even by one day.

The biggest problem with the Fahey line of reasoning is that it encourages taxpayers who did not file on time, and who might later seek to discharge their tax debts in bankruptcy, to NOT file returns but instead to wait for the IRS to open up a non-filer audit and then to NOT agree to the results of that audit but instead to ask the IRS to issue a 90 day letter so that they can file a Tax Court petition and enter into a stipulated Tax Court decision. That type of agreed Tax Court decision likely DOES constitute a “return” for purposes of the BK Code. So the Fahey rule actually encourages people who for any reason miss a return filing deadline, even by one day, to never file Forms 1040.

The Fahey rule treats more favorably those who never file a Form 1040 and who later go to Tax Court to get a stipulated decision than those people who accidentally file their return a few days late. Talk about an absurd result!

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