In Briggs v. United States, 511 B.R. 707 (Bankr. N.D. Ga. 2014), Bankruptcy Judge Wendy Hagenau carefully examined the facts of the case and the applicable law in concluding that a Form 1040 filed after the IRS assessed taxes based on a substitute for return procedures met the requirements for filing a return. I previously blogged about the mess created by the litigation and legislation in this area. Judge Hagenau worked her way through existing precedent and arrived at a conclusion that offers hope to many taxpayers who fail to timely file their return and later seek relief through bankruptcy.
The Briggs case presents a classic set of facts. The taxpayer did not file his 2002 return by the due date as extended. Eventually, the IRS calculated his liability using IRC 6020(b) procedures and sent him a statutory notice of deficiency. He did not petition the Tax Court within 90 days. The IRS assessed the tax (over $200,000) and began collection. He eventually filed a Form 1040 showing that his correct tax liability was $149,870 rather than the $226, 536 assessed. The IRS accepted the Form 1040 as a claim for abatement and abated his tax to the lower amount. The IRS partially collected the lower liability through levy and offset but he still owed a substantial liability for 2002 when he filed bankruptcy on March 23, 2013.
The IRS made two arguments in support of its position that BC 523(a)(1)(B)(i) excepts the 2002 taxes from discharge. First, it argued that the tax “debt” arose from the IRS assessment and not from the late filed Form 1040, making the debt one from which the debtor had an unfiled return at the time it arose. This argument represents later thinking by the Government than its original position on this issue and seeks to create a bright line test not available through the Beard test. Second it made its original argument slightly modified by the passage of BC 523(a)(*), that an untimely return filed after assessment does not qualify as a “return” under applicable non-bankruptcy law.
The Court first addressed the “debt” argument and used bankruptcy definitions to reject it. My guess is that the IRS will appeal the case because it has had several successful outcomes with this argument and it represents a clear path to victory. Judge Hagenau, citing Rhodes v. United States (In re Rhodes), 498 B.R. 357 (Bankr. N.D. Ga. 2013), rejected this argument because the term “debt” in bankruptcy focuses “on the nature and source of debt . . . not on the mechanism to determine debt.” Under bankruptcy law the debt to the IRS arises at the end of the tax period and not when assessment occurs. The assessment or non-assessment of a tax does not “change the fact that the right to payment existed.” So, Judge Hagenau placed no importance on the assessment as creating the debt before the later filed return since the debt for bankruptcy purposes arose long before either of these events. Her interpretation makes the most sense given the bankruptcy definition of debt. The IRS will continue making this argument because of its ability to create a clear statement regarding discharge.
The Court next addressed whether the late-filed Form 1040 qualifies as a return. This is the original issue on which the IRS won in In re Hindenlang, 164 F.3d 1029 (6th Cir. 1999), although now with the overlay of BC 523(a)(*) adopted in 2005. Remembering the peculiar facts of Hindenlang provides important background information. Like Briggs, Mr. Hindenlang did not timely file his return and the IRS made an assessment after using the substitute for return procedures and issuing a notice of deficiency from which he did not petition the Tax Court. Mr. Hindenlang’s subsequent Form 1040, however, merely mirrored the substitute for return prepared by the IRS. He did not report any more tax or, like Mr. Briggs, any less tax than the IRS determined from its examination. That unusual fact pattern must have influenced the 6th Circuit as it reviewed the Hindenlang case.
The late filed Form 1040 submitted by Mr. Briggs reported a tax liability over $75,000 less than the amount assessed by the IRS using the substitute for return procedures. The IRS accepted his Form 1040 and abated the liability down to the amount shown on the form. Mr. Briggs’ form had meaning while Mr. Hindenlang’s form really added nothing to the situation. A Form 1040, such as the one Mr. Hindenlang filed, really does not seem like an honest attempt to file a return under the circumstances; however, a return like the one Mr. Briggs filed had meaning and the IRS abated his liability based on that meaning. Judge Hagenau drew from that fact. Before simply applying the facts in the Briggs case to the Beard test she analyzed BC 523(a)(*) to determine what new requirements the 2005 changes imposed, if any, since the Hindenlang decision started the inquiry regarding late filed returns.
Judge Hagenau’s analysis of the requirements led to a discussion of the cases decided after 2005. A line of cases, led by McCoy v. Miss. State Tax Comm’n (In re McCoy), 666 F.3d 924 (5th Cir. 2012), interprets the 2005 amendment to encompass a timeliness element that makes any untimely filed Form 1040, even if only one day late, something other than a return for purposes of the discharge provisions. The IRS does not agree with this interpretation but the Court here looked at this line of cases before concluding – correctly in my opinion – that the term applicable non-bankruptcy law in BC 523(a)(*) “does not incorporate the timeliness requirements of the tax code.” Judge Hagenau explained that the interpretation in McCoy and its progeny does violence to the overall workings of the bankruptcy code.
Judge Hagenau then turned at last to the Beard test, which requires that a document must meet four tests to be a return: (1) purport to be a return, (2) be executed under penalty of perjury, (3) contain sufficient data to allow calculation of tax, and (4) represent an honest and reasonable attempt to satisfy the requirements of tax law. In these cases the focus is almost always on the fourth test. Remember that Hindenlang’s Form 1040 really served no purpose except to seek to start the two year period for discharge. Here, the Court agreed with the minority view of cases lead by In re Colson that a return such as the one Mr. Brigg’s filed does meet the Beard test. Therefore, the Court determined that the remaining 2002 taxes were discharged.
This issue bears careful watching. The IRS chose not to file a petition for cert when it lost Colson in 2006. If its new argument that the debt arose before the late filed return fails and it does not adopt the McCoy argument, it is left with the fact specific Beard argument. Without a bright line legal argument the IRS takes on a lot of administrative risks with this issue because it is not discharging taxes in these situations. It leaves these liabilities on its books and restarts collection action after bankruptcy. If it ultimately must concede this issue, fifteen years or more of post-discharge taxes will exist on its books that it must address. Similar to the situation that now exists in the post-Rand concession, the IRS will need to clean up its assessment records and with the discharge injunction hanging over its head the burden will clearly be on the IRS and cannot be pushed off to the taxpayer. The path it has taken on post-Hindenlang is a risky path and one that is difficult to administer. It tried to fix the problem in 2005 but got language that has proven inadequate. Keep an eye on this issue if you have clients with late filed returns who may need bankruptcy as a refuge.