First Circuit Sustains Holding That Late Filed Return Is Not a Return for Bankruptcy Discharge (11/25/22)

As readers of this blog know, there are a lot of fun facts about the Internal Revenue Code and the twists and turns it has taken from passage, amendment, and application by the IRS and the Courts (including interpretation). Sort of like the line from the Major-General’s song in G&S’s Pirates of Penzance:

About binomial theorem I'm teeming with a lot o' news,
With many cheerful facts about the square of the hypotenuse.

OK, no more diversions. The topic today is the famous “hanging paragraph” (sometimes called the “so-called hanging paragraph,” the “unnumbered hanging paragraph,” etc.) in the Bankruptcy Code at 11 USC § 523(a), here [I link the Code section because you just have to see it in context to fully enjoy it; it appears sort of just out there at the end of subsection (a) and just before subsection (b)]. The hanging paragraph is also referred to as “§ 523(a)(*)” (or some variation with an asterisk). In full, the hanging paragraph is:

For 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.

There are other hanging paragraphs in the U.S. Code (either the positive law Codes or the compilation Codes (on which see On the Internal Revenue Code (Title 26), the U.S. Codes, and Statutes, here).

This Bankruptcy Code’s hanging paragraph has created discordant notes in the courts as to the meaning of the statutory text: “the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).”  (Emphasis supplied.) Specifically, does “applicable filing requirements” mean that the return has to be timely in order to achieve a discharge? This often comes up in the context of the IRS having prepared a substitute for return (“SFR”) pursuant to § 6020(b) after the taxpayer failed to file a return. The tax computed in the SFR is assessed. The IRS tries to collect. The taxpayer dodges and weaves. The taxpayer, wanting to rid himself (or herself) of this nuisance, then checks out the possibility of a bankruptcy discharge. The taxpayer’s lawyer, unaware of or unconcerned about the hanging paragraph commotion in the courts, advises that the taxpayer needs to file a return and wait two years before filing for bankruptcy. So he files a tax return mimicking the results of the SFR, waits two years, seeks bankruptcy protection and, hopefully, discharge of the tax liability. 

The question is whether the late-filed return after the SFR fails the requirement of the "applicable filing requirements) requirement. Normally, as I note below, the Code’s requirement for a return does not require timely filing and, in that sense, a late filed return might meet applicable filing requirements.  The courts have split as to that question.

In In Re: Kriss v. United States, ___ F.4th ___,  2022 U.S. App. LEXIS 32197 (1st Cir. 11/22/22), CA1 here and GS here, the Court dipped its toe into the issue without fully wading in. The panel called the hanging paragraph “particularly puzzling section of the Bankruptcy Code.”  The Court refers to the paragraph as § “523(a)(*).” The panel offers this introduction (Slip Op. 4-5):

            This section requires us to decide whether Kriss's returns "satisf[y] the requirements of applicable nonbankruptcy law (including applicable filing requirements)." In 2015, we - 5 - decided a case presenting a similar inquiry. In re Fahey, 779 F.3d 1 (1st Cir. 2015). In that case, the debtor owed Massachusetts income tax, so we looked to Massachusetts state law as the applicable nonbankruptcy law. Id. at 4. That law included a requirement that returns be filed by a specified date. Id. And because the debtor's return was filed after that specified date, we held that the return was not a "return" within section 523(a)(*) (the so-called "one-day-late" rule). Id. at 5.

            At least on its face, Fahey does not directly control this appeal because Massachusetts's filing requirements are not applicable given that the debt here arises under federal law. One might nevertheless think that distinction easily erased. After all, federal tax law required Kriss to file his returns before he did. See 26 U.S.C. § 6072. The United States, though, makes clear that it nonetheless regards many late-filed federal returns to be returns within the meaning of section 523(a)(*).

            Ultimately, we need not decide whether Fahey entirely applies to federal returns just as it applies to Massachusetts returns. Nor need we consider the cogent arguments well marshalled by Kriss on appeal for rethinking Fahey. Rather, even if Fahey does not control, Kriss loses because his much belated filings did not qualify as returns under section 523(a)(*) even under the alternative test put forward by Kriss in the bankruptcy court. See United States v. Lara, 970 F.3d 68, 78 (1st Cir. 2020) ("We - 6 - need not decide which standard applies in this case, as [appellant's] challenge fails under either standard."); United States v. Burgos-Montes, 786 F.3d 92, 105 (1st Cir. 2015).

The alternative test argued by the taxpayer was the late-filed return, if a valid return under the ubiquitous Beard test of Beard v. Commissioner, 82 T.C. 766 (1984), aff'd, 793 F.2d 139 (6th Cir. 1986) applies to meet the return requirement in the hanging paragraph. Taxpayer argued that, if his late filed return was a return under Beard, then it should be a return filed under the hanging paragraph because. The Beard test seemingly determinate on its face is not really. See The Report of the Death of the Interpretive Regulation Is an Exaggeration  117-118 (SSRN December 14, 2021), here. Kriss brings out some of the subtleties in “return” as variously used in the Code because of the “applicable filing requirements” specifically used in the hanging paragraph to describe "return." A late-filed return can meet the filing requirements except that it is late, a condition not contained in the Beard test in other return contexts. For example, if the Beard conditions are otherwise met, the taxpayer could certainly be prosecuted for tax perjury (§ 7206(1)) which requires a return.

But the Court essentially ducks the issue by saying that Beard has both a subjective and objective test, but Kriss only argued the subjective test which the court below rejected as a factual matter and the appellate panel affirmed. Now, as to Beard’s objective test, Kriss had waived by not arguing that he met that test below. So, net, net, the Kriss Court shed no new light on this “particularly puzzling section of the Bankruptcy Code.”

The Court noted in its only footnote (Slip Op.. 9 n. 1):

    n1 The United States argues that a return filed after the IRS estimates and assesses a tax on its own can never be the product of an honest and reasonable effort to comply. Given our holding, we need not decide whether that is so.

So, the Court did some dodging of its own on the key issue of whether the hanging paragraph actually requires a timely filed return. I suppose this is like “judicial minimalism” which I just last night read in Liza Batkin, The Kingdom of Antonin Scalia (The New Yorker 11/12/22), here:

Judicial minimalism, defended by the Harvard scholar Cass Sunstein, commands the Court to decide cases on the narrowest grounds available.