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Amicus Brief Couldn't Sway Supreme Court to Hear Bankruptcy Discharge Case

(Parker Tax Publishing March 2017)

The Supreme Court declined to hear an appeal of a Ninth Circuit case affirming a district court's decision that had reversed a bankruptcy court holding, which had been favorable to the taxpayer. The Court was apparently unswayed by an amicus brief filed on behalf of the taxpayer which argued that, because the circuits are divided on the issue of the dischargeability of tax debts, the ability of debtors to discharge tax debt in a bankruptcy will depend upon their geography, leading to disparate treatment of debtors and an inconsistent application of federal bankruptcy law. In re Smith, 2016 PTC 249 (9th Cir. 2016), cert. denied (2/21/17); Amicus Brief in re Smith.

After Martin Smith failed to timely file his 2001 tax return, the IRS prepared a Substitute for Return (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. Two months after that, in July 2009, Smith submitted an offer in compromise, hoping to resolve his tax liability. The IRS rejected his offer. Smith later lost his job and the IRS allowed him to pay his tax bill in monthly installments of $150.

Several months later, Smith declared bankruptcy and sought to discharge his 2001 tax debt before the bankruptcy court. Smith and the IRS agreed that the increase in the assessment based on Smith's late-filed form was dischargeable, but they disputed whether the IRS's original $70,662 assessment was also dischargeable. The bankruptcy court ruled that it was but a district court reversed that holding and the Ninth Circuit affirmed the district court's decision.

Bankruptcy Code Section 523(a)(1)(B)(i) 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." In In re Hatton, 220 F.3d 1057 (9th Cir. 2000), the Ninth Circuit adopted the Tax Court's widely-accepted definition of "return" for purposes of Bankruptcy Code Section 523(a)(1)(B)(i). In Hatton, the Ninth Circuit stated that in 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.

When the Ninth Circuit decided Hatton, the Bankruptcy Code did not define the term "return." Congress subsequently amended the Bankruptcy Code in 2005 and added the following definition of a return: "the term return' means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements)." While observing that it had not yet interpreted this new definition, the Ninth Circuit noted that both Smith and the IRS, the Tax Court, and several circuit courts agreed that Hatton's four-factor test still applied.

The dispute between Smith and the IRS centered on whether Smith's filing met the fourth requirement of the operative test. In other words, was his filing of his 2001 tax return an honest and reasonable attempt to satisfy the requirements of the tax law?

The Ninth Circuit held that Smith's belated acceptance of responsibility was not a reasonable attempt to comply with the Tax Code. The court noted that many of its sister circuits have held that post-assessment tax filings are not "honest and reasonable" attempts to comply and are therefore not "returns" at all. In the instant situation, the court observed, 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. To the court, this meant that the filing of Smith's 2001 tax return was not an honest and reasonable attempt to comply with the tax law.

Smith appealed the decision to the Supreme Court. Two nonprofit organizations, the National Consumer Bankruptcy Rights Center (NCBRC) and the National Association of Consumer Bankruptcy Attorneys (NACBA), filed an amici curiae in support of certiorari being granted in Smith's case. In the brief, the organizations stated that the primary issue in this case whether tax liability based on late-filed tax returns is dischargeable in bankruptcy directly implicates the interests of the consumers whose rights NCBRC and NACBA support. This issue, they said, has been widely litigated across the circuits, and the courts are fractured in their approach. The ability of debtors to discharge tax debt in a bankruptcy, they contened, will depend upon their geography, leading to disparate treatment of debtors and an inconsistent application of federal bankruptcy law. Deeply divided circuits, they argued, have multiple, conflicting answers to the question of whether the filing of a late tax return absolutely bars bankruptcy discharge of related tax obligations.

The brief noted that the Eighth Circuit may permit discharge if a bankruptcy petition is filed two years after a late-filed return, but in the Fourth, Sixth, Seventh, Ninth and Eleventh Circuits, by contrast, any return filed after the IRS has made its own assessment of tax liability is not considered a return for purposes of bankruptcy dischargeability. The First, Fifth and Tenth Circuits have taken a more severe approach, the brief stated, ruling that all taxes described on late-filed returns even those filed one day late for any reason are barred from discharge.

The Supreme Court was apparently unswayed by the amicus brief and declined to grant certiorari in the case.

For a discussion of discharges of tax debts in bankruptcy, see Parker Tax ¶16,169.

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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