Extended Due Date Treated as Transaction Date for Failure to File Penalty, Discharge in Bankruptcy Disallowed

The date of the “transaction” that lead to a failure-to-file penalty under IRC §6651(a)(1) was interpreted differently by the U.S. District Court that heard the appeal than by the original Bankruptcy Court in the case of United States v. Wilson, DC ND Cal., Case No. 3:15-cv-04118 reversing Wilson v. United States, Case No. 14-1106 (Bankr. N.D. Cal).

The timeline in the case is important to an understanding of the case. 

  • Mr. Wilson’s 2008 income tax return was original due on April 15, 2009.  Generally the tax would become due at that date.  He filed for an extension of time to file the return
  • Mr. Wilson’s extension expired on October 15, 2009.  He failed to file the return and, in fact, did not file the return until 2011
  • On July 24, 2012 Mr. Wilson filed a Chapter 7 bankruptcy petition.

Mr. Wilson sought to have this failure-to-file penalty discharged in bankruptcy while the IRS argued that the penalty was not dischargable.

Section 523(a)(7)(B) of the Bankruptcy Code provides for the following regarding the potential discharge of a tax penalty:

A discharge under . . . this title does not discharge an individual debtor from any debt . . . to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty . . . imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition.

The bankruptcy court, interpreting that provision, found that the failure to file penalty accrued at the same time as the tax itself accrued on April 15, 2009.  In that case, Mr. Wilson’s filing of his bankruptcy petition on July 24, 2012 was more than three years after his 2008 tax accrued.  Thus the trial court found that the IRS’s claim was dischargable in bankruptcy and did, in fact, order it discharged.

However the District Court, hearing the IRS’s appeal, did not agree.  The Court cited the language found in IRC §6651(a)(1) that imposes the penalty which provides:

(a) Addition to the tax

In case of failure—

(1)  to file any return required under authority of subchapter A of chapter 61 (other than part III thereof), subchapter A of chapter 51 (relating to distilled spirits, wines, and beer), or of subchapter A of chapter 52 (relating to tobacco, cigars, cigarettes, and cigarette papers and tubes), or of subchapter A of chapter 53 (relating to machine guns and certain other firearms), on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;

Given that provision, the District Court found:

In this case, the mandatory language of section 6651(a)(1) indicates that penalties were required to be imposed when Wilson failed to file by the extended deadline, such that the penalty could be said to have "accru[ed]" within the meaning of McKay on October 16, 2009, when it was clear Wilson had failed to file by the extended deadline. 957 F.2d at 693.

Since that event was what triggered the imposition of the penalty, the court found that to be the transaction which would be tested for having occurred more than 3 years before the filing of his petition.  Since that was not the case (he filed a little less than 3 months before that 3 year date would have passed) the penalty was not dischargable in his bankruptcy.  Note that under the District Court’s interpretation if Mr. Wilson had not filed for an extension of time to file his 2009 tax return then the penalty would have been dischargable since then his failure to file either a return or a request for extension at April 15, 2009 would have created the transaction upon which the three year clock began to run.

The case illustrates some of the traps that can arise in bankruptcy cases and why it is crucial that taxpayers considering a filing seek out competent legal counsel on these matters.