The Ninth Circuit Court of Appeals took its first look at the question of whether a (very) late filed return constituted a “reasonable attempt to comply with the tax law” that resulted in a tax liability that can be discharged in bankruptcy in the case of Smith v. United States Internal Revenue Service, Case No. 14-15857, 2016 TNT 135-12.
The Ninth Circuit had not considered the issue of the impact of a late return on the ability to have the debt discharged in bankruptcy under the most recent revisions to the bankruptcy law. The opinion notes that a number of other circuits have considered the issue of whether a late filed return can ever result in a tax liability that can be discharged in bankruptcy”
Many of our sister circuits have held that post-assessment tax filings are not ‘honest and reasonable” attempts to comply and are therefore not “returns” at all. See In re Justice, 817 F.3d at 746; In re Payne, 431 F.3d 1055, 1057-60 (7th Cir. 2005); In re Moroney, 352 F.3d 902, 907 (4th Cir. 2003); In re Hindenlang, 164 F.3d 1029, 1034-35 (6th Cir. 1999). But see In re Colsen, 446 F.3d 836, 840-41 (8th Cir. 2006).
In this case the facts are rather extreme:
After Martin Smith failed to timely file his 2001 tax forms, the IRS prepared a Substitute for Return or “SFR” based on information it gathered from third parties. In March 2006, the IRS mailed Smith a notice of deficiency. Smith did not challenge the notice of deficiency within the allotted 90 days and the IRS assessed a deficiency against him of $70,662. Three years later, in May 2009, Smith filed a Form 1040 for the year 2001 on which he wrote “original return to replace SFR.” On this late-filed form, Smith reported a higher income than the one the IRS calculated in its assessment, thereby increasing his tax liability. The IRS added the additional arrearage to its assessment.
The taxpayer eventually filed bankruptcy and sought to have this debt discharged as part of that bankruptcy. The IRS objected to that, holding that he did not meet the qualifications to have a tax debt discharged in bankruptcy.
The Ninth Circuit outlined the law that had previously been applied to decide if a tax debt was dischargable in bankruptcy and the revision Congress made to the law after that date:
The bankruptcy code exempts from discharge “any . . . debt for a tax . . . with respect to which a return, or equivalent report or notice, if required . . . was not filed or given.” 11 U.S.C. § 523(a)(1)(B)(i). In In re Hatton, we adopted the Tax Court's widely-accepted definition of “return.” 220 F.3d at 1060 (internal citation omitted). There, we stated that “[i]n order for a document to qualify as a [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.” Id. at 1060-61 (internal citation and quotation marks omitted).
When we decided Hatton, the bankruptcy code did not define “return,” id. at 1060, but Congress amended the bankruptcy code in 2005 and it added a definition. In pertinent part, the amendment reads:
For purposes of this subsection, the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).
11 U.S.C. § 523(a).
The parties in this case agreed that the basic tests set out in Hatton still would generally apply after the revision. The key question was whether this met the fourth requirement—was it an honest and reasonable attempt to satisfy the requirements of the tax law?
The Ninth Circuit explained the facts that caused it to hold that the taxpayer in Hatton failed to meet that criteria:
The taxpayer in Hatton failed to file a tax return and the IRS computed and assessed his tax liability by creating an SFR. Hatton, 220 F.3d at 1059. Throughout the process, the IRS sent numerous notices to Hatton, but it received no responses. Id. Hatton finally met with the IRS more than seven years after the original return was due and more than four years after the IRS assessed a deficiency. Id. He did not dispute his liability and the IRS agreed to a $200-a-month payment plan. Id. We held that Hatton’s “belated acceptance of responsibility” was not an honest and reasonable attempt to comply with the tax code. Id. At 1061.
Smith pointed out that, unlike Hatton, he had actually filed a return and argued that the inquiry should be limited solely to what was reported on the return he had prepared and filed.
The Ninth Circuit disagreed with that view:
Hatton focused the "honest and reasonable" inquiry on the honesty and reasonableness of the taxpayer's conduct, not on any deficiency in the documents' form or content. See Hatton, 220 F.3d at 1061 ("Hatton made every attempt to avoid paying his taxes until the IRS left him with no other choice.").
The Court now turned to Smith’s overall conduct and, not surprisingly, this did not go well for him:
Here, Smith failed to make a tax filing until seven years after his return was due and three years after the IRS went to the trouble of calculating a deficiency and issuing an assessment. Under these circumstances, Smith's "belated acceptance of responsibility" was not a reasonable attempt to comply with the tax code.
But the Ninth Circuit did not go on to decide if a late filed return never could meet this test, as some sister circuits had held, noting: “[w]e need not decide the close question of whether any post-assessment filing could be "honest and reasonable" because these are not close facts; the IRS communicated with Smith for years before assessing a deficiency, and Smith waited several more years before responding to the IRS or reporting his 2001 financial information.”
So, for now, there would still be a possibility that a late filed return could be found open to discharge in the Ninth Circuit—but the facts would have to be significantly better than those found in this case.