Can an income tax return filed after the IRS has assessed the taxpayer's liability be discharged in bankruptcy?
One of the hallmarks of the United States Bankruptcy Code is to afford individuals with a "fresh start" by granting a discharge of pre-bankruptcy debts. However, not all pre-bankruptcy debts can we wiped out or discharged. One exception applies to tax debts incurred within a certain time period before the bankruptcy.
Specifically, Section 523(a)(1)(B) prohibits discharging tax debts where a return:
(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;
11 U.S.C. § 523(a)(1)(B).
Under the two year rule mentioned in 11 U.S.C.§ 523(a)(1)(B)(ii), an individual debtor's income tax returns must have been filed at least two years before filing a bankruptcy petition. This requirement allows a debtor to discharge taxes even if the tax return was filed late, as long as the return was filed at least two years before the debtor's bankruptcy filing date.
Section 523(a) defines the term "return" as "a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements)." 11 U.S.C. § 523(a). Does a late tax return filed after the IRS has assessed the taxpayer's liability meet this definition?
No, according to a recent decision issued by the United States Appeals for the Third Circuit, In re Giacchi, No. 15-3761 (3rd Cir. May 5, 2017). In that case, the debtor Thomas Giacchi failed to file income tax returns for 2000, 2001, or 2002. Beginning in 2004, the IRS assessed his liability for these years. Following that, Giacchi submitted his returns - late but otherwise properly submitted. He did not pay the taxes due for those years, and then waited more than two years and filed Ch. 7 bankruptcy seeking to discharge the tax debts.
The Third Circuit framed the issue as whether Forms 1040 filed after the IRS already assessed the taxpayer's liability constituted "returns" under 11 U.S.C. § 523(a)(1)(B). The Third Circuit held that the late Forms 1040 did not constitute returns.
The Third Circuit focused on the language of § 523(a)(1)(B), which provides in relevant part, "any . . . debt for a tax . . . with respect to which a return, or equivalent report or notice, if required, . . . was not filed or given." Thus, the critical question was whether "belatedly filed forms constitute 'returns.'"
The Court adopted the following standard for establishing the required elements of a proper tax return: "(1) it must purport to be a return, (2) it must be executed under penalty of perjury, (3) it must contain sufficient data to allow calculation of tax, and (4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law."
Here, the Third Circuit noted that "[f]orms filed after their due dates and after an IRS assessment rarely, if ever, qualify as an honest or reasonable attempt to satisfy the tax law." In other words, according to the Court, "[o]nce the IRS assesses the taxpayer's liability, a subsequent filing can no longer serve the tax return's purpose, and thus could not be an honest and reasonable attempt to comply with the tax law. "[T]he timing of the filing of a tax form is relevant to determining whether the form evinces an honest and reasonable attempt to comply with tax law," the Court remarked.
The Court also rejected Giacchi's second main argument that, because the IRS abated, in part, the tax assessment due to late filings, those documents served some tax purpose. The Court responded that because the IRS had to initially estimate the tax liability, the taxpayer "cannot now seek to benefit from the IRS's imprecise estimate."
In sum, the Third Circuit found that, in this case, "belated filings after assessment are not an honest and reasonable effort to comply with the tax law under and, as such, the filings do not constitute returns." Consequently, Giacchi could not discharge the tax debts for those years pursuant to 11 U.S.C. § 523(a)(1)(B).
The Court essentially said that once a return is late and the tax assessed, that return can never be considered "filed" for purposes of Code §523(a)(1), and the tax debt can therefore never be discharged. It makes no difference if the taxpayer files a proper (but late) return, nor that they wait more than two years before declaring bankruptcy.
This decision merits close attention by taxpayers residing within, and bankruptcy lawyers practicing within, the jurisdiction of the Third Circuit which covers Delaware, New Jersey, Pennsylvania, and the Virgin Islands.