A district judge in Nashville leapt into the split of circuits by holding that tax debts related to late-filed tax returns can sometimes be discharged.
The circuits fall into two camps. The First, Fifth and Tenth Circuits use the one-day-late rule: If a return is filed even one day late, the underlying debt can never be discharged. The Fourth, Sixth, Seventh, Eighth and Eleventh Circuits follow the four-part test resulting from a 1984 Tax Court decision known as Beard. Courts invoking the Beard test ordinarily focus on the fourth factor: Was there an honest and reasonable attempt to satisfy the requirements of tax law?
The appeal before District Judge Waverly D. Crenshaw, Jr. involved a debtor who did not file timely tax returns for 2001 through 2004. He finally filed returns in 2007 after the Internal Revenue Service had made assessments. He filed a chapter 7 petition in 2009, more than two years after he filed his late returns.
The debtor claimed to have legitimate reasons for late filings. He said that a secured lender seized his records and never gave them back. He hired an accountant to assist in preparing the returns but fired the accountant for doing essentially nothing. He was able to file his returns with help from a second accountant. In addition, he moved 11 times between 1999 and 2008.
The bankruptcy judge ruled that the tax liabilities were nondischargeable simply because the returns were late. The debtor appealed and won remand from Judge Crenshaw in an opinion on Sept. 9.
As with all the cases dealing with late-filed returns, the question invokes the so-called hanging paragraph added to Section 523(a) along with the BAPCPA amendments in 2005. Section 523(a)(*) was intended to clarify the meaning of the word “return.” To be a return, an IRS filing must “satisfy the requirements of applicable nonbankruptcy law” and must also comply with “applicable filing requirements.”
Courts adopting the one-day-late rule will say that a late-filed return is not a “return” for the purpose of Section 523 because it does not comply with filing requirements.
Judge Crenshaw was writing on a relatively blank slate because the Sixth Circuit had adopted Beard before BAPCPA. Unlike the First, Fifth and Tenth Circuits, the Sixth Circuit has not yet decided whether BAPCPA alters or abandons the Beard test.
Coming down on the side of continuing vitality in the Beard test, Judge Crenshaw said that the one-day-late rule “creates a harsh result that appears inconsistent with the statute’s intent.” He went on to observe that “the draconian result of a per se rule” cannot be “reconciled with the well-established rule that exceptions to discharge are to be strictly construed in favor of the debtor.”
He said that Section 523(a)(*)’s reference to “applicable nonbankruptcy law” includes “pre-BAPCPA case law, which encompasses the Beard test.”
In the case before him, the IRS conceded that the debtor satisfied the first three Beard tests, leaving only the question of whether the late-filed returns were an honest and reasonable attempt to satisfy the requirements of tax law.
Remanding the case, Judge Crenshaw fleshed out the fourth Beard test. Using Tax Court decisions as authority, he said the bankruptcy court should consider the “debtor’s subjective intent and actions.” He said there can be compliance with the fourth prong “even after assessment” and even “when untimely forms do not report additional tax liability.”