In Mallo v. Internal Revenue Service, No. 13-1464 (Tenth Circuit Court of Appeals, Dec. 29, 2014), another Circuit Court of Appeals weighed in on an old issue as to which several of the leading Circuit Court decisions are in conflict.
In a familiar scenario, the Mallos had unfiled returns for the 2000 and 2001 tax years. However, instead if issuing SFRs, the IRS did an examination and issued Notices of Deficiency, which went unchallenged, and were reduced to assessments in 2006. In 2007, the taxpayers jointly filed 1040 tax returns reporting their income for the 2000 and 2001 tax periods. These returns were filed in 2007. The 2000 return resulted in additional liabilities of $4,576 for the 2000 tax year.
On February 18, 2010, the taxpayers filed for bankruptcy under Chapter 13, which was later converted to a Ch. 7. Following discharge, the taxpayers sought to discharge the IRS liabilities in an adversary proceeding. In general, a debtor under chapter 7 of the Bankruptcy Code is granted a discharge from all debts that arose prior to the filing of the bankruptcy petition. 11 U.S.C. § 727(b). There are some exceptions to discharge, however, including certain tax liabilities. 11 U.S.C. § 523(a)(1)(A)-(C).
Discharge is generally available if the applicable income tax return was filed more than two years before the date of filing of the bankruptcy court petition (11 USC section 523(a)(1)(B)(ii)), if taxes have been assessed for more than 240 days (11 USC section 507(a)(8)(A)(ii)), and if the last date for filing the return without penalty was over three years before the petition (11 USC section 507(a)(8)(A)(i)).
In Mallo v. Internal Revenue Service, the question before the Court was whether the Mallos had filed a “return” for purposes of Section 523(a) the Bankruptcy Code that would make the 2000 and 2001 taxes dischargeable under the above provisions. Clearly, the debts arose pre-petition, were not otherwise excepted, and were beyond the limitations period.
The Court concluded that the post-assessment income tax returns were not “returns” for purposes of Section 523(a)(1)(B), because they “served no tax purpose.”
This may be a confusing result, but it follows from the fact that the United States Income Tax system is a “self-reporting” system. Thus, when the IRS must do the work of making an assessment in a situation where the taxpayer, for whatever reason, fails to file, a taxpayer who later files an amended return cannot be said to have “reported” income in the traditional sense. In the post-assessment context, the taxpayer can be said to have “corrected” an erroneous assessment, which is their right.
A number of Circuit Courts have agreed with the Beard rationale invoked by the Tenth Circuit in Mallo v. Internal Revenue Service. The Eighth Circuit has held that liabilities for post-assessment tax returns are dischargeable.
Thus, of the 11 Circuit Courts in the United States, the current tally is 5 for the IRS and 1 for the taxpayer. The 4th, 6th, 7th, 9th and 10th are all for the IRS. The 8th is for the taxpayer.
Crucially, the 3rd Circuit Court of Appeals (covering NJ and PA) and the 2nd Circuit Court of Appeals (covering NY) have not yet weighed in on the issue.
If a few circuits come in on the taxpayer’s behalf, this Circuit Split will be ripe for review by the United States Supreme Court.
Perhaps, in the final analysis, the law will develop in some coherent manner or Congress will address the issue. Ironically, the IRS frames the issue on the basis of the nature of the debt, whereas the Bankruptcy courts frame the issue with reference to the definition of a return. Neither way of analyzing the issue ultimately makes any sense. The simple and inescapable fact apparent to anyone familiar with the issue is that the statutory language in Section 523(a) was not designed to and does not address the “post-assessment filing” scenario. The statute is otherwise clear in a number of respects. No amount of contorting the statutory language will ultimately yield a uniform or satisfactory result.
Here, though it was not discussed in the case, the Mallos waited many years to file their returns. But, the returns reported additional income. This may be significant with reference to the Beard criteria, which requires that the tax return serve some reporting purpose. Beard v. Commissioner, 82 T.C. 766, 777 (1984). It is also worth noting that in the Circuit Court decision in Mallo, no particular hardship was stated that precipitated the non-filing and no excuse was given for a six-year delay in remedying the issue. The upshot of these facts is that there are insufficient facts of record that peer into the intent behind the filing, which may, indeed, have been to qualify the Mallos for bankruptcy protection. Nevertheless, the facts do not line up with any abusive or salutary purpose that would be recognizable under either the Internal Revenue Code or the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 119 Stat. 23 (April 20, 2005)(the “BAPCPA).
The Mallo court focused on the expense and cost to the IRS to make an assessment that can later be altered by an amended return. But, note that this rationale in no way relates to the actual statutory language, which is controlling. The argument is that a delayed filing that is so late that it comes after an assessment is made should come with a forfeiture of rights as a penalty, because of the burden to the government. While a valid argument, neither the plain statutory language of BAPCPA, nor the Beard factors focuses on the government burden, but rather on whether the “return” is an honest and reasonable attempt to satisfy the requirements of the tax law, and whether it serves a valid tax purpose. The one set of criteria has nothing to do with the other.
The IRS position is that the “debt” the bankruptcy court is looking at is a “debt for which no return was filed.” The IRS arrives at this position by focusing on the time of assessment. In the IRS view, the debt the taxpayer seeks to discharge is the assessment, not the subsequently filed return, and the subsequent filing does not change the original status of the debt. This rationale seems a bit artificial and was not adopted by the court in Mallo, which chose instead to focus on the statutory language, though their conclusion sounds in public policy rationale and is a bit hard to reconcile with the underlying premises on which it stands or the “consumer protection” focus of the BAPCPA revisions.
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