The First Circuit recently joined the Tenth and Fifth Circuits in determining that untimely tax returns are not “returns” for purposes of discharging tax debt. The Court in In re Fahey reviewed the four bankruptcy court decisions concerning the dischargeability of state tax liabilities where the debtor filed the return untimely. The returns at issue were Massachusetts state tax returns that were filed late, but more than two years before the filing of the bankruptcy petition. The First Circuit ultimately concluded that because the returns were untimely, they did not meet the definition of “return” for purposes of allowing discharge of tax debt under the Bankruptcy Code.
The Bankruptcy Code provides that tax debts are dischargeable unless the taxpayer willfully failed to pay taxes. The Code provides two other circumstances under which returns are not dischargeable: (1) if the return was not filed, or (ii) if the return was filed after the date it was due, but within two years before the filing of the petition. Most courts have interpreted this language to permit the discharge of tax debts if a return is filed late, but more than two years before the filing of the petition. In other words, the exception to discharge – an untimely return – is excepted from that exception if the untimely return is filed at least two years before the bankruptcy petition, which makes it dischargeable. However, a small change to the Bankruptcy Code in 2005 has led the IRS to argue (and courts to conclude) that liabilities arising from an untimely return cannot be discharged, even if the return was filed more than two years before the petition.
The small change was additional language to define “return” in connection with these exceptions to discharge. Under the revised provision, return is defined as “a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law.” 11 U.S.C. § 523(a). Because the return has to satisfy “applicable filing requirements,” an untimely return will not meet these requirements unless State or local law allows for late filing. Looking to Massachusetts law, the First Circuit determined that the untimely returns did not meet the applicable filing requirement.
The inevitable result of the First Circuit’s decision is that the only late-filed returns that are eligible for discharge would be returns filed under 6020(a). Section 6020(a) is a provision that allows the IRS to work with a taxpayer to prepare an untimely return, but does not require that the IRS do so. Alternatively, the Service can use section 6020(b) to prepare a taxpayer’s untimely return without the taxpayer’s input. In light of the First Circuit’s decision, we expect that the Service to prepare even fewer returns under the procedures in 6020(a) and expect more taxes to be assessed under 6020(b).
It is not clear whether Congress intended such a harsh result for late filers, however, in at least three Circuits, late filers will not be getting much relief in bankruptcy. In those Circuits, timely filing returns is more important than ever as it can have significant future repercussions.