Failure to File Returns before IRS Assessed Liability Precludes Discharge of Taxes

(Parker Tax Publishing February 2025)

A bankruptcy court held that, pursuant to Bankruptcy Code Section 523(a)(1)(B), a debtor's unpaid tax liabilities for 2005 and 2006, which were assessed by the IRS before the debtor filed those tax returns, were not dischargeable in bankruptcy. The court concluded that a post-assessment, late filed return is not a "return" for purposes of Bankruptcy Code Section 523. Morris v. U.S., 2025 PTC 39 (Bankr. N.D. Ill. 2025).

Background

Sarah Morris filed for Chapter 13 bankruptcy in 2014. For the prior 10 years, Morris failed to timely file federal income tax returns for years other than 2008, 2009, and 2013. She also generally had insufficient W-2 withholdings; failed to make any estimated pre-payments or payments with a return; and failed to make any voluntary payments, except for her 2003 tax year. The case was closed in 2019 and a discharge was issued.

Subsequently, the IRS issued several notices alleging that Morris remained liable for unpaid taxes for 2003, 2005, and 2006. Because Morris had not filed returns for those years, the IRS filed returns for her under Code Sec. 6020(b) and assessed the tax owed for each year. The IRS seized various overpayments and refunds to which Morris was otherwise entitled, applying them to the balance due for tax year 2003. Except for a very small portion of her 2003 income taxes that were paid through her Chapter 13 plan, all of Morris's 2003, 2005, and 2006 taxes remained unpaid as of the closing of her Chapter 13 case. While the case was open, neither Morris nor the IRS sought a determination of the dischargeability of those tax debts.

Over the years that followed, the IRS refused to refund amounts seized from Morris and instead applied those amounts to the balance due for tax year 2003. The IRS continued to show balances owed for 2005 and 2006. Morris then filed an adversary proceeding, asking that her liability for 2003, 2005, and 2006 taxes, to the extent not paid as of her original bankruptcy petition date, be fully discharged.

Since the IRS recouped enough from Morris to pay off her 2003 tax liability, the government sought a determination that Morris's income tax liabilities for 2005 and 2006 were nondischargeable pursuant to Bankruptcy Code Section 523(a)(1)(B). Under Section 523(a)(1)(B)(i) and (ii), an individual's taxes are not discharged with respect to a return that either (1) was not filed; or (2) was filed after the date it was due, and after two years before the date of the filing of a bankruptcy petition.

Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the term "return" was specifically defined in what is known as the "hanging paragraph" (also referred to as Section 523(a)()). For purposes of that subsection, the term "return" means a return that satisfies the requirements of applicable nonbankruptcy law.

In a motion for summary judgment, Morris noted that, before BAPCPA and the addition of the hanging paragraph, bankruptcy courts applied the four-prong test enunciated in Beard v. Comm'r, 82 T.C. 766 (1984), aff'd, 793 F.2d 139 (6th Cir. 1986), in determining what qualified as a "return." Under the Beard test, a document filed with the IRS had to (1) purport to be a "return," (2) be signed under penalty of perjury, (3) contain enough information to enable the taxpayer's tax liability to be calculated, and (4) show an honest and reasonable endeavor to satisfy the law.

The Seventh Circuit, the court to which Morris's case would be appealable, relied on the Beard decision in In re Payne, 431 F.3d 1055 (7th Cir. 2005). The issue presented in Payne was whether a debtor may obtain a discharge in bankruptcy for a tax debt owed to the IRS if the taxpayer did not file a return until after the IRS assessed the tax owed. At the time that Payne was decided, the Bankruptcy Code did not define the term "return." The Seventh Circuit held that a purported return not satisfying all four conditions in Beard could not fulfill the intended role for which a tax return serves in the federal tax system, that of self-assessment. Thus, the court said, while a "return" that satisfies the first three conditions in Beard comports with the literal meaning of the word, it does not comport with the functional meaning.

The Payne court found that the fourth condition had not been satisfied. Specifically, the court stated that the debtor's late-filed return "was not a reasonable effort to satisfy the requirements of the tax law, namely, the requirements of filing a timely return and paying the amount of tax calculated on the return." Because the IRS had already calculated the tax owed, Payne had defeated the main purpose of self-filed returns: "to spare the tax authorities the burden of trying to reconstruct a taxpayer's income and income-tax liability without any help from him." Thus, the Seventh Circuit held that the document at issue was not a "return" for purposes of allowing the debtor to discharge his tax liabilities in bankruptcy. In so holding, the court noted that its finding was consistent with all of the appellate decisions that had dealt "with untimely tax returns brandished in the bankruptcy court in an effort to obtain a discharge."

Before the bankruptcy court, Morris argued that because the hanging paragraph provides a statutory definition of "return," bankruptcy courts cannot continue to apply the Beard test in a manner that imposes requirements beyond those in applicable nonbankruptcy (i.e., tax) law. Filing in a timely manner, Morris said, was a pre-BAPCPA "non-tax law" requirement created by bankruptcy case law decisions, not by "applicable nonbankruptcy law." Such requirements and decisions, Morris argued, have been rendered "immaterial" and "improper" with the addition of Section 523(a)(). Morris even provided the court with various approaches that might guide the court's decision and provided a decision tree for the court to consider in reviewing those approaches.

Analysis

The bankruptcy court held that, under Section 523(a)(1)(B), Morris's unpaid tax liabilities for 2005 and 2006 were not dischargeable in bankruptcy because she failed to file her 2005 and 2006 income tax returns before the IRS filed those returns on her behalf. While the court found Morris's arguments and analyses to be thorough and creative, it also found that Morris failed to sufficiently address the Seventh Circuit's Payne decision or present reasons that the bankruptcy court should now ignore what is otherwise clearly controlling precedent in the Seventh Circuit.

The court also noted that, since the addition of the hanging paragraph defining the term "return" in Section 523, none of the circuit courts applying the Beard test before the enactment of BAPCPA have reversed their decisions. Moreover, the court observed, no circuit court has found, post-BAPCPA, that a post-assessment, late-filed return constitutes a "return" under Section 523(a)() for purposes of Section 523(a)(1)(B)(i).

The court also observed that the Ninth Circuit revisited this issue in In re Smith, 828 F.3d 1094 (9th Cir. 2016), and held that the Beard test still applies, despite the addition of Section 523(a)(). Likewise, the court said, the Third and Eleventh Circuits have found that the Beard test is applicable when determining whether a purported return satisfies the requirements of "applicable nonbankruptcy law (including applicable filing requirements)" pursuant to Section 523(a)(). In addition, the bankruptcy court found that the First, Fifth, and Tenth Circuits, have held that post-assessment filings are not "returns" under Section 523(a)() -- not through application of the Beard test, but simply because filing deadlines themselves are "applicable filing requirements." Finally, the court noted that no circuit court has found, post-BAPCPA, that a post-assessment, late-filed return constitutes a "return" under Section 523(a)() for purposes of Section 523(a)(1)(B)(i).

For a discussion of when taxes can be discharged in bankruptcy, see Parker Tax ¶16,160.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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