Tax clients often ask me what they should do when they know that they owe taxes and April 15 is approaching. The correct answer is: file the tax return and pay what you can. The IRS and Department of Revenue charge interest and penalty whether you file or not. They will then tack on penalties for not filing. If you do not file, the IRS and the Department of Revenue might file for you, and the one they file will never be better than the true one. Some payment will dodge collection efforts for some time. There are so many people who owe taxes and do not pay anything. Somebody who is at least making an effort is not likely to be harassed immediately. However, there are bankruptcy related reasons for filing your return on time. Tax debt may be dischargeable. However, there is an ambiguity regarding dischargeability if the return was not filed on time.
Section 523(a) of the Bankruptcy Code declares that tax liabilities are non-dischargeable if a Debtor fails to file a return. However, when the code was amended in 2005 the Congress saw fit to add an unnumbered paragraph to define the term “return”. It requires that a return satisfy applicable non-bankruptcy law including “applicable filing requirements”.
The effect of this language is far from clear and different judges have interpreted it differently. Judge Hoffman and Judge Boroff, who are the two Judges who sit in Worcester, have held that a late filed return does qualify as a return as it does serve a tax purpose under Massachusetts law. Judge Hillman, who sits in Boston, has come to the opposite conclusion. Interestingly enough, the IRS enforcement guidelines currently accept that late filed returns are dischargeable under Section 523(a), while the Massachusetts Department of Revenue is aggressively challenging discharges of late filed returns under Section 523(a).
Judge Hoffman’s decision upholding the dischargeability of late filed tax returns was appealed to the Bankruptcy Appellant Panel, which is the Bankruptcy appeals court and upheld. Judge Boroff’s decision upholding the dischargeability of late filed returns was appealed to the Federal District Court where Judge Young overturned Judge Boroff’s decision. Interestingly enough, the decisions of the Bankruptcy Appellant Panel and Judge Young were handed down within twenty-four (24) hours of each other and directly contradict each other. So the law remains in limbo. It is my understanding that these decisions are being appealed to the First Circuit Court of Appeals and we may get some finality, at least where cases in New England are concerned.
While we will most likely have much greater clarity of this issue in coming months, and certainly coming years, the fact of the matter is that this issue is not clear now. I have filed several bankruptcy petitions in recent months, where my clients have tax debt that is over three (3) years old and where the tax returns were filed more than two (2) years prior, but were late filed. I can only advise them that maybe their debt will be discharged. I advised them that I do not expect a problem from the IRS, although they may change their mind if the First Circuit Court of Appeals decides the other way. I have to advise them to expect a challenge from the Department of Revenue. Since most of my filings are in Worcester, I am hopeful that the judges will continue to rule in favor of discharge. If the decision should come down while the case is pending, they will be bound to rule against us. Similarly, if the Department of Revenue should appeal their decision in favor of us, then the case will still be pending when the Appeals Court renders its judgment. By far the safest course is to file your taxes on time, and try your best to deal with it. If you remain unable to pay, and if the government is unreasonable in fashioning a payment plan, there may be a bankruptcy option for you later.
The bottom line is that delaying filing until after the applicable deadline does not solve any problem, but it may create several severe problems including possibly rendering the debt non-dischareable in bankruptcy.