Article of the Week

“Discharging Taxes in Bankruptcy – Not So Quick” by Mark Ericsson

The IRS never ceases to amaze us.

The story begins with three cases involving the so-called two year rule. Practitioners have always recognized a “3 year/two year/240 day” rule when determining which taxes are dischargeable in a bankruptcy. If the income tax return of the debtor was due at least three years before the filing of the petition, was actually filed two years before the filing of the petition, and assessed at least 240 days before the filing of the petition, any tax liability owing was generally dischargeable. In 2008 and 2009, the IRS successfully challenged the two year prong of that rule at the trial court level. Contrary to what they were told at the time, hundreds of taxpayers will be unable to discharge taxes for which they filed a return more than two years ago.

This result comes about because in 2005 Congress added the following to the end of bankruptcy code §523(a):

For purposes of this subsection, the term “return” means 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, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.

Few thought this would change the application of §523(a)(1)(B)(ii) which excepts from discharge a tax arising from a return that was filed less than two years before the date of the filing of the petition, thereby allowing discharge of a tax filed more than two years before the filing of the petition.

However in three cases, taxing agencies successfully argued that a late filed return is not a return for purposes of §523(a)(1)(B)(ii) because a late filed return does not satisfy all “applicable filing requirements” since filing on time is one such requirement. In re Creekmore, 401 B.R. 748 (Bankr.N.D.Miss.2008); Links v. U. S., 2009 WL 2966162 (bkrtcy.N.D.Ohio); McCoy v. Mississippi State Tax Commission, 2009 WL 2835258 (bkrtcy.S.D.Miss.). In McCoy, the Court points out that under 6020(a), the Secretary may prepare a "substitute return" with the cooperation of the taxpayer, while under 6020(b) the return is prepared without the taxpayer's cooperation. Thus, the Court holds that there is a safe harbor provided that the requirements of 6020(a) or a similar state law are met.

Then, in a brief filed September 18, 2009, following an adversary hearing in an Illinois case (Bankr. Cas No. 08-27159), the IRS withdrew its objection to discharge, stating that “the Internal Revenue Service has concluded that the definition is ambiguous and that the better view is that Congress did not intend to repeal the longstanding law that taxes assessed in accordance with a return filed late are governed primarily by section 523(a)(1)(B)(ii) rather than (i) so that the tax is dischargeable if more than two years have elapsed between the filing of the return and the bankruptcy petition.” Of course the brief position is not binding on the IRS, but does represent its thinking. It will be up to the practitioner to decide whether to rely upon the Internal Revenue Service to follow this stated position.

Mark Ericsson
Youngman, Ericsson & Low, LLP
1981 N. Broadway, Suite 300
Walnut Creek, CA 94596
925-330-6000 • fax 925-934-5377

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