In general, tax debts can be discharged in bankruptcy if the tax liability is over three years old at the time of filing bankruptcy. (BRC 507(a)(8)(A)(i)) However, the exception to that discharge lies in the Habitually Late Tax-Filer Rule, found in BRC 523(a)(1) which states that, in short, if a debtor has not made good faith attempts to comply with tax law in filing their tax returns, there will be no discharge of those liabilities in bankruptcy.
This article analyses and seeks to predict an unsettled question of law as to whether the Middle District of Alabama will adopt the one-day-late rule or the totality-of-the-circumstances rule as it relates to this exception to discharging tax liability.
The Middle District of Florida reminds us that the “primary policy purpose of the Bankruptcy Code is to “relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh, free from the obligations and responsibilities consequent upon business misfortunes.” People with a good-faith reason for filing late and who are not “committing fraud” or “trying to game the system,” should receive their fresh start promised by a bankruptcy discharge. “Debtors who legitimately resort to bankruptcy when they reach wit’s end should not be punished for the lack of clarity that persists in the very laws enacted to help them.” In re Shek, 578 B.R. 918, 922 (Bankr. M.D. Fla. 2017)
The most contentious issue in the analysis of whether a debtor should receive tax-liability discharge boils down to a difference of opinion on how to interpret “late filing.” Some circuits have found that one-day-late results in loss of the discharge, while other circuits look at the totality-of-the-circumstances to determine if the debtor was trying to game the system.
The foundational case for understanding this exception to discharge is In re Justice, 817 F.3d 738 (11th Cir. 2016), cert. denied sub nom. Justice v. I.R.S., 137 S. Ct. 1375 (2017), wherein the 11th Circuit found four requirements for a document to serve as a tax return (i.e., whether the debtor can avail themselves of the discharge): “(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.” Only the last prong was at issue in Justice.
For the Middle District of Alabama, as of today’s date, neither Judge Williams nor Judge Sawyer have published opinions referencing Justice. However, there are other published opinions arising form courts within the 11th Circuit which reference In re Justice that may shed light on the direction of the Middle District of Alabama.
In In re Briggs, No. 1:15-CV-2427-MHC, 2017 WL 9512443 (N.D. Ga. June 7, 2017), the court held that “IRS has burden to prove that the “tax return was not an honest and reasonable attempt to satisfy the requirements of the tax law. . . . The burden of proving that a debtor did not file a return and the 2002 tax liability is non-dischargeable is on the creditor, the United States.” Furthermore, “The United States must prove its case by a preponderance of the evidence.”
Most importantly the court did not apply the strict liability analysis of the one-day late rule: “The District Court affirmed the “The Bankruptcy Court’s finding that the totality of the circumstances indicated that the IRS failed to establish that the 2002 return was not an honest and reasonable attempt to satisfy the requirements of the tax law is not clearly erroneous.”
In Briggs the Debtor relied on his business partner to file his 2002 tax return; which were never filed. When Debtor entered into litigation with his business partner, he employed forensic accountants and attorneys to obtain copies of documents necessary to file his return. He forwarded the documents he did obtain to an accounting firm to prepare his 2002 taxes. Because Debtors income tax is dependent on Schedule C, these documents were necessary to file taxes. IRS sent deficiency and assessment notices to the wrong address and Debtor never received them.
The Bankruptcy Court ruled that IRS had not met it’s burden to prove that the filing of the 2002 return was not an honest and reasonable attempt at compliance:
“Even under [the] view of the Beard factors [that considers timeliness as a factor], the Court concludes the 2002 return was an honest and reasonable attempt to satisfy the requirements of the tax law. The Debtor testified without contest that he was under the impression his 2002 tax return had been filed as he signed it and approved it for filing. Since the deficiency letters from the IRS were sent to Illinois and not to the Debtor’s home address, he did not receive them and had no reason to believe that his tax returns had not been filed until, during the course of litigation with his former business partner, he discovered the various omissions of the business partner. Moreover, the Debtor testified without contest that he did not have access to the business records which were necessary in order to complete his tax return. The 2002 tax return shows that the Debtor did not receive a 1099 or a W-2, so only by calculating the gross income and expenses of the business could the Debtor report his income to the IRS.” Id. At 3.
The District Court affirmed the Bankruptcy Court’s conclusion, but reversed the Bankruptcy Court’s reasoning that timeliness is not relevant in analyzing the Fourth Beard factor. “In Justice, the Eleventh Circuit adopted the majority view of three other circuit courts that have held that delinquency in filing is relevant to the fourth Beard factor.” Id. at 4.
“[T]he fourth Beard factor requires analysis of the entire time frame relevant to the taxpayer’s actions. Failure to file a timely return, at least without a legitimate excuse or explanation, evinces the lack of a reasonable effort to comply with the law. This interpretation comports with the common-sense meaning of “honest and reasonable.” It is also consistent with the purpose of bankruptcy generally: to provide a “fresh start” to the “honest but unfortunate debtor.” Id. at 4 (citations omitted)
Another case which may shed light on the direction of the Middle District of Alabama is In re Shek, 578 B.R. 918, 922 (Bankr. M.D. Fla. 2017). In Shek, the Department of Revenue argued “that even if filing deadlines are not “filing requirements,” the Debtor’s tax liability was not discharged because the Debtor does not satisfy the fourth prong of the Beard test, which requires the document to “represent honest and reasonable attempt to satisfy the requirements of tax law.” According to MDR, the Debtor gave no reason for needing a copy of his former spouse’s tax return since they filed “Married, Filing Separately,” which allows no taxpayer to claim an exemption on behalf of the spouse and which gives a taxpayer half of the standard deductions had he or she filed “Married, Filing Jointly.”
The Debtor responded with the explanation that “his seven month delay in filing the tax return resulted from an honest and reasonable attempt to satisfy the  Tax Code. He was going through a divorce, he allegedly did not know his former spouse would file “Married Filing Separately,” and his delay resulted from his efforts to obtain a copy of his former spouse’s tax return to determine the deductions and exemptions she had used.” The Debtor also pointed out that the Revenue Department “issued an assessment only after the Debtor filed a return.”
The Court held that there was, indeed, a factual dispute as to whether the Debtor’s delay in filing the return was an honest and reasonable attempt to satisfy the  Tax Code under the Beard test.” Most importantly, the court’s reasoning in Shek is illuminating to the present analysis:
“The primary policy purpose of the Bankruptcy Code is to “relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes.” People with a good-faith reason for filing late and who are not “committing fraud” or “trying to game the system,” should receive their fresh start promised by a bankruptcy discharge. “Debtors who legitimately resort to bankruptcy when they reach wit’s end should not be punished for the lack of clarity that persists in the very laws enacted to help them.”
The Shek court concluded with the very direct observation that “the ‘one-day late’ rule adopted by some courts defies common sense, years of established case law, clear bankruptcy policies, and the plain language of the Code.”
The next case we can analyze as we try to predict where the Middle District of Alabama will land on the question is In re Bell, 565 B.R. 702, 705 (Bankr. M.D. Fla. 2017). Bell centered around a discussion of whether a Form 1040 qualified as a “tax return”, thereby allowing the Debtor to qualify for the tax liability discharge. Here, the court focused on the fact that the Debtor did not file Form 1040 until after he had received the notice of deficiency and assessment of tax liability.
“For a late Form 1040 to qualify as a tax return, it must represent an honest and reasonable attempt to satisfy the tax laws. Generally, a late Form 1040 does not represent an honest and reasonable effort to comply with the tax laws, if the taxpayer does not file the Form until after the IRS has issued a notice of deficiency and assessed the tax liability, and the taxpayer does not provide a legitimate explanation or justification for his tardiness. According to the Eleventh Circuit Court of Appeals, the appropriate period to evaluate a late Form 1040 is the entire time frame of the taxpayer’s actions.
“In this case, the Debtor submitted Form 1040s for the 2001, 2002, 2003, and 2004 tax years in February of 2007, after the IRS had issued Notices of Deficiency and assessed the tax liabilities for those years. The record for the entire period of the Debtor’s conduct shows that (1) the Debtor’s initial failure to file the Forms was based on an invalid challenge to the constitutionality and legality of the tax laws, (2) the Debtor continued the challenge during the IRS’s process of estimating the tax liability, and (3) the Debtor did not file the late Form 1040s until six months after the taxes were assessed, and seven months after he received the Forms from his tax preparer.
Not surprisingly, the court held that “[f]or these reasons, the late Form 1040s do not represent an honest and reasonable effort to satisfy the tax laws, and do not constitute returns under applicable nonbankruptcy law. Accordingly, the Debtor’s tax liabilities for 2001, 2002, 2003, and 2004 are excepted from discharge under § 523(a)(1)(B)(i) of the Bankruptcy Code.”
The Bell court then went on to provide a very helpful explanation of In re Justice:
“In In re Justice, 817 F.3d 738, 740 (11th Cir. 2016), the debtor had filed late Form 1040s for four tax years, after the IRS had issued Notices of Deficiency and assessed the taxes, and the issue was whether the late Forms were “returns” for purposes of dischargeability under § 523(a). The Eleventh Circuit Court of Appeals found that the Forms did not qualify as tax returns under the Beard test because they did not evidence an honest and reasonable effort to comply with the tax laws. Consequently, the debtor’s tax liabilities for the relevant years were nondischargeable under § 523(a)(1)(B)(i) of the Bankruptcy Code. In re Justice, 817 F.3d at 746.
“In reaching this conclusion, the Eleventh Circuit held that “the fourth Beard factor requires analysis of the entire time frame relevant to the taxpayer’s actions. Failure to file a timely return, at least without a legitimate excuse or explanation, evinces the lack of a reasonable effort to comply with the law.” Id. at 744.
“The holding includes at least two components. First, the time frame to evaluate the taxpayer’s efforts at compliance is the entire period of his conduct regarding the relevant tax years. This period includes all of the taxpayer’s conduct from the time of the original delinquency through the filing of the late documents, and not just the shortened period surrounding the taxpayer’s ultimate decision to file the late forms. In re Justice, 817 F.3d at 744–45. See In re Johnson, 2016 WL 1599609, at 4 (Bankr. S.D. Fla.)(In determining that the debtor’s filings did not represent an honest and reasonable attempt at compliance, the Court considered “the entire time frame from delinquency through when the belated returns were filed.”).
“Second, for a late filing to constitute a return, the taxpayer must establish a “legitimate excuse or explanation” for his tardiness. In Justice, for example, the Eleventh Circuit found that the debtor’s Form 1040s were not returns, because they were filed many years late and “without any justification at all.” In re Justice, 817 F.3d at 746. See In re Johnson, 2016 WL 1599609, at 4 (The Court found that the debtor provided no justification for his tardiness, where he simply stated in conclusory fashion that his filings were made in good faith to satisfy his obligations under the tax laws.). In re Bell, 565 B.R. 702, 705 (Bankr. M.D. Fla. 2017)
With these recent case law developments in mind, we can see that other courts in the circuit are taking the position that a totality of the circumstances should be evaluated when seeking to determine if there exists an exception to discharging tax liability. While this is no guarantee that the Middle District of Alabama will follow suit, it is a good indicator of the trend.
Thus, some good questions to keep in mind as you analyze your own case:
Are you like the debtor in In re Bell, whose tax liabilities were excepted from discharge because he did not file for four years, and only after IRS sent a notice of deficiency and assessed tax liability?
Can you make the same argument as the debtor in In re Shek, who filed his taxes prior to a notice of deficiency and argued good faith compliance with complex state law?
Are you relying on the argument that you delegated your responsibility to file the tax return to someone else who failed to follow through? If so, have you heeded the warning in In re Briggs, No. 1:15-CV-2427-MHC, 2017 WL 9512443 (N.D. Ga. June 7, 2017), where the District Court seemed open to the IRS’s argument that a person’s responsibility to promptly and properly file taxes cannot be delegated: “The IRS contends that Briggs’s reliance on his business partner does not excuse his failure because a taxpayer may not delegate his duty to file his tax returns.”
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