Harsh McCoy Rule Rejected in Late Tax Return Cases

The bankruptcy court for the district of New Jersey bucked the current trend, and “agree[d] with those decisions that hold that the timing of the filing is not a factor in determining whether the document meets the definition of a ‘return.’”In re Davis, No. 14-26507 (Bankr. D. N.J. Sept. 29, 2015). See also, In re Maitland, 531 B.R. 516 (Bankr. D. N.J. 2015).

The Tax Code permits the IRS two ways of filing a tax return on behalf of a delinquent tax debtor. Under section 6020(a) the IRS fills out the return with the cooperation of the tax debtor. Under section 6020(b) the IRS fills out the return based on information available to it, but without involvement of the tax debtor. In this case, the IRS filed Mr. Davis’s tax returns for the three years that he had missed under section 6020(b). Mr. Davis then filed his own tax returns for those years in an attempt to compromise the debt. When that failed Davis filed a chapter 7 bankruptcy petition listing the IRS as holding a claim of $103,628.89, of which $2,156.40 was entitled to priority. The debtor received a discharge without controversy with respect to the tax claims.

When Mr. Davis filed his chapter 13 petition, he listed a portion of his tax debt as unsecured and argued that it had been discharged in his previous chapter 7 bankruptcy. The IRS countered that the tax liability was excepted from discharge in the prior case under section 523(a)(1)(B)(i) because Mr. Davis had not filed his return until after the IRS had filled out a return for him.

Section 523(a)(1)(B)(i) excepts from discharge any debt for a tax, “with respect to which a return, or equivalent reports or notice, if required, was not filed or given.” The court began its analysis with a look at pre-BAPCPA treatment of late filed tax returns. Under the so-called “Beard Test” a late-filed return must “1) purport to be a return; 2) be executed by the debtor under penalty of perjury; 3) contain sufficient data to allow the calculation of the tax liability; and 4) represent an honest and reasonable attempt on the part of the taxpayer to satisfy the requirements of the law.” Beard v. Commissioner, 82 T.C. 766, 777-78 (1984), aff’d, 793 F.2d 139 (6th Cir. 1986).

When applying the Beard Test, the issue typically turns on the fourth factor with some courts taking the hard line that any return filed after the IRS has performed an independent assessment under section 6020(b) cannot be said to be the result of an honest and reasonable attempt to satisfy tax law, e.g., In re Hindenlang, 164 F.3d 1029, 1034 (6th Cir. 1999), and other courts allowing that there could be extenuating circumstances rendering a debtor’s post-assessment filing an “honest and reasonable” attempt to comply. E.g., In re Moroney, 352 F.3d 902, 907 (4th Cir. 2003), and In re Hetzler, 262 B.R. 47 (Bankr. D.N.J. 2001). Still other courts have found that timeliness is altogether irrelevant to the issue of whether the tax debtor’s late-filing was an honest and reasonable effort to comply with tax laws. The only factor going to that consideration is whether the forms themselves represent an honest and reasonable attempt to satisfy the law. E.g., In re Colsen, 446 F.3d 836, 840 (8th Cir. 2006) (adopting Judge Easterbrook’s dissenting view in In re Payne, 431 F.3d 1055, 1061, 1062 (7th Cir. 2005) that “[t]imely filing and satisfaction of one’s financial obligations are requirements distinct from the definition of a ‘return;’ the majority, however, rolls them all together. . . . motive may affect the consequences of a return, but not the definition.”).

In 2005 Congress got involved and hung a paragraph on the end of section 523(a) which defines “return” as follows:

“For the 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.” 11 U.S.C. § 523(a)(*).

Based on this language, the First, Fifth and Tenth Circuits have all found that late-filed returns do not qualify as “returns” within the meaning of section 523(a)(*), finding that timeliness is an “applicable filing requirement” rendering all late-filed briefs non-dischargeable. See In re Fahey, 779 F.3d 1 (1st Cir. 2015); In re Mallo, 774 F.3d 1313 (10th Cir. 2014); In re McCoy, 666 F.3d 924 (5th Cir. 2012).

The Davis court discussed In re Maitland, 531 B.R. 516 (Bankr. D. N.J. 2015) and its finding that McCoy’s so-called “one day rule” does not withstand scrutiny. The court agreed that: “1) those courts’ reading of the definition of ‘return’ would render other parts of the statute superfluous; 2) a plain language approach does not fully support those courts’ reading of the term ‘return’; 3) the draconian result of the one-day rule is inconsistent with the underlying purpose of the Bankruptcy Code to give a fresh start to honest but unfortunate debtors; 4) the one-day rule is anomalous with the broader statutory scheme of 523(a), which primarily address debts arising out of culpable conduct of the debtor, not blameless mistake; and 5) the courts fail to address the detrimental impact the rulings would have on unsecured creditors.”

The court noted that there was no issue as to the debtor’s honesty and reasonableness and  went on to conclude that “[w]e agree with those decisions that hold that the timing of the filing is not a factor in determining whether the document meets the definition of a ‘return.’ We are persuaded by the comprehensive analysis done by the court in In re Maitland, as well as the by reasoning set forth by Judge Easterbrook in his dissent in In re Payne, and find that a late filed return can still constitute a ‘return’ for the purposes of discharge under 523(a).”

The court noted that its decision was in harmony with the treatment by the IRS of late-filed returns as “returns” for tax purposes, explaining that “[t]he IRS clearly accepts late-filed returns. Returns must be filed, late or not, in order to make an OIC. The IRS uses information contained in late-filed returns to replace estimated liabilities with actual liabilities.” Moreover, other protections and penalties in place in both the IRC and the Bankruptcy Code that deal with late returns would be rendered meaningless if a return no longer enjoys the status of “return” merely by virtue of being filed late.

Davis Bankr NJ opinion Maitland Bankr. D NJ opinion