On Wednesday I quickly put up a copy of the opinion in Smith with the promise of further discussion. Today, we are fortunate to have commentary on the case by guest blogger Ken Weil. Ken blogged with us earlier this year on George Washington’s birthday. Ken has his own practice in Seattle that focuses on representing individuals with tax debt and resolving that debt through administrative action with the IRS or through bankruptcy. He has written a book on his specialty area, Weil, Taxes and Bankruptcy, (CCH IntelliConnect Service Online Only) (3d ed. 2014). He is a one of the top experts at the crossroads of personal bankruptcy and taxes. We are fortunate to have him back with us again. Keith
Case law continues percolating in the late-filed-return field. On July 13, the Ninth Circuit decided Smith v. United States (In re Smith), No. 14-15857, Pacer Docket Entry 51. (9th Cir. 2016). In Smith, the Ninth Circuit reaffirmed its position that, even after the bankruptcy law changed in 2005, a subjective test is still applied to determine whether a document filed by a taxpayer is an honest and reasonable attempt to comply with the tax law. Smith, supra at p.7; and see, Beard v. Comm’r, 82 T.C. 766, 775-778 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986) (four-part test used to determine whether the document in question is a valid tax return; one of the four parts is whether the taxpayer made an honest and reasonable attempt to comply with the tax law). This blog piece discusses the subjective and objective tests as methods for determining whether a taxpayer made an honest and reasonable attempt to comply with the law, the previous confusion surrounding the Ninth Circuit’s leading case in the area, the Smith decision, and the interaction of Smith with an earlier 2016 Ninth Circuit Bankruptcy Appellate Panel (BAP) case that rejected application of the one-day-late rule.
Subjective and objective tests.
Mr. Smith filed his 2001 tax document seven years after it was due and three years after the IRS assessed tax due. Smith, supra at p.7. In affirming the district court’s determination that Mr. Smith had not made an honest and reasonable attempt to comply with the tax law, the Ninth Circuit held that United States v. Hatton (In re Hatton), 220 F.3d 1057 (9th Cir. 2000) still applied even after the 2005 Bankruptcy Code amendments. Smith, supra at p.7. Hatton used a subjective test and not an objective test to determine whether a document would pass the honest and reasonableness prong of the Beard test. Under the subjective test, one looks beyond the four corners of the document to determine whether the taxpayer has made an honest and reasonable attempt to comply with the law. Prior to Smith, the most recent circuit court to look beyond the four corners of the document was the Eleventh, which was blogged here. Justice v. United States (In re Justice), 817 F.3d 738 (11th Cir. 2016). The objective test limits the applicable inquiry to the four corners of the filed document to determine whether it qualifies as a return. The leading case in support of the objective test remains Colsen v. United States, 446 F.3d 836 (8th Cir. 2006). The use of the terms “subjective test” and “objective test” are co-opted, at least in part, from Martin v. United States (In re Martin), 542 B.R. 479, 482 (9th Cir. B.A.P. 2015)(blogged here)(Hindenlang is broad in scope and takes at least a partially subjective focus; the test used by the bankruptcy court was narrow in scope and exclusively objective in focus) and Colsen, 446 F.3d at 840.
Confusion with Hatton.
Hatton had made for somewhat confusing precedent. In Hatton, the taxpayer flunked two prongs of the Beard test. The document purporting to be a return was not filed under penalty of perjury and it was filed very late and only after collection pressure from the IRS so that it flunked the subjective test. Did this dual failure mean that there was still room for the objective test in the Ninth Circuit, especially since the Ninth Circuit BAP had previously applied the objective test? United States v. Nunez (In re Nunez), 232 B.R. 778 (9th Cir. B.A.P. 1999) (applying the objective test). Martin, 542 B.R. at 490 swept away any remaining confusion. It stated clearly that both Hatton reasons for rejecting the document as a return had to be given equal consideration: “When alternate grounds are given for a holding, neither ground constitutes non-binding dicta.” Id. (citation omitted). Martin then applied the subjective test and found the document in question was not an honest and reasonable attempt to comply with the law. The alternate-grounds rule is also helpful in understanding Smith. As will be seen in the following paragraphs, the Ninth Circuit was careful to limit its holding to one reason.
The decision in Smith, and, the Court’s refusal to address ancillary arguments.
Like Martin, Smith applied the subjective test. It held “that Hatton applies to the bankruptcy code as amended….” Id. at p.7. The court observed that two Circuit courts, the Tax Court, and both parties all agreed the four-factor Beard test still applied after that the new definition of return in § 523(a)(*) was added to the Bankruptcy Code. Id. at p.5. Mr. Smith’s delay in filing made it an easy decision for the court to affirm the district court’s ruling that the tax was nondischargeable. See, id. at p.6 (“these are not close facts”). Although it agreed with Martin, Smith never cited Martin. The failure to cite Martin is an interesting choice, and, this omission is discussed again under the one-day-late rule below.
In Smith, the government argued, as it almost always does, for a per se rule. The per se rule states that any document filed after the IRS assessment is not a document that will qualify as a return. The leading case supporting the per se rule is United States v. Hindenlang (In re Hindenlang), 164 F.3d 1029 (6th Cir. 1999). The Smith Court felt the facts before it were overwhelming, and, it did not need to answer the government’s per se argument. “We need not decide the close question of whether any post-assessment filing could be ‘honest and reasonable’ because these are not close facts.” Smith, supra, at p.6 (emphasis in original). Thus, the government’s per se argument was set aside for now.
Because it held the purported document was not a return, the Court also declined to address the government’s argument that the tax was not associated with a return. The government had argued that a return was not filed when it assessed the deficiency. Id. at p.7, n.1; and see, 11 U.S.C. § 523(a)(1)(B) (tax for respect to which a return is made). Martin addressed this issue, basically stating that the government’s argument proves too much. Tax debt arises under bankruptcy law at the end of the applicable tax year and almost always exists before an assessment is made and even before a return is filed. Martin, 542 B.R. at 491.
Impact of Smith on the one-day-late rule in the Ninth Circuit.
The facts in Martin are similar to the facts in Smith, i.e., tax documents filed only after an IRS audit and assessment. Unlike Smith, Martin addressed the one-day-late rule, and, it rejected the one-day-late rule with a persuasive attack on its underpinnings. Martin, 542 B.R. at 483-489.
Practitioners in the Ninth Circuit should be acutely aware of the First, Fifth, and Tenth Circuit decisions in support of the one-day-late rule. McCoy v. Miss. State Tax Comm’n (In re McCoy), 666 F.3d 924 (5th Cir. 2012); Mallo v. IRS (In re Mallo), 774 F.3d 1313 (10th Cir. 2014); and Fahey v. Mass. Dep’t of Rev. (In re Fahey), 779 F.3d 1 (1st Cir. 2015). Those cases apply the “applicable filing requirements” language of 11 U.S.C. § 523(a)(*) to mean that a return filed late, even by one second, is not a valid return for bankruptcy purposes. It is clear that the Smith panel purposely side-stepped the one-day-late rule. The one-day-late rule is never mentioned in the opinion. This also means Martin’s persuasive attack on the one-day-late rule is also not mentioned. (And, yes, I understand that the government did not advocate for it.)
In the Ninth Circuit, although BAP decisions are not binding, they are persuasive and generally held in high regard. State Compensation Ins. Fund v. Zamora (In re Silverman), 616 F.3d 1001, 1005, n.1 (9th Cir. 2010) (Ninth Circuit has never held that bankruptcy courts are bound by BAP decisions, but, BAP opinions are treated as persuasive authority and promote uniformity of bankruptcy law throughout the Circuit); and see, B. Camp, “Bound by the BAP: The Stare Decisis Effects of BAP Decisions,” 34 San Diego L. Rev. 1643 (1997) (yes, that is Bryan Camp, who posts here). For all practical purposes, assuming the Smith case goes no further, whether by a request for an en banc hearing or a petition for certiorari, the one-day-late rule will not apply in the Ninth Circuit, at least for now. It will take a state-court tax case to undo the one-day-late rule. And, then, the case will need to be before a bankruptcy judge who does not feel bound by BAP decisions or an independent-thinking district court judge.
What happens if the Third Circuit in Davis follows the First, Fifth, and Tenth Circuits and accepts the one-day-late rule? Keith posted on this recently. Will the IRS capitulate? If so, what happens in the Ninth Circuit? Will the IRS feel strongly enough to litigate the issue in the face of Martin?
Mr. Smith’s counsel must feel that the subjective test is wrong and the Ninth Circuit should have reversed Hatton. Although the objective test is very much the minority position, there are strong arguments in its favor. Those arguments are well-stated in Colsen, 446 F.3d at 840-841, and, they do not need to be restated here. But, from the perspective of containing the one-day-late rule, further appeals, whether a request for an en banc hearing or a petition for certiorari, could easily do more harm than good. This is doubly so because the IRS still is not pressing the one-day-late rule. One need look no further than Mallo to see what could happen. Every case that asks an appeals court to look at the subjective versus objective test is another opportunity for a court to rule in favor of the one-day-late rule. It is relatively easy for a judge to say that the literal language of § 523(a)(*) must be applied and timeliness is an applicable filing requirement. It takes much more work to do what Judge Kurtz did and systematically explain why the one-day-late rule does not make sense. While Mr. Smith and his counsel might disagree, in general, delinquent taxpayers in the Ninth Circuit are very fortunate that the Martin and Smith courts ruled as they did.
Here is one final piece of trivia. The taxpayer’s first name in Smith is Martin.