California Debtors Allowed to Discharge Federal Tax Debt According to Bankruptcy Court Ruling

California Debtors Allowed to Discharge Federal Tax Debt According to Bankruptcy Court Ruling | Bankruptcy Law CenterEarlier this year, a California bankruptcy court found that a couple’s tax liabilities were subject to discharge under Chapter 7 of the U.S. Bankruptcy Code. The question before the court was whether the couple’s debt accrued when the IRS assessed their tax liability in March of 2009, or when the couples filed multiple years of late returns in June of 2009.

The Timeline

The couple failed to file an IRS Form 1040 tax returns the years 2004, 2005, and 2006. In June of 2008, the Internal Revenue Service (“IRS”) conducted an audit on the couple. That August of 2008, the IRS sent the couple a “notice of deficiency” for each one of the years that they failed to file income taxes. By December 2008, an accountant had completed the tax returns for the years 2004 through 2006. The couple, however, did not sign the returns or submit them to the IRS until June of 2009.

In March of 2009, the IRS assessed the couple’s total tax liability and sent them multiple notices and demands for payment. In late May of 2009, the IRS issued a due process notice, which initiated the debt collection process. It was about a week after this notice was sent by the IRS that the couple signed and submitted their tax returns to the IRS.

The couple filed for Chapter 7 bankruptcy in November of 2011. At the time they filed for bankruptcy, they had not paid any of their tax debt. In July of 2012, the couple filed an adversary proceeding against the IRS alleging their tax debt was dischargeable. Not surprisingly, the IRS filed a motion for summary judgment. In its motion, the IRS argued there is an exception to discharge covering tax debts when a return was not filed or given under 11 U.S.C. §523(a)(1)(B)(i). The IRS argued this exception should apply because the couple failed to file their tax returns until after the IRS had assessed their tax liability and began debt collection procedures.

The Court’s Decision

The IRS cited several decisions from appellate courts in other circuits outside of California’s 9th Circuit Court of Appeals. One decision held that a late tax filing did not count as a “return” for purposes of bankruptcy discharge. Another decision found that, while a late filing still counted as a “return,” only the IRS makes an assessment of tax liability. Not persuaded by either decision, the California bankruptcy court followed a decision from an outside appellate court that found timeliness was not a factor to determine whether or not a filing met the requirements of a “return” under IRS regulations.

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(image courtesy of Aidan Bartos)

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