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Bankruptcy Courts Becoming Less Forgiving of Late Tax Returns

It’s not a phenomenon that’s affected people filing New York bankruptcy yet, but it might become one in the not-so-distant future: Some federal courts in other states are ruling that tax debts that would otherwise be dischargeable are in fact not.

Here’s the background. Typically, discharging a tax debt requires the debtor to meet three rules: the three-year rule, the two-year rule, and the 240-day rule, which are divided between Sections 507 and 523 of the Bankruptcy Code. Here’s what they mean.

Three-year rule: The taxes must be due no fewer than three years before the bankruptcy filing plus extensions.

Two-year rule: The debtor must have filed a tax return including the tax debt no fewer than two years before the bankruptcy petition.

240-day rule: The tax debt must have been assessed, if ever, at least 240 days before the bankruptcy. Usually this occurs promptly after the return is filed, but if the IRS audits the debtor subsequently or disputes the tax return, then the clock for this rule is reset.

Recently, the U.S. Court of Appeals for the First Circuit, which covers most of New England and Puerto Rico, held that late tax returns do not fit these requirements. This is because the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 created what’s called a “hanging paragraph” in Section 523 (written as “523(a)(*)”), which states that a tax return “satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” The “filing requirements,” the First Circuit held, includes the filing deadline. So now, even if one’s taxes are filed so much as a day late, no matter how ancient they are, are nondischargeable in bankruptcy.

A few other circuits have adopted similar interpretations of the Bankruptcy Code, the Fifth Circuit (broadly, Texas to Mississippi) and the Tenth Circuit (the interior southwest, e.g. Colorado and New Mexico). On the other hand, the Eighth Circuit (Minnesota down to Missouri) has ruled in favor of debtors. The good news for New Yorkers is that the Second Circuit has not yet heard a case along these lines. That means that New Yorkers facing bankruptcy need not worry that a late return will cost them a discharge. However, that may change in the future.

Ultimately, the issue can only be resolved if the U.S. Supreme Court tries to reconcile the split among the circuit courts, or if Congress changes the Bankruptcy Code.

The First Circuit’s opinion in Fahey v. Massachusetts Dept. of Revenue can be found here (pdf).

As always, even if you cannot pay it, it is crucial to file your tax return on time or ask for an extension.

Due to the complex rules surrounding them, tax debts can make a New York bankruptcy more difficult than more conventional cases. An experienced New York bankruptcy attorney can help advise you so your tax debts are discharged.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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