Tax Notes logo

Bankruptcy Court Grants IRS Equitable Tolling and Denies Discharge on Late Return

Posted on Dec. 16, 2014

I have written before about the controversy current surrounding the ability to discharge late filed returns. See What is a Return – The Long Slow Fight in the Bankruptcy Courts (Dec. 4, 2013); A Cogent Look at the “What is a Return?” Question (Sept. 26, 2014); Willful Attempt to Evade or Defeat the Payment of Tax (Sept. 8, 2014).  On the blog we have also written about equitable tolling and the strong position the IRS takes when taxpayers seek equitable tolling. See Boeri: Not a citizen, Never Lived or Worked in the US? IRS Will Still Keep Your Money (Aug. 26, 2014); Supreme Court Will Hear Federal Tort Claims Act Equitable Tolling Cases, Which Could Affect Tax Refund Suits (July 2, 2014); Supreme Court’s Likely Review of Rulings Equitably Tolling FTCA Claims May Impact Tax Refund Suits (May 1, 2014); Timely Filing a Tax Court Petition from Prison (Apr. 16, 2014).  The Ollie-Barnes case involves a situation in which the IRS requests the bankruptcy court equitably toll the time period on a discharge provision governing untimely returns and it obtains a decision significantly extending the IRSs’ ability to prevent discharge in this area.

Bankruptcy generally grants a discharge as its pot of gold at the end of the rainbow but not all debts get included in the pot of gold. Section 523(a)(1) provides the rules for individuals seeking a discharge of taxes and has three separate hurdles that a debtor must cross: 1) no discharge for taxes entitled to priority status in the bankruptcy case generally meaning that the taxes arose within three years of the bankruptcy petition but many exceptions to that generalization exists; 2) no discharge where the taxpayer failed to file a return or filed it late and within two years of the bankruptcy petition; and 3) no discharge if the taxpayer filed a fraudulent return or attempted to evade or defeat the payment of taxes.  For a detailed discussion on how section 523(a)(1)(C) should be interpreted, compare A. Lavar Taylor, What Constitutes an Attempt to Evade or Defeat Taxes for Purposes of Section 523(a)(1)(C) of the Bankruptcy Code: The Ninth Circuit Parts Company with Other Circuits (Part 2) (Sept. 14, 2014) with Bryan Camp, Taking Issue with the Ninth Circuit and Lavar Taylor’s View of a Willful Attempt to Evade or Defeat Tax (Oct. 6, 2014).

The second of the three bases for discharge presents itself in the Ollie-Barnes case. She filed her returns late; however, she filed them long before the filing of the bankruptcy petition so the two-year rule potentially causing the exception of her debts from discharge only applies if something suspends the two-year period.  The IRS successfully argued that prior bankruptcy cases suspended that time period.  This argument has a history spanning over two decades including one Supreme Court case and one major bankruptcy reform act which partially addressed this issue.  Yet, the Ollie-Barnes case represents a new strain on the IRS argument regarding equitable tolling for prior bankruptcy filings.

The first case in which the IRS argued that a prior bankruptcy proceeding tolled bankruptcy time period related to tax occurred in Brickley.  In that case the IRS first argued that it did not get the full opportunity to collect on a tax prior to the time the liability lost its priority status under bankruptcy code section 507(a)(8) (formerly section 507(a)(7)).  The priority scheme of the 1978 bankruptcy code allowed taxes as a priority claim but only if they met certain criteria.  Generally, taxes have priority status when a petitioner files bankruptcy if they arose within three years of the filing of the bankruptcy petition or were assessed within 240 days of the bankruptcy petition.  Once taxes age beyond the time set out in the priority provision, they lose their special status and become general unsecured claims, making them much less likely to receive a distribution from the estate and eligible for discharge.  In Brickley, the IRS argued that since the test for determining if taxes had priority status generally turned on the age of the tax events that intervened during the relevant time period keeping the IRS from quickly collecting should equitably toll the priority time period.  The court explained that Congress wanted to give the IRS a fair shot at collecting the tax before it aged into general unsecured status, and since a prior bankruptcy case created an automatic stay preventing the IRS from collecting taxes, the time period in 507(a)(8) should not run, or equitable tolling should occur, if a taxpayer sat in bankruptcy prior to the current bankruptcy case.

Let me illustrate the issue. Assume a taxpayer timely filed their 2009 tax return on April 15, 2010, reporting a liability of $10,000 which the taxpayer does not pay.  That liability has priority status in any bankruptcy filed prior to April 16, 2013.  As mentioned above, a major benefit to the IRS of having priority status is that bankruptcy does not discharge the debt even if the IRS does not get paid in the bankruptcy.  Assume on these facts that the taxpayer filed a chapter 13 bankruptcy petition on May 15, 2010 and the bankruptcy case was dismissed on March 15, 2013.  During that entire period the automatic stay would have prevented the IRS from collecting from the taxpayer except by receiving distributions from the bankruptcy estate (and possibly excepting offset, but set that aside for this discussion).  Assume further that taxpayer files another bankruptcy case on April 16, 2013.  Under these facts the IRS had only two months to try to collect the 2009 liability prior to the filing of the second bankruptcy.  In the second bankruptcy the IRS claim for 2009 has lost its priority status due to age.  By sitting in bankruptcy for almost three years, even though the taxpayer may not have paid creditors during that period, the taxpayer has transformed a perfectly good priority tax claim into a horrible (from the IRS’s perspective) general unsecured claim which will receive little payment in bankruptcy and get discharged.

You can see why the IRS wants to toll the time period for priority status while bankruptcy cases exist during that period.  After Brickley, cases were fought on this issue all over the country and this issue eventually culminated into the Young case, where the Supreme Court issued a decision favorable to the IRS.  Most of the litigation took place during the time the Bankruptcy Commission (created by the Bankruptcy Reform Act of 1994) sought to reform the bankruptcy code and the commission proposed an amendment to 507(a)(8) to address the problem.  That proposed amendment was adopted in 2005, which provided:

An otherwise applicable time period specified in this paragraph shall be suspended for any period during which a governmental unit is prohibited under applicable nonbankruptcy law from collecting a tax as a result of a request by the debtor for a hearing and an appeal of any collection action taken or proposed against the debtor, plus 90 days; plus any time during which the stay of proceedings was in effect in a prior case under this title or during which collection was precluded by the existence of 1 or more confirmed plans under this title, plus 90 days.

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 2005 Pub. L. 109-8, § 705(2).  Throughout the litigation and the legislation, the priority status of the IRS claim served as the focal point of the equitable tolling argument although the priority status of that claim does serve as a basis for excepting the claim from discharge under 523(a)(1)(A).

Now, the IRS seeks to take the hard fought and somewhat long ago victory it won regarding the priority status of its claim and import that logic to the purely discharge situation presented with the late-filed return provision of 523(a)(1)(B)(ii). This argument creates an end run around, or certainly an extension of, the 240 day provision in the priority provisions that comes over into the discharge provisions through 523(a)(1)(A).  Here, the timing of the late filed returns (and the assessment of the liabilities on those returns) and the timing of the intervening bankruptcy cases creates a period greater than 240 days from the assessment, but less than two years from the filing of the returns.  That 16 month window is the only time the IRS would need to make this argument.

The facts in the Ollie-Brown case match the situation I describe above. An understanding the facts provides a critical basis for understanding what the IRS sought.

Ollie-Brown Timeline

Date Event
1-26-2003 1995 return filed
3-31-2003 1st bankruptcy filed
3-24-2004 1st bankruptcy dismissed
5-6-2004 1993, 1998, 1999, 2000, and 2001 returns filed
5-20-2004 2nd bankruptcy filed
8-29-2008 2nd bankruptcy dismissed
12-9-2009 3rd (and so far final) bankruptcy filed – this is the case with the discharge issue
7-22-2013 Final decree stating that she fulfilled Ch. 13 obligations and received discharge

The opinion contains a discrepancy in describing the time periods. At one point it says Ms. Ollie-Barnes was out of bankruptcy only five months between the time of the filing of the returns for 1993, 1998, 1999, 2000, and 2001.  I calculate that she was out of bankruptcy for approximately 16 months for these periods before the filing of the final petition.  I calculate a period of almost 20 months for the 1995 return.  Both the 16 and 20 month periods are less than two years yet greater than 240 days which is why the IRS makes the tolling argument under the discharge provision of 523(a)(1)(B)(ii) in this case.

The Court makes relatively quick work of the tolling argument. It finds it has the equitable power to toll.  It finds this situation consistent with Young and that it had decided this issue earlier in 2014 in In re Putnam.  It spends no time or energy worrying about the fact that the tolling provisions in Young related to priority status and that different considerations might exists in a pure discharge setting.

This issue bears watching. While the circumstances here may not arise with great frequency, they do come up regularly.  If the IRS loses its arguments under Hindenlang and its progeny, debtors filing multiple bankruptcy petitions must still carefully count the days to avoid falling into the extension of the exception to discharge rule presented on these facts.  I expected more pushback and more analysis than the Ollie-Barnes case offered for an extension of this equitable tolling provision into the discharge rules where expansion of the provisions are generally interpreted in the least favorable manner for the creditor.  The issue also has importance because of the IRS view of equitable tolling when it comes to the Internal Revenue Code.  The IRS takes the position that equitable tolling does not apply to taxes when taxpayers seek this remedy.  This facet of tax exceptionalism gets harder to swallow the more the IRS uses equitable tolling for its own purposes.

Copy RID