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.
