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38-SEP Am. Bankr. Inst. J. 14

American Bankruptcy Institute Journal

September, 2019

Consumer Corner
John N. Tedford, IV a1
Danning, Gill, Diamond & Kollitz, LLP
Los Angeles

Copyright © 2019 by American Bankruptcy Institute; John N. Tedford, IV

*14 DISCHARGEABILITY OF NONPRIORITY TAXES FOR LATE-FILED

TAX RETURN
Priority tax claims are nondischargeable. Whether a nonpriority tax claim is dischargeable largely depends on whether and
when the debtor filed a tax return. Unfortunately, it also depends on where the debtor lives because courts cannot agree on the
answer to this seemingly simple question: For purposes of § 523(a)(1)(B), what is a “return”?

Dischargeability of Taxes

Since 1966, Congress has sought to balance a debtor's need for a fresh start, policies favoring equitable distributions among
unsecured creditors, and the government's need for sufficient time to conduct its auditing, assessment and collection functions.
Today, § 523(a)(1)(B) provides that a discharge does not discharge a nonpriority tax

with respect to which a return, or equivalent report or notice, if required--

(i) was not filed or given; or

(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or
under any extension, and after two years before the date of the filing of the petition.

Section 523(a)(1)(B) serves two purposes: (1) It discourages debtors from using bankruptcy as a tax-evasion device; and (2)
it gives the government at least two years to audit returns, assess deficiencies and collect taxes or create liens before the taxes
may be discharged. It requires only objective analyses, referencing easily discernable facts and requiring no inquiry into the
debtor's motives.

Early Decisions

At least at first, courts had little trouble applying § 523(a)(1)(B). The only truly difficult cases arose when debtors argued
that returns prepared by the Internal Revenue Service (IRS) under § 6020 of the Internal Revenue Code (IRC), or stipulated
judgments entered in tax courts, constituted “returns” for purposes of § 523(a)(1)(B).

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When a taxpayer fails to timely file a proper return, the IRS prepares a substitute return under IRC § 6020(a) or (b). Under
IRC § 6020(a), a taxpayer provides the IRS with the information needed to prepare the return. Once it is signed, the IRS may
accept it as the taxpayer's return. Generally, courts have held that returns prepared under IRC § 6020(a) qualify as “returns”
for purposes of § 523(a)(1)(B). 1

Under IRC § 6020(b), the IRS prepares the substitute return using information from third parties. The IRS gives notice of its
proposed assessment, and the taxpayer has 90 days to file a petition with the tax court to challenge the proposed assessment. 2
If no petition is filed, the IRS makes an assessment in the proposed amount. 3 Almost universally, courts have held that returns
prepared under IRC § 6020(b) do not qualify as “returns.” 4 Similarly, at least one court has held that a settlement resulting in
entry of a stipulated tax court decision did not qualify as a “return.” 5

Other than in these situations, courts did not struggle with defining “return.” As one put it, “The plain meaning of the word
‘return’ should be conclusive, as it has a very specific meaning in the world of taxation. Certainly, taxpayers know what it means
to have to file a tax return; they do it each year.” 6 A debtor's motives were irrelevant. However, that began to change in 1997
when courts began using the Beard test to determine whether late-filed returns qualified as returns under § 523(a)(1)(B).

The Beard Test

To determine whether a document qualifies as a “return,” federal courts follow the “Beard test” formulated by the U.S. Tax
Court in 1984 from two depression-era Supreme Court cases. 7 Under the Beard test:

(1) there must be sufficient data to calculate tax liability;

(2) the document must purport to be a return;

(3) there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and

(4) the taxpayer must execute the return under penalty of perjury.

*15 After formulating the test, the Beard court discussed “[t]he most recent Supreme Court reaffirmation of the test”:
Badaracco v. Commissioner. 8 In that case, taxpayers filed fraudulent returns, but later filed nonfraudulent amended returns.
The Supreme Court ruled that “the original returns ... purported to be returns, were sworn to as such, and appeared on their
faces to constitute endeavors to satisfy the law.” 9 Thus, although indisputably fraudulent, the documents were returns.

Beard involved a taxpayer who, in protest, tampered with his Form 1040. The tax court held that the impermissibly modified
form was not a return. Badaracco and Beard illustrate how the third prong of the Beard test should be applied. Instinctively,
a taxpayer who files a fraudulent return has not made an “honest and reasonable attempt to satisfy the requirements of the tax
law.” However, Badaracco shows that this instinct is wrong. The third prong should be determined by reference to the face of
the document, not to the filer's motive.

Post-Assessment Approach

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The Beard test went mostly unnoticed in bankruptcy cases until 1997. In In re Hindenlang, the IRS prepared substitute returns
under IRC § 6020(b), sent deficiency notices to which the debtor did not respond, and assessed taxes. After the taxes were
assessed, the debtor filed returns. More than two years later, he filed for bankruptcy. Applying the Beard test, the bankruptcy
court held that the taxes were discharged because returns were filed more than two years pre-petition. 10

The Sixth Circuit reversed, holding that a purported return filed too late to have any effect under the IRC cannot, as a matter
of law, constitute an “honest and reasonable attempt to satisfy the requirements of the tax law.” 11 Because the debtor could
not identify any tax purpose for his late-filed Form 1040s, the court ruled that they were not “returns,” therefore the taxes were
nondischargeable.

In a similar case, the Fourth Circuit reached the same result, but for a different reason: “Simply put, to belatedly accept
responsibility for one's tax liabilities, only when the IRS has left one with no other choice, is hardly how honest and reasonable
taxpayers attempt to comply with the [T]ax [C]ode.” 12 The court declined to expressly hold that a post-assessment return can
never qualify as a return, but shifted the burden to the debtor to prove that he/she made an honest and reasonable attempt to
comply with the tax law.

The approach by the Sixth and Fourth Circuits is referred to as the “post-assessment approach.” Theoretically, debtors can
attempt to explain that they made honest and reasonable attempts to comply with tax laws. However, in practice, the post-
assessment approach renders nondischargeable almost any tax for which a return was filed after the tax was assessed.

*58 Totality-of-the-Circumstances Approach

In the late 1990s, the Ninth Circuit Bankruptcy Appellate Panel (BAP) ruled in In re Hatton that a debtor provided the equivalent
of a return by acknowledging the tax assessed by the IRS after it prepared a substitute return under IRC § 6020(b), and by
entering into an installment agreement to pay the tax over time. 13 The Ninth Circuit reversed, ruling that neither the substitute
return nor the installment agreement constituted a “return” of a kind that would permit a discharge of the debt. 14 Since neither
document was signed under penalty of perjury, the fourth prong of the Beard test was clearly not met. However, the court found
that the third prong was also not satisfied because the debtor “made every attempt to avoid paying his taxes until the IRS left
him with no other choice.” 15

The Ninth Circuit cited Hindenlang but did not follow the post-assessment approach. Instead, the court conducted a more
comprehensive inquiry of the facts. Subsequent cases in the Ninth Circuit correctly follow Hatton by examining all relevant facts
and circumstances pertaining to the honesty and reasonableness of the debtors' efforts. 16 Thus, the Ninth Circuit's approach
is referred to as the totality-of-the-circumstances approach.

No-Time-Limit Approach

In In re Colsen, the debtor filed five years' worth of tax returns post-assessment. The bankruptcy court, BAP and Eighth Circuit
all agreed that whether a document constitutes a return must be viewed objectively, as the Supreme Court did in Badaracco. 17
Alas, “the honesty and genuineness of the filer's attempt to satisfy the tax laws should be determined from the face of the form
itself, not from the filer's delinquency or the reasons for it.” 18 Because the time of filing is irrelevant, this is referred to as
the no-time-limit approach.

Functional Approach

In 2005, the Seventh Circuit adopted a functional approach to determining whether a document is a return. Writing for the
majority, Hon. Richard Posner wrote that “there is no reason why the word ‘return’ ... should carry the same meaning regardless
of context.” 19 A document can be considered a return in one context to discourage fraud (such as in Badaracco), but not

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considered a return in the bankruptcy context “to discourage people from using bankruptcy law to avoid having to satisfy their
tax liabilities.” 20

Hon. Frank Easterbrook filed a notable dissent. Following the no-time-limit approach, he would have held the taxes as
dischargeable simply because the document filed with the IRS contained all required information and was filed more than two
years pre-petition. 21

BAPCPA's Addition of § 523(a)(*)

In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) added a hanging paragraph at the end of
§ 523(a) (a.k.a. § 523(a)(*)):

For purposes of [§ 523(a)], the term “return” means a return that satisfies the requirements of applicable
nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to
[IRC § 6020(a)], or similar State or local law, or a written stipulation to a judgment or a final order entered by
a nonbankruptcy tribunal, but does not include a return made pursuant to [IRC § 6020(b)], or a similar State or
local law.

The sparse legislative history of § 523(a)(*) suggests that it was meant only to resolve three basic questions. For purposes of
§ 523(a)(1), (1) is a return prepared under IRC § 6020(a) (with the taxpayer's help) a return; (2) is a substitute return prepared
under IRC § 6020(b) (without the taxpayer's help) a return; and (3) if a debtor contests a proposed assessment but later agrees
to a stipulated decision regarding *59 the tax owed, is that a return? There is nothing to suggest that § 523(a)(*) was intended
to adopt--or reject--any particular approach to defining “return.” Unfortunately, while resolving these three questions, § 523(a)
(*)--particularly the parenthetical phrase “including applicable filing requirements”--exacerbated the debate over whether late-
filed returns constitute returns for purposes of § 523(a)(1).

Initial Reactions

One of the first cases to examine § 523(a)(*) concluded that it “apparently means that a late-filed income tax return, unless it
was filed pursuant to [IRC § 6020(a)], can never qualify as a return for dischargeability purposes because it does not comply
with the ‘applicable filing requirements' set forth in the [IRC].” 22 Numerous lower courts concurred, and some have ruled that
§ 523(a)(*) supplanted the Beard test. 23 Others disagreed, however. As expressed by the Tenth Circuit BAP:

Each of the two sentences in [§ 523(a)(*)] appears quite straightforward when standing alone. However, when
the two are read together, we are not convinced ... that the precise meaning and effect of the hanging paragraph
is clear .... Our own research has uncovered nothing to support the conclusion that the hanging paragraph was
intended to create the rule that a late-filed federal income tax return can never lead to discharge unless it ... is
prepared pursuant to IRC § 6020(a) or similar provision. 24

Some courts have opined that interpreting § 523(a)(*) that way would make § 523(a)(1)(B)(ii) superfluous or insignificant, 25
and others have noted that if late-filed returns are never “returns,” there was no need for Congress to specify that substitute
returns prepared under IRC § 6020(b) are not returns. 26

One-Day-Late Approach

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In In re McCoy, the Fifth Circuit agreed with the first group of post-BAPCPA cases and held that a late-filed state tax return is
not a return for purposes of § 523(a) unless it is filed under a “safe harbor” provision similar to IRC § 6020(a). 27 The Tenth
Circuit followed suit in In re Mallo, ruling that § 523(a)(*) “plainly excludes late-filed Form 1040s from the definition of a
return.” 28 The First Circuit reached the same conclusion in In re Fahey. 29 This approach is referred to as the one-day-late
approach because it renders a tax nondischargeable if the return is filed as little as one day late.

Both debtors and the IRS consistently urge courts to reject the one-day-late approach. From the IRS's perspective, it eliminates
an incentive for debtors to file tax returns after they are due. It also burdens the IRS by increasing the number of taxpayers who
ask the IRS to prepare returns pursuant to IRC § 6020(a). At least one court found McCoy's conclusions “troubling particularly
because the IRS does not agree with [its] position.” 30

Other Circuits

The Ninth Circuit is the only circuit to have rejected the one-day-late approach. In In re Martin, the Ninth Circuit BAP
commented that “[t]he more one considers the phrase ‘applicable filing requirements' in context, the more doubtful the
literal construction becomes.” 31 In a subsequent case, the Ninth Circuit continued to apply its pre-BAPCPA totality-of-the-
circumstances approach, implicitly rejecting the one-day-late approach. 32

Both the Third and Eleventh Circuits have so far expressly declined to accept or reject the one-day-late approach. 33 The Eighth
Circuit has not yet ruled on whether § 523(a)(*) abrogated its no-time-limit approach.

IRS Approach

Further complicating matters, the IRS advocates for an approach that does not rely on any definition of “return.” According
to the IRS, when a taxpayer files a return after the IRS makes an assessment, the debt is based on the assessment, not on the
return. 34 The IRS contends that the tax is therefore not a debt “with respect to which a [required] return” was filed, and is
therefore nondischargeable under § 523(a)(1)(B)(i). The IRS approach is most similar to the post-assessment approach, and in
most cases it achieves the same result: It has been rejected by almost every court to consider it. 35

Conclusion

The no-time-limit approach adopted by the Eighth Circuit in Colsen is most consistent with Badaracco, gives full effect to
§ 523(a)(1) and (*), and maintains the balance struck more than 50 years ago between the debtor's need for a fresh start and
the government's need for sufficient time to conduct its auditing, assessment and collection functions. For debtors who file
returns even a single day late, the one-day-late approach leaves them “saddled with a continued liability for ... taxes until the
last lingering echo of Gabriel's horn trembles into ultimate silence.” 36 There is nothing in BAPCPA's legislative history to
suggest that Congress intended for § 523(a)(*) to have this effect.

Footnotes

a1 John Tedford is a partner with Danning, Gill, Diamond & Kollitz, LLP in Los Angeles.
1 See, e.g., In re Lowrie, 162 B.R. 864 (Bankr. D. Nev. 1994).
2
26 U.S.C. §§ 6212(a), 6213(a).

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3
26 U.S.C. §§ 6203, 6213(c).
4
See, e.g., In re Hofmann, 76 B.R. 853 (Bankr. S.D. Fla. 1987).
5
See In re Gushue, 126 B.R. 202 (Bankr. E.D. Pa. 1991).
6
In re Jerauld, 208 B.R. 183, 188 (B.A.P. 9th Cir. 1997).
7
Beard v. Comm'r, 82 T.C. 766 (1984) (citing Florsheim Bros. Drygoods Co. v. U.S., 280 U.S. 453 (1930);
Zellerbach Paper Co. v. Helvering, 293 U.S. 172 (1934)).
8
Badaracco v. Comm'r, 464 U.S. 386 (1984).
9
Id. at 397 (emphasis added).
10
In re Hindenlang, 205 B.R. 874, 878 (Bankr. S.D. Ohio 1997).
11
In re Hindenlang, 164 F.3d 1029, 1034-35 (6th Cir. 1999).
12
In re Moroney, 352 F.3d 902, 906 (4th Cir. 2003).
13
In re Hatton, 216 B.R. 278 (B.A.P. 9th Cir. 1997).
14
In re Hatton, 220 F.3d 1057 (9th Cir. 2000).
15
Id. at 1061.
16
See, e.g., In re Martin, 542 B.R. 479, 491 (B.A.P. 9th Cir. 2015).
17
In re Colsen, 311 B.R. 765 (Bankr. N.D. Iowa 2004); In re Colsen, 322 B.R. 118 (B.A.P. 8th Cir. 2005); In re Colsen,
446 F.3d 836 (8th Cir. 2006).
18
Colsen, 446 F.3d at 840.
19
In re Payne, 431 F.3d 1055, 1058 (7th Cir. 2005).
20
Id. at 1059.
21
Id. at 1062-63.
22
In re Creekmore, 401 B.R. 748, 751 (Bankr. N.D. Miss. 2008).
23 See, e.g., In re Casano, 473 B.R. 504, 507 (Bankr. E.D.N.Y. 2012).
24
In re Wogoman, 475 B.R. 239, 248-249 (B.A.P. 10th Cir. 2012).

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25
See, e.g., In re Brown, 489 B.R. 1, 5 (Bankr. D. Mass. 2013).
26
See, e.g., In re Gonzalez, 506 B.R. 317, 328 (B.A.P. 1st Cir. 2014).
27
In re McCoy, 666 F.3d 924, 932 (5th Cir. 2012).
28
In re Mallo, 774 F.3d 1313, 1321 (10th Cir. 2014). Notably, the court would have adopted the no-time-limit approach
but for § 523(a)(*).
29
Fahey v. Mass. Dept. of Rev., 779 F.3d 1 (1st Cir. 2015).
30 In re Coyle, 524 B.R. 863, 867 (Bankr. S.D. Fla. 2015).
31
Martin, 542 B.R. at 487.
32 In re Smith, 828 F.3d 1094, 1096-97 (9th Cir. 2016).
33
See In re Giacchi, 856 F.3d 244, 247-48 (3d Cir. 2017); In re Justice, 817 F.3d 738, 743 (11th Cir. 2016).
34 See IRS Chief Counsel Notice 2010-016 (Sept. 2, 2010).
35
See, e.g., In re Rhodes, 498 B.R. 357, 362 (Bankr. N.D. Ga. 2013); but see In re Pitts, 497 B.R. 73 (Bankr. C.D.
Cal. 2013).
36 Discharge of Taxes in Bankruptcy: Hearing on S. 976 (H.R. 3438) and S. 1912 (H.R. 136) Before the S. Comm. on
Finance, 89th Cong. 21 (1965) (statement of Sen. Sam J. Ervin).

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