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Taxes Not Dischargeable in Bankruptcy Where Debtor Filed Return 7 Years Late

(Parker Tax Publishing August 2016)

The Ninth Circuit affirmed a district court's order, which reversed a bankruptcy court, and held that a debtor's tax liabilities were nondischargeable in bankruptcy because the debtor's late-filed Form 1040 did not represent an honest and reasonable attempt to satisfy tax law requirements and, thus, the debtor did not file a "return" within the meaning of 11 U.S.C. Section 523(a)(1)(B)(i). Agreeing with other circuits, the Ninth Circuit held that In re Hatton, 220 F.3d 1070 (9th Cir. 2000), which adopted the Tax Court's widely-accepted definition of "return," applied to the Bankruptcy Code as amended in 2005. In re Smith, 2016 PTC 249 (9th Cir. 2016).


After Martin Smith failed to timely file his 2001 tax return, the IRS prepared a Substitute for Return (SFR) based on information the IRS had gathered from third parties. In March 2006, the IRS mailed Smith a notice of deficiency. Smith did not challenge the notice of deficiency within the allotted 90 days and the IRS assessed a deficiency against him of $70,662.

Three years later, in May 2009, Smith filed a Form 1040 for 2001 on which he wrote "original return to replace SFR." On this late-filed form, Smith reported a higher income than the one the IRS calculated in its assessment, thereby increasing his tax liability. The IRS added the additional arrearage to its assessment. Two months after that, in July 2009, Smith submitted an offer in compromise, which the IRS rejected. Smith later lost his job and the IRS allowed him to pay his tax bill in monthly installments of $150.

About five months later, Smith declared bankruptcy and sought to have his 2001 tax debt discharged in bankruptcy. Smith and the IRS agreed that the increase in the assessment based on Smith's late-filed 2001 tax return was dischargeable, but they disputed whether the IRS's original $70,662 assessment was also dischargeable. The bankruptcy court ruled that it was but a district court reversed that decision. Smith appealed to the Ninth Circuit.


Bankruptcy Code Section 523(a)(1)(B)(i) exempts from discharge "any . . . debt for a tax . . . with respect to which a return, or equivalent report or notice, if required . . . was not filed or given." In In re Hatton, 220 F.3d 1057 (9th Cir. 2000), the Ninth Circuit adopted the Tax Court's widely-accepted definition of "return" for purposes of Bankruptcy Code Section 523(a)(1)(B)(i). In Hatton, the Ninth Circuit stated that in order for a document to qualify as a tax return:

(1) it must purport to be a return;

(2) it must be executed under penalty of perjury;

(3) it must contain sufficient data to allow calculation of tax; and

(4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law.

When the Ninth Circuit decided Hatton, the Bankruptcy Code did not define the term "return." Congress subsequently amended the Bankruptcy Code in 2005 and it added the following definition of a return: "the term return' means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements)." While observing that it had not yet interpreted this new definition, the Ninth Circuit noted that both Smith and the IRS, the Tax Court, and several circuit courts agreed that Hatton's four-factor test still applied.

The dispute between Smith and the IRS centered on whether Smith's filing met the fourth requirement of the operative test. In other words, was his filing of his 2001 tax return an honest and reasonable attempt to satisfy the requirements of the tax law?

The Ninth Circuit held that Smith's belated acceptance of responsibility was not a reasonable attempt to comply with the Tax Code. The court noted that many of its sister circuits have held that post-assessment tax filings are not "honest and reasonable" attempts to comply and are therefore not "returns" at all. In the instant situation, the court observed, Smith failed to make a tax filing until seven years after his return was due and three years after the IRS went to the trouble of calculating a deficiency and issuing an assessment. To the court, this meant that the filing of Smith's 2001 tax return was not an honest and reasonable attempt to comply with the tax law.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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