An important and recurring issue in personal bankruptcy cases is the dischargeability of taxes related to a non-filed or a late filed tax return. Bankruptcy Code §523(a)(1)(B) governs the dischargeability of taxes pertaining to non-filed or late filed tax returns, and this provision states:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt— (1) for a tax or a customs duty— * * * * (B) with respect to which a return, or equivalent report or notice, if required— (i) was not filed or given; or (ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition;

11 U.S.C. §523(a)(1)(B).

Pursuant to Bankruptcy Code §523(a)(1)(B)(i), a debtor's tax liability is not discharged with respect for which he or she failed to file a tax return or the equivalent. 4 Collier on Bankruptcy ¶ 523.07[3][a] (16th ed. 2018). Under Bankruptcy Code §523(a)(1)(B)(ii), a debtor's tax liability is not discharged if he or she filed a late return within two years of the commencement of the bankruptcy case. Fahey v. Massachusetts Department of Revenue (In re Fahey), 779 F.3d 1, 4 (1st. Cir. 2015).

A recent decision that involves the dischargeability of taxes pertaining to a non-filed or late filed tax return is In re DeFreze, 2018 WL 4182451 (Bankr. W.D.N.Y. 2019). In DeFreze, the debtor was required to file his New York state tax return by April 15, 2009. The debtor mailed his 2008 New York state tax return on June 18, 2009. The debtor failed to execute and date his late filed return, and this defect was remedied on July 6, 2009. Subsequently, the IRS audited the debtor, and it contended that the debtor had substantially under-reported his income. On July 14, 2015, the U.S. Tax Court found that the debtor had under-reported his gross income by $108,377. Pursuant to New York law, the debtor was required to file an amended New York state tax return within 90 days of the entry of the Tax Court Order. The debtor failed to file a New York state amended tax return within the time period prescribed by statute. On Oct. 28, 2015, the debtor filed his late New York amended tax return, which included the previously unreported gross income. The New York State Department of Tax and Finance (NYSDTF) issued a notice of assessment for $18,544.60.

On Sept. 30, 2017, the debtor filed for Chapter 7. On Jan. 12, 2018, the debtor received his discharge. On Jan. 28, 2018, the NYSDTF mailed the debtor a notice of adjusted assessment seeking payment of $16,970.85 for tax year 2008. Thereafter, the debtor sought a determination that its liability for tax year 2008 was discharged. Pursuant to Bankruptcy Code §523(a)(1)(B), the NYSDTF contended that the debtor's tax liability was exempted from discharge.

Judge Warren ruled that under Bankruptcy Code §523(a)(1)(B)(i) the New York state tax return was not a return under the Bankruptcy Code, and thus, the $16,970.85 tax claim was not dischargeable. In addition, the judge ruled that under Bankruptcy Code §523(a)(2)(B)(ii), the $16,970.85 tax claim was non-dischargeable because the debtor commenced his bankruptcy case within two years after his late filed amended 2008 tax return was filed.

In 2005, Bankruptcy Code §523(a)(1)(B) was amended to provide a definition of the term “return.” For purposes of Bankruptcy Code §523(a)(1) a return means a tax return that satisfies the requirements of non-bankruptcy law. The court noted that although the Second Circuit Court of Appeals had not addressed the issue, a majority of Circuit Courts that have ruled that a tax return, even one filed one day late, does not meet the requirement of the definition of “return.” under Bankruptcy Code §523(a)(1).

Judge Warren ruled that the test in Beard v. Comm'r, 82 T.C. 766 (1984) aff'd, 793 F.2d 139 (6th Cir. 1986) was useful to determine whether a document constitutes a return under non-bankruptcy law. In Beard, the court enunciated the four-part test under Beard, that must be satisfied for a document to constitute a return:

Under Beard, a document must meet four requirements to be 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 tax law.

Id. at 3.

Judge Warren focused on the fourth Beard factor: whether the debtor's 2008 New York State Form IT-201 was an honest and reasonable effort to comply with the New York State tax law? The court ruled against the debtor. The debtor's purported tax return was filed months after its due date; was not signed under penalty of perjury; and failed to disclose over a $100,000.00 in gross income. In addition, the debtor filed the amended return beyond the required statutory period. Under these circumstances, the debtor failed to make an honest and reasonable effort to comply with applicable law. Therefore, under Bankruptcy Code §523(a)(1)(B)(i) the 2008 taxes due to the NYSDTF are non-dischargeable.

Judge Warren also held that, pursuant to Bankruptcy Code §523(a)(1)(B)(ii), the debtor's 2008 New York state tax debt is nondischargeable. The court stated:

Alternatively and additionally, under the facts at hand, the Court finds that 11 U.S.C. §523(a)(1)(B)(ii) is an impediment to discharge of Mr. DeFreze's 2008 New York State tax debt. Mr. DeFreze's late-filed “amended” New York State Form IT-201-X for tax year 2008 was “a return, or equivalent report or notice” required by New York law that was “filed or given after the due date” and within two years of the filing of the bankruptcy case. 11 U.S.C. §523(a)(1)(B)(ii). The late-filing of that required “equivalent report or notice” would also serve as a basis to find that Mr. DeFreze's 2008 tax obligation to NYSDTF was not discharged under 11 U.S.C. §523(a)(1)(B)(ii), because this bankruptcy case was filed less than two years after the amended return was filed—and only after the IRS had made an assessment and only after the Tax Court had entered its order.

Id. at 4.

The DeFreze decision is reflective that Bankruptcy Code §523(a)(1) is intended to protect the taxing authorities. The Bankruptcy Code embodies different public policy pronouncements. Bankruptcy Code §523(a)(1) fosters the public policy that it is important for an individual to pay his or her tax liability. This case demonstrates that the burden of proof is on a debtor to prove that the tax debt in question is dischargeable. Bankruptcy is intended to provide debt relief to a poor but unfortunate debtor. The Bankruptcy Court is a court of equity. A debtor who has unclean hands will be denied equitable relief. As this case reflects, a debtor who has acted in bad faith by attempting to circumvent the requirements of the applicable tax laws faces a difficult challenge in discharging a tax claim. An attorney must be circumspect when advising a client who has significant tax concerning unfiled or late filed income tax returns.

Carlos J. Cuevas is a solo practitioner in Yonkers, N.Y., and a research associate at the University of Houston School of Law.