Consumer Bankruptcy Journal Spring 2017 | Page 14

Navigating the Late Tax Return Problem in Tax Discharge Cases By Morgan D. King, of Morgan King Company & Morgan King Law Offices Dublin, California L ike many issues in consumer bankruptcy cases, discharging taxes is both simple and complicated. The simple part is the 5 rules that must be satisfied to discharge the taxes and interest on the taxes (penalties and interest on the penalties are treated under a different standard). I won’t re-hash the 5 rules as I have done that in previous articles. 1 The 3-year and 240 day rules 2 are comparatively simple. But the other time-sensitive rule, typically called “the 2-year rule,” presents several tricky questions, some of them subjective, that must be addressed. The 2-year rule prescribes that in order to be dischargeable, among other things, the taxpayer must have filed his/her tax return (or “equivalent”) more than 2 years prior to filing the bankruptcy. 3 In many cases, satisfaction of the 2-year rule is simple - the IRS Account Transcript shows the taxpayer filed 14 CONSUMER BANKRUPTCY JOURNAL his/her 1040 return more than 2 years before the BK date, where there are no questions of possible tolling of the 2-year period. 4 The court concluded that the document was not an equivalent, nor was it required to discharge the state tax. 5 However, the validity of a tax return for discharge purposes requires special attention. Here is one logical order in which to address tax return issues for tax-discharge cases. 3. Timely or late? If required, was it filed - a. Timely (that is, filed not later than the most recent due date for filing) or filed late? If so, you can skip down to question # 6. 1. Does it purport to be a tax “return”? Is the document in question a tax “return,” or an “equivalent report or notice?” The case law has not clarified what, exactly, an “equivalent report or notice” is. One case has indicated that there is a distinction between a return and an equivalent report, but did not throw any light on the distinction. b. Late - was it filed in the 1st, 5th, or 10th circuits? 6 Those three circuits have adopted what is often called “the McCoy Rule,” which states that a late- filed return is, by definition, not a valid tax return. 7 If subject to the McCoy rule, there are two exceptions; an “agreed” return pursuant to 26 U.S.C. § 6020(a), or a “… stipulation to a judgment or a final order …” 11 U.S.C. § 523(a)(19)(B). Again, in which circuit it will be filed is a simple elective. 2. Is it required? Whatever it is called, is it required to be filed? This is a simple yes or no. This question and the first question above frequently arise in cases dealing with state tax reporting requirements, often in cases where the taxpayer was supposed to provide the state with information derived from an IRS audit. For example, In re Ciotti, the court struggled with whether or not Maryland’s requirement to send a “report” to the state following an audit was actually required, and whether the report in question was an “equivalent report.” Spring 2017 4. Not a McCoy circuit. If a non- McCoy state, meaning any circuit other than the three listed above, was it filed before, or after the tax was assessed? 9 One of the time rules is that the assessment must have happened more than 240 days prior to the bankruptcy, but, that rule is not involved here. What we are looking at here is not whether the assessment satisfies the 240-day rule, but rather did the date of the assessment have a bearing on the validity of the tax return, and hence the 8 National Association of Consumer Bankruptcy Attorneys