United States District Court, N.D. California
April 29, 2014
IN RE MARTIN SMITH, DEBTOR.
MARTIN SMITH, APPELLEE INTERNAL REVENUE SERVICE, APPELLANT,
Bankruptcy Case No. 11-73272 RLE. Adversary Proceeding No. 12-4086.
For Internal Revenue Service, United States of America, Appellants: Chong Sung Hong, LEAD ATTORNEY, U.S. Attorney's Office, San Francisco, CA; Landon Monte Yost, Tax Division, Civil Western, Washington, DC; Thomas Moore, U.S. Attorney's Office, Tax Division, San Francisco, CA.
For Martin Smith, Debtor, Appellee: Robert Lawrence Goldstein, LEAD ATTORNEY, Sarah Drinkwater, Law Offices of Robert L. Goldstein, San Francisco, CA.
For California Franchise Tax Board, Appellee: Karen W. Yiu, LEAD ATTORNEY, Office of the Attorney General, San Francisco, CA; Todd M. Bailey, California Franchise Tax Board, Rancho Cordova, CA.
U.S. Bankruptcy Court, Northern District of California, Oakland, Miscellaneous, Pro se, Oakland, CA.
Judge Roger L. Efremsky, Miscellaneous, Pro se, Oakland, CA.
Order Reversing Decision of Bankruptcy Court; Denying Debtor's Motion to Strike (Dkt. No. 20)
YVONNE GONZALEZ ROGERS, UNITED STATES DISTRICT COURT JUDGE.
This is an appeal by the Internal Revenue Service (" IRS" ) from the Order Granting Debtor Martin Smith's (" Debtor" ) Request for Summary Judgment and Denying IRS's Motion for Summary Judgment, entered by the Bankruptcy Court on January 31, 2013, and more fully explicated on the record on January 8, 2013. IRS filed a Notice of Appeal on February 14, 2013, as well as a statement of election to have the United States District Court for the Northern District of California hear its appeal of the Order. See 28 U.S.C. 158(c)(1)(A), Fed. R. Bankr. P. 8001(e), and 9th Cir. B.A.P. L.R. 8001(e)-1. The controversy stems from the treatment, for bankruptcy purposes, of a Form 1040 submitted seven years after it was due and three years after the IRS made an assessment and commenced collection proceedings.
Having carefully reviewed the record of the proceedings in this matter, the legal determinations in the Bankruptcy Court's decision, and the parties' briefing, the Court is persuaded the approach used in a majority of the circuits across the United States in their treatment of late-filed tax returns is the appropriate method of resolving this issue presented. Accordingly, with respect to the facts presented here, the Court Reverses the Bankruptcy Court's January 31, 2013 Order and Remands for further proceedings consistent with this Decision.
I. STATEMENT OF THE FACTS
Debtor filed a voluntary petition under Chapter 7, Title 11, of the United States Code on December 22, 2011. The Court issued a discharge order on May 11, 2012. The only year at issue in this adversary proceeding is 2001, a year for which Debtor did not file an income tax return timely. The IRS sent Debtor a letter requesting that he file an income tax return for 2001, but Debtor failed to do so. The IRS then
began an examination regarding Debtor's liability for the 2001 tax year and determined his tax liability for 2001 based on information gathered from third parties. After making its determination, the IRS prepared a " substitute for return" (or " SFR" ) pursuant to 26 U.S.C. § 6020(b) for 2001.
On March 27, 2006, the IRS mailed a notice of deficiency to Debtor for the 2001 tax year showing the IRS's determination of tax liability of $70,662. Debtor had ninety days from March 27, 2006, to challenge the notice of deficiency by filing a petition with the United States Tax Court. Debtor filed no such challenge. On July 31, 2006, the IRS assessed the $70,662 tax liability and began collection activities.
On May 22, 2009--over seven years after Debtor's 2001 tax return was due, over three years after the IRS had determined Debtor's tax liability for 2001, and after the IRS had already initiated collection activity on the debt--Debtor submitted a Form 1040 for the 2001 tax year, reporting a higher tax liability than the IRS previously had determined (" the Return at Issue" ). He thereafter filed his bankruptcy petition on December 22, 2011. This appeal focuses on the treatment of the $70,662 tax liability assessed by the IRS in 2006, in light of the bankruptcy.
A. Standard of Review and Statutory Framework
In reviewing a bankruptcy court's decision, this Court functions as an appellate body and is authorized to affirm, reverse, modify or remand the Bankruptcy Court's ruling. 28 U.S.C. § 158(a); Fed. R. Bankr. P. 8013. In this case the relevant facts are undisputed. The Bankruptcy Court's conclusions of law are subject to de novo review. Miller v. United States, 363 F.3d 999, 1003-1004 (9th Cir. 2004).
The question presented is whether Debtor's 2001 federal income tax liabilities, assessed by the IRS based upon its own examination and determination, should be (i) discharged in bankruptcy, or (ii) non-dischargeable pursuant to 11 U.S.C. section 523(a)(1)(B)(i). In general, the filing of a bankruptcy petition allows a debtor to discharge personal liability for all debts incurred prior to the filing of the petition, including unpaid taxes. 11 U.S.C. § 727(b); see also Hatton, 220 F.3d 1057, 1060 (9th Cir. 2000). However, Section 523(a)(1) of Bankruptcy Code sets forth certain exceptions to dischargeability identified in nineteen subsections. See 11 U.S.C. § 523(a)(1)-(a)(19). At issue here is the exception set forth in section 523(a)(1)(B) which provides:
(a) A discharge [in bankruptcy]...does not discharge an individual debtor from any debt--
(1) for a tax ... --
(B) with respect to which a return... if required--
(i) was not filed or given; or
(ii) was filed or given after the date on which such return... was last due, under applicable law or under any extension, and after
two years before the date of the filing of the petition.
11 U.S.C. § 523(a)(1)(B).
Importantly, a precise statutory definition of the term " return" does not exist. In fact, case law abounds with colorful discussions involving the meaning of the term " return" in tax-avoider cases. While the Ninth Circuit has generally held that the meaning of " return" should be the same under the Tax Code and Bankruptcy Code, the Tax Code itself does not provide a definition of " return." Hatton, 220 F.3d at 1060 (" [a]lthough the I.R.C. [Internal Revenue Code] does not provide a statutory definition of 'return,' the Tax Court developed a widely-accepted interpretation of that term..." ). Thus, the Ninth Circuit, relying on the seminal case of Beard v. Commissioner, 82 T.C. 766, 774-79, 1984 WL 15573 (1984), aff'd, 793 F.2d 139 (6th Cir. 1986)), held that whether a " document" is considered a " return" for statute of limitations purposes depends upon four elements. Hatton, 220 F.3d at 1060-61. Those elements, as stated in Beard, are:
First, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury.
Beard, 82 T.C. at 777 (relying on the definition of " return" established by the Supreme Court in Germantown Trust Co. v. Commissioner, 309 U.S. 304, 60 S.Ct. 566, 84 L.Ed. 770, 1940-1 C.B. 178 (1940), and Zellerbach Paper Co. v. Helvering, 293 U.S. 172, 55 S.Ct. 127, 79 L.Ed. 264, 1934-2 C.B. 341 (1934)).
Thereafter, in 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 119 Stat. 23 (April 20, 2005) (" BAPCPA" ) effective October 2005 which amended Section 523(a). For the first time, through BAPCPA, the Bankruptcy Code now provided some guidance on the meaning of the term " return," even though it did not offer a precise definition. It did so with the inclusion of a new unnumbered paragraph at the end of the subsections 523(a)(1) through 523(a)(19). This paragraph (frequently termed the " hanging paragraph" ) states in pertinent part:
For purposes of this subsection, the term 'return' means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).
Id. Thus, the hanging paragraph codified, in part, what the Ninth Circuit stated in 2000 in Hatton : that the definition of " return" for purposes of bankruptcy law should be one that satisfies the requirements of non-bankruptcy law; there, the
definition of " return" used under the Tax Code. Hatton, 220 F.3d at 1060.
B. Legal Analysis
Based upon the legal framework outlined above, the Court first reviews the basis for the Bankruptcy Court's decision, including the various circuits' reasoning relative to defining the term " return." The Court will then outline the parties' respective positions, and finally, set forth its own analysis of the meaning of " return" in the context of this bankruptcy appeal.
1. Bankruptcy Court's Decision
Here, the Bankruptcy Court found that the Return at Issue, filed some three years after the IRS assessed Debtor's tax liability, was properly discharged after the filing of the bankruptcy petition. In its decision, the Bankruptcy Court adopted the reasoning of another bankruptcy court's decision, In re Martin, 482 B.R. 635 (Bkrtcy. D. Colorado 2012) (" Martin I " ). The Martin I court had adopted the reasoning of Colsen v. United States, 446 F.3d 836 (8th Cir. 2006). The Court first notes that Martin I has since been reversed on appeal by a district court sitting in the Tenth Circuit. In re Martin, 500 B.R. 1 (D. Colo. September 23, 2013) (" Martin II " ). Because Martin I 's analysis was essentially the sole basis for the underlying decision here, the Court sets forth that analysis in some detail.
Martin I concerned the dischargeability of (i) an IRS debt for the years 2000 and 2001, (ii) due after the IRS made an assessment in 2004, and (iii) for which the debtor submitted Forms 1040 in 2005. Martin I, 482 B.R. 635. The debtor argued that because Form 1040s had been filed, irrespective of the timing or the debtor's motivations, the debt was dischargeable and the plain language of section 523(a)(1)(B)(i) supported the debtor's position. Said differently, the plain language of Section 523(a) indicates that non-dischargability is required:
(1) for a tax...
(B) with respect to which a return...if required-
(i) was not filed....
In Martin I, the debtor urged that because the Form 1040s were submitted, section 523(a)(1)(B)(i) could not be applied to prohibit discharge of this debt, even though they were untimely. The Martin I court agreed.
The Martin I court began its analysis with the question of the definition of a return. As set forth above, no controversy exists that prior to BAPCPA, the Bankruptcy Code was silent on the meaning of the word " return." The Martin I court thus turned its attention to the hanging paragraph's language that " the term 'return' means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements)." Martin I, 482 B.R. at 638. The Martin I court reasoned that the reference to " applicable filing requirements" could not refer to regular time requirements and due dates for filing a tax return for three reasons: One, such a strict interpretation would mean that any late-filed
return would not be a " return" for purposes of dischargeability under section 523(a)(1)(B)(i). Two, such an interpretation would render section 523(a)(1)(B)(ii) surplusage, since it sets forth a separate exception for a return filed " after such return was last due" and less than 2 years prior to the date of bankruptcy. Martin I, 482 B.R. at 639. Three, such an interpretation would have the effect of imposing different meanings to the term " return" as between section 523(a)(1)(B)(i) and section 523(a)(1)(B)(ii), contrary to the normal canons of statutory construction. Id. Thus, the bankruptcy court in Martin I concluded " '[a]pplicable filing requirements' must refer to considerations other than timeliness, such as the form and contents of a return, the place and manner of filing, and the types of taxpayers that are required to file returns." Id. On this basis, the Martin I court found that the debtors' late-filed 1040s could qualify as a " return" and were properly dischargeable as they had been filed. Id.
The bankruptcy court in Martin I then turned to the more traditional approach set forth in Beard to determine whether a Form 1040 filed after an assessment constituted a " return." The judge outlined the 3-to-1 split in the circuits with respect to the application of Beard 's " honest and reasonable attempt" factor when a taxpayer files a post-assessment Form 1040. Martin I, 482 B.R. at 640. The Fourth and Seventh Circuits joined the Sixth Circuit in finding a post-assessment Form 1040 not to be an " honest and reasonable attempt to satisfy the requirements of the tax law." Id. ( citing In re Hindenlang, 164 F.3d 1029, 1034-35 (6th Cir. 1999); In re Moroney, 352 F.3d 902, 906 (4th Cir. 2003); and In re Payne, 431 F.3d 1055, 1059-60 (7th Cir. 2005)). In contrast, the Eighth Circuit disagreed and found the timing or subjective intent of the filer of a post-assessment Form 1040 to be irrelevant. Colsen, 446 F.3d at 840. The Eighth Circuit further held that this Beard factor should require no more than an objective determination, from the face of the form itself, of an attempt to comply, and not an " inquiry into the circumstances under which a document was filed." Id.  The bankruptcy court in Martin I, citing both to Colsen and to Judge Easterbrook's dissent in Payne, reasoned that issues of the taxpayer's intent and timeliness were addressed in subsections 523(a)(1)(B)(ii) and 523(a)(1)(C) and need not be incorporated into subsection (1)(B)(i). Martin I,
482 B.R. at 640-41. On these grounds the bankruptcy court in Martin I found that the tax based on the post-assessment Form 1040 should be discharged, as it met the " objective" requirements of a " return" under subsection 523(a)(1)(B)(i).
2. Summary of Parties' Arguments
Appellant IRS contends the underlying decision here was based upon legal error. First, Appellant argues that section 523(a)(1)(B)(i) controls because Debtor never filed a voluntary, self-assessment tax return prior to the IRS's assessment, the money owed is and remains a tax debt for which no return was filed thereunder, regardless of any subsequent late-filed return by Debtor. Alternatively, IRS argues that the Court should employ the Beard test and the majority understanding of its " honest and genuine endeavor to comply" factor to a post-assessment Form 1040 filing. While the Ninth Circuit has not specifically ruled on this issue, under the reasoning of a majority of circuits and the Ninth Circuit's decision in Hatton, the IRS argues that the post-assessment Form 1040 would not constitute a " return" that " satisfies the requirements of applicable nonbankruptcy law" within the meaning of the Tax Code, and would therefore not be eligible for discharge.
For his part, Debtor contends that the approach in Martin I, also the Eighth Circuit's approach in Colsen, is the correct one. Debtor argues that the filing of a Form 1040 for the 2001 tax year, even if submitted long after the IRS assessed taxes for that year, means that the debt is dischargeable, within the plain meaning of the hanging paragraph and section 523(a)(1)(B)(ii). Debtor further argues that this " objective" approach to the definition of return, which finds compliance with the Beard test regardless of when the " return" is submitted, is supported by the Ninth Circuit's pre-BAPCPA decision in In re Hatton, 220 F.3d 1057 (9th Cir. 2000) and the Bankruptcy Appellate Panel of the Ninth Circuit in In re Nunez, 232 B.R. 778 (B.A.P. 9th Cir. 1999), discussed below.
The question before the Court is whether the Return at Issue constitutes a " return" for purposes of section 523(a)'s non-dischargeability provisions. The Ninth Circuit has not squarely addressed this question post-BAPCPA for purposes of section 523(a). However, the Ninth Circuit's pre-BAPCPA ruling in Hatton addresses the meaning of a " return" under section 523(a) in circumstances analogous to the case at bar. Hatton, 220 F.3d 1057. The reasoning is instructive and not undermined by the inclusion of the BAPCPA's hanging paragraph.
In Hatton, as here, the IRS prepared a substitute return on the debtor's behalf when he failed to file a federal return for one tax year. Hatton, 220 F.3d at 1058-59. The IRS issued an assessment, and then undertook collection activities. Hatton never denied the tax liability. Only
after ignoring several delinquency notices and negotiating an installment agreement with the IRS did he begin to repay the tax debt. Prior to full repayment, Hatton filed for bankruptcy and sought discharge of the remainder owed. The question before the Ninth Circuit in Hatton was whether the substitute return and installment agreement satisfied the Beard factors and constituted a " return" for purposes of section 523(a)(1)(B)(i). Id. at 1059. The court found that neither document, nor the combination, satisfied the " honest and reasonable attempt" prong of the Beard test. Hatton, 220 F.3d at 1061. The court stated that " belated acceptance of responsibility... does not constitute an honest and reasonable attempt to comply with the requirements of the tax law." Id. Because the debtor " made every attempt to avoid paying his taxes until the IRS left him with no other choice" and " only cooperated with the IRS once collection became inevitable," the debt was not properly exempted from discharge under section 523. Id. 
Here, Debtor incorrectly contends that Hatton requires a court to apply the Beard factors as an " objective" test which does not consider the subjective intent of the debtor. To the contrary, the Ninth Circuit in Hatton held that debtors' tax liabilities are not dischargeable when they fail to comply with our tax system's voluntary self-assessment principles, and instead refuse to cooperate until well past the point of an assessment. Hatton, 220 F.3d 1057, 1061 (9th Cir. 2000). While the other three Beard factors are based on objective, face-of-the-documents considerations, the " honest and reasonable attempt" factor necessarily involves an individualized review of the equities. Thus, Debtor's argument that the Ninth Circuit's " only problem with the taxpayer seeking to discharge the liability was that the taxpayer never actually filed a return" (Appellee's Opening Brief at 14:24-25) simply disregards the reasons stated in Hatton for finding non-dischargeability.
Likewise, a majority of the federal circuit courts have held that a late-filed, self-assessment Form 1040 does not constitute a " return" that " satisfies the requirements of applicable nonbankruptcy law" because it is not an " honest and reasonable attempt to comply with the tax law." Hindenlang, 164 F.3d 1029, 1034-35 (6th Cir. 1999); In re Moroney, 352 F.3d 902, 906 (4th Cir. 2003); In re Payne, 431 F.3d 1055, 1059-60 (7th Cir. 2005); see also In re Wogoman, No. B.R. 11-11044-SBB, 2011 WL 3652281 (Bankr. D. Colo. Aug. 19, 2011) aff'd,475 B.R. 239 (10th Cir. B.A.P. 2012) (interpreting hanging paragraph and the Tax Code to mean that a Form 1040 filed after the IRS had created a substitute return and assessed the tax liability was not a " return" for purposes of discharge of the tax liability " under the facts and circumstances
of this case" ); Mendes v. C.I.R., 121 T.C. 308, 331 (2003) (fact that return was filed more than eight years after the due date and two years after IRS notice of deficiency were proper considerations under Beard test, establishing return was not an " honest and reasonable attempt" to comply with the tax laws) (Vasquez, J., concurring). The Fourth Circuit in Moroney stated the principle succinctly: " to belatedly accept responsibility for one's tax liabilities, only when the IRS has left one no other choice, is hardly how honest and reasonable taxpayers attempt to comply with the tax code." Moroney v. United States, 352 F.3d 902, 906 (4th Cir. 2003); see also In re Mallo, No. 10-12979 MER, 2013 WL 49774 (Bankr. D. Colo. Jan. 3, 2013) aff'd, 498 B.R. 268 (D. Colo. 2013) (late filed returns did " not represent an honest and reasonable attempt to comply with tax law[; r]ather, they are belated attempts to create a record of compliance when none really exists, long after the IRS had filed substitutes for returns and provided notices of deficiency" ). Or, as Judge Posner stated in Payne, " a purported return that does not satisfy" the honest and reasonable attempt requirement " does not play the role that a tax return is intended to play in... our federal tax system of self-assessment... while a 'return' that satisfies the [other] three conditions comports with the literal meaning of the word, it does not comport with the functional meaning." In re Payne, 431 F.3d at 1057.
Courts taking the minority view have opined that the language of the hanging paragraph, particularly when read together with section 523(a)(1)(B)(i) and (ii), indicates that timeliness of the return has no bearing on whether it meets the definition of " return." Colsen, 446 F.3d at 840. Martin I, 482 B.R. at 641. According to interpretation of the bankruptcy court in Martin I, section 523(a)(1)(B)(ii) already addresses late filing of a return, making any consideration of timeliness superfluous to the definition of " return" itself, and therefore irrelevant to section 523(a)(1)(B)(i). Martin I, 482 B.R. at 641. The Court cannot agree with this interpretation of the statutory language.
First, the hanging paragraph added by BAPCPA makes clear that a " return" must satisfy the requirements of non-bankruptcy law. Thus, the hanging paragraph in no way excludes the Beard factors, but indeed incorporates them since they are relevant, long-standing non-bankruptcy law on the meaning of return. Moreover, there is no inconsistency between: (1) taking late-filing, and the reasons therefore, into account in deciding whether a document is a " return" at all for purposes of Beard, and (2) barring discharge of returns that are filed untimely and " after two years before the date of the filing of the petition." It is easy to imagine a scenario under which a late-filed document meets the Beard definition of " return," i.e., is filed late but in good faith, yet is still barred from discharge under section 523(a)(1)(B)(ii). Cf. Payne, 431 F.3d at 1058 (the Beard test considers whether late return is " a reasonable endeavor to satisfy the taxpayer's obligations, as it might be if the taxpayer had tried to file a timely return but had failed to do so because of an error by the Postal Service" ) (emphasis in original). Likewise, the opposing scenario -- a return filed late but within the two years prior to the filing of the petition -- would mean that discharge was not necessarily barred by section 523(a)(1)(B)(ii), unless the " return" failed the Beard test (as here). Id. at 1058 (document purporting to be a return, with all the data necessary and signed under penalty of perjury is not an honest and reasonable attempt if deliberately mailed to Arlington National Cemetery instead of IRS). Finally, the fact that the second sentence of the hanging paragraph allows a return prepared by the IRS with the
taxpayer's cooperation (under section 6020(a)) to be considered a " return" for purposes of section 523(a), but not a return prepared by the IRS without such cooperation (under section 6020(b)) is, again, completely consistent with concerns set forth in the Beard test: whether the taxpayer made an " honest and reasonable attempt to comply" with the tax laws. Thus, there is nothing about taking timeliness and the reasons therefore into account, per Beard, that renders any of the language in the hanging paragraph or section 523(a)(1)(B)(ii) superfluous or inoperable.
In examining the holdings of the various courts, the reasoning therefore, and the language of section 523(a)(1)(B) itself, the Court finds that the majority position on this issue is the correct one. Since the hanging paragraph in Section 523(a)(1) does not completely define the term " return," it is appropriate for the Court to look to long-established authority concerning the definition of " return" under " applicable nonbankruptcy law," primarily the Tax Code. Similarly, the hanging paragraph does nothing to undermine the four-factor test or years of jurisprudence following Beard. Consistent with the Tax Code's standards for a " return," as stated in Beard and the Ninth Circuit's decision in Hatton, the meaning of " return" must take into account the late-filers' evidence of a good faith attempt to comply with the tax laws. Where, as here, the taxpayer and bankruptcy debtor fails to comply with self-assessment and payment of tax obligations until years after the IRS has initiated action, created a substitute return, assessed and begun collection proceedings, the Court simply cannot find his conduct to be " an honest and reasonable attempt to comply with the tax law." This approach does not mean, as Debtor argues, that the " honest and reasonable attempt" factor creates a per se rule barring taxpayers from filing returns once the IRS has created a substitute return. To the contrary, this prong of the test is meant to consider each case on its particular facts, an approach which necessarily precludes a per se determination.
In sum, Debtor's belated Form 1040 for Tax Year 2001 does not meet the definition " return" under established tax law. It follows that the tax liability assessed by the IRS for Tax Year 2001 is a " tax...with respect to which a return...was not filed or given," and is not dischargeable in bankruptcy pursuant to section 523(a)(1)(B)(i).
Consequently, the Court Reverses the Bankruptcy Court's Order that the subjected tax liability was excepted from discharge under 11 U.S.C. § 523(a)(1)(B)(i), and granting summary judgment in favor of Debtor.
In addition, Debtor's Motion to Strike Defendant's Notice (Dkt. No. 20) is Denied. The IRS's Notice of Recent Decision (Dkt. No. 19) was not filed improperly.
This matter is Remanded to the Bankruptcy Court for proceedings consistent with this Decision, including entry of judgment in favor of IRS.
It Is So Ordered.