by A tax return filed seven years after it was due and three years after the IRS conducted its independent assessment does not meet the test for an “honest and reasonable” attempt to comply with tax laws. Smith v. IRS, No. 14-15857 (9th Cir. July 13, 2016).
Martin Smith filed his 1040 tax return seven years after it was due and three years after the IRS had filed a Substitute for Return (SFR) and assessed a deficiency against him. Mr. Smith’s tax return declared more income and higher tax liability than the IRS’s assessment. Upon filing for bankruptcy relief, Mr. Smith and the IRS agreed the increased tax liability resulting from Mr. Smith’s return was dischargeable, but disagreed as to the dischargeability of his tax liability as assessed in the SFR.
The bankruptcy court found the entire tax debt to be dischargeable. The district court reversed and the BAP affirmed finding that section 523(a)(1)(B)(i), which “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,’” rendered the tax debt non-dischargeable.
On appeal the Ninth Circuit relied on the definition of tax “return” adopted in In re Hatton, 220 F.3d 1057, 1059 (9th Cir. 2000), under which “(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.” [This test is equivalent to the Beard test which is widely applied in other jurisdictions].
The court found this four-part test continued to apply notwithstanding BAPCPA’s added definition of “return” in the hanging paragraph to section 523(a), and that Mr. Smith’s belated filing of his tax return did not meet the fourth prong of the test. The court held that a tax return filed seven years late and three years after the IRS performed its own assessment was not an “honest and reasonable” attempt to comply with tax laws. The court rejected Mr. Martin’s argument that his case was distinguishable from Hatton because the debtor in Hatton failed to file a tax return at all and that, by filing proper documents and forms, Mr. Martin met the “honest and reasonable” requirement. The court declined to limit the inquiry to the face of the forms filed without regard to the time of filing. Instead, it held that the “honest and reasonable” requirement related to the taxpayer’s conduct rather than the form of the documents filed.
Finding that the case was not close on its facts, the court declined to decide whether a tax return filed after the IRS has done its own tax assessment without the cooperation of the tax payer, can ever constitute an honest and reasonable attempt to comply.