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A California bankruptcy court ruled that a debtor couple’s federal tax liabilities were subject to discharge under Chapter 7 of the Bankruptcy Code. In re Martin, 508 B.R. 717 (Bankr. E.D. Cal. 2014) (PDF file). The debtors did not file Form 1040 tax returns for those tax years before the IRS assessed the amount of tax liability and began efforts to collect the debt. The court had to determine when tax liability becomes a “debt” for purposes of bankruptcy law:  when the IRS assessed the debt or when the debtors filed their returns. It ruled that the filing of the returns was the critical factor, and therefore it ruled for the debtors.

According to the court’s ruling, the debtors, a married couple, did not file federal income tax returns for the tax years 2004, 2005, and 2006. The IRS conducted an audit of the debtors in June 2008. The following August, it sent them a “notice of deficiency” for each of the three years. An accountant completed the three tax returns for the debtors in December 2008, but the debtors did not sign the returns or send them to the IRS until June 2009.

Meanwhile, in March 2009, the IRS assessed the debtors’ total tax liability and sent them several notices and demands for payment. It issued a due process notice, which initiated the collection process, in late May 2009. The debtors signed the returns and mailed them to the IRS about a week later.

In November 2011, the debtors filed for Chapter 7 bankruptcy, having not yet paid any of this tax debt. They filed an adversary proceeding against the IRS in July 2012, claiming that the tax debt was dischargeable. The IRS moved for summary judgment. It argued that the exception to discharge covering tax debts for which a return “was not filed or given,” 11 U.S.C. § 523(a)(1)(B)(i), should apply because the debtors did not file their Form 1040 returns until after it had assessed the debt and commenced collection efforts.

The question for the bankruptcy court was whether the tax debt accrued when the IRS assessed the amount due in March 2009, or when the debtors filed their returns in June 2009. The court found the IRS’ argument—that its assessment established the debt—to be unpersuasive. It also rejected the IRS’ arguments based on appellate court rulings from other circuits:

– The Fifth Circuit’s “One-Day-Late” rule, which holds that a late-filed tax return is “not a ‘return’ for bankruptcy discharge purposes under § 523(a).” Martin, 508 B.R. at 726, quoting In re McCoy, 666 F.3d 924, 932 (5th Cir. 2012); and
– The Sixth Circuit’s “Post-Assessment” rule, which holds that a late-filed return may still count as a “return” under § 523, but only until the IRS makes an assessment of tax debt. In re Hindenlang, 164 F.3d 1029 (6th Cir. 1999).

Instead, the court went with the “No-Time-Limit” rule established by the Eighth Circuit, which holds that “timeliness” is not a factor in determining whether a return meets the requirements of § 523. Martin, 508 B.R. at 731, quoting In re Colsen, 446 F.3d 836, 840 (8th Cir. 2006).

If you need to speak to a tax debt attorney in the Los Angeles area, contact the Law Offices of Devin Sawdayi online or at (310) 475-939 today to schedule a free and confidential consultation. We help individuals and families use the Chapter 7 or Chapter 13 bankruptcy processes to rebuild their finances with dignity and respect.

More Blog Posts:

Tax Penalties Accrued More than Three Years Before Bankruptcy Filing Date Are Dischargeable, Court Rules, Los Angeles Bankruptcy Lawyer Blawg, July 24, 2015

Bankruptcy Court Rules that State Tax Debt Is Dischargeable in Chapter 7 Bankruptcy Case, Los Angeles Bankruptcy Lawyer Blawg, July 16, 2015

Discharging Tax Debts in Chapter 7 or Chapter 13 Bankruptcy, Los Angeles Bankruptcy Lawyer Blawg, August 4, 2014