In Mallo v. Internal Revenue Service, decided on Dec. 29, 2014, the Tenth Circuit Court of Appeals ruled that Edison and Liana Mallo’s 2000 and 2001 tax debt was not dischargeable in bankruptcy, notwithstanding their filing of tax returns for those years—although admittedly they filed late. Nevertheless, this result seems to run counter to the expressed intent of the Bankruptcy Code. More to the point, it will drive a stake through the heart of any attempt by a delinquent taxpayer to “clean his slate” through the use of bankruptcy.
The Mallos did not file timely federal income tax returns for 2000 and 2001 and were issued a statutory notice of deficiency by the IRS, assessing $34,464 in taxes including penalties and interest for 2001, and $19,022 in taxes for the year 2000. Assessments were made in 2005 and 2006, and in 2006 the IRS began collection efforts.
Subsequently, in 2007, the Mallos filed delinquent joint income tax returns for 2000 and 2001. Based on the filed returns, the IRS assessed additional joint tax liability against the Mallos. A companion case involved Peter Martin, who also did not file timely returns for the tax years 2000 and 2001 and was issued a statutory notice of deficiency in 2004. The IRS began collecting taxes against Martin, and in May of 2005, Martin filed delinquent income tax returns for 2000 and 2001.
In 2011, the Mallos filed Chapter 13 bankruptcy, which was later converted to a Chapter 7 proceeding. The Bankruptcy Court issued a general order discharging the Mallos’ debts. The Mallos then filed an adversary proceeding against the IRS in Bankruptcy Court, seeking a determination that their income tax liabilities for 2000 and 2001 had been discharged. The IRS opposed.
The Bankruptcy Court denied the Mallos’ motion for summary judgment and granted the IRS’ motion based on the conclusion that the Mallos had not filed a “return” for purposes of Section 523(a) of the Bankruptcy Code, and that, therefore, their 2000 and 2001 tax debt were not dischargeable. The Mallos appealed to the District Court of Colorado.
In Martin’s bankruptcy case, which was a Chapter 7, he too received a general discharge order and like the Mallos filed an adversary proceeding against the IRS seeking a determination that the 2000 and 2001 tax debt had been discharged. The bankruptcy judge found that, in Martin’s case, the late income tax returns were tax returns and therefore the tax debt was not excepted from the order of discharge. The IRS appealed.
In the district court, the two cases were consolidated. The district court concluded that these late, post-assessment income tax returns were not “returns” for purposes of Section 523(a)(1)(B), because “they served no tax purpose.” As a result, the district court affirmed the decision of the Bankruptcy Court in the Mallos’ case and reversed the order entered in the Martin case. Both the Mallos and Martin filed separate appeals, which were consolidated before the Tenth Circuit.
The Tenth Circuit reviewed Section 523(a) of the Bankruptcy Code to determine whether a general order of discharge also discharges tax debts from income tax returns which were filed late. The Circuit focused on the portion of Section 523(a)(*) referred to as the “hanging paragraph,” which reads as follows:
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. (Emphasis added.)
The court applied the plain meaning rules of construction and determined that when Congress added this “hanging” paragraph as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the hanging paragraph defined “return” as “a return that satisfies the requirements of the applicable nonbankruptcy law (including applicable filing requirements).” The court then reviewed nonbankruptcy law to make its determination.
The court turned to Justice Cardozo’s decision in Zellerbach Paper Co. v. Helvering, 293 U.S. 172 (1934), approved by the United States Court of Appeals for the Sixth Circuit in Beard v. Commissioner, 793 F. 2d 139 (6th Cir. 1986), and often therefore referred to as the “Beard test.” The Beard test has four elements: 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 v. Commissioner, 82 T.C. 766, 777 (1984).
Applying the Beard test to Mallo, the district court noted that, although the Beard test has four elements, only the third was in dispute—that is, whether an income tax return filed after the IRS assesses a taxpayer’s liability evinces “an honest and reasonable attempt to satisfy their requirements of tax law.” Beard, 82 T.C. at 777. Several courts have held that tax forms filed after the IRS assesses the taxpayer’s liability have no valid purpose and therefore cannot satisfy the third element of the Beard test. See, e.g., In re Payne, 431 F. 3d 1055, 1058 (7th Cir. 2005); In re Moroney, 352 F. 3d 902, 906 (4th Cir. 2003); In re Hatton, 220 F. 3d 1057 (9th Cir. 2000); In re Hindenlang, 164 F. 3d 1029 (6th Cir. 1999).
The court also took note of Judge Easterbrook’s dissent in Payne, which argued that an amended tax return provides new information which can be useful to the IRS. Moreover, the only federal circuit to consider the issue since Payne agreed with Judge Easterbrook’s dissent. In In re Colsen, 446 F. 3d 836 (8th Cir. 2006), the court held that the issue of whether a tax form evinces an honest and genuine attempt to satisfy the tax laws “does not require inquiry into the circumstances under which a document was filed.” Colsen at 840. The Eighth Circuit held that a post-assessment filed income tax return is a “return for purposes of discharge in bankruptcy if the document itself provides the information necessary to determine tax liability.”
While the Mallo court recognized the cogent arguments raised by Judge Easterbrook, and Colsen, it instead rested its decision not on the Beard test but on the fact that the taxpayer did not comply with “applicable filing requirements.”
The Mallo court interpreted the phrase “applicable filing requirements” by examining the required time for filing tax returns and other similar documents. As one knows, a taxpayer who is on a calendar year must file a tax return on or before April 15. The Mallo court concluded that the phrase “shall be filed on or before a particular day” is a classic example of something that must be done with respect to filing a tax return and therefore is an “applicable filing requirement.” In doing so, the court referenced other Supreme Court nontax cases. The court concluded that because the Mallos had filed their tax returns after the due date, a “return” had not been filed as required by the Bankruptcy Code and, therefore, the tax debts were excepted from discharge under Section 523(a)(1)(B)(i) of the Bankruptcy Code. Martin fared similarly.
The import of the Mallo decision, and the supporting rulings upon which it relies, is significant. For the most part, taxpayers who owe taxes often find themselves in a situation where they have filed either no returns or late returns. Prior to 2005, assuming other requirements of the Bankruptcy Code were met, such tax debts could be discharged. As a result of the Mallo decision, however, there are now four circuits which support the government’s position that, once a return is late—even if it is subsequently filed—that tax debt can never be discharged in bankruptcy. This is in spite of the clear wording of Section 523 that such a debt can be discharged as long as the late return is in fact filed no later than “two years before the date of the filing of the [bankruptcy] petition.” Section 523(a)(1)(B)(ii) of the Bankruptcy Code.
One circuit remains in favor of the taxpayer’s position—the Eighth in In re Colsen. It would seem that, because of this split in the circuits, the issue should be ripe for review by the Supreme Court. If the IRS’ position is sustained, it would have a significant impact on debtors. The primary focus of a bankruptcy filing is to obtain “a fresh start” and to be able to move forward with one’s life and not be burdened by past debts. Since tax debts often result in very high assessments, it would seem that the nondischargeability of a tax debt because of a late-filed income tax return would fly in the face of the purpose of the bankruptcy system.
It will be very interesting to see what develops in the near future from these decisions. •