Beyond bankruptcy attorneys, most people aren’t aware of what actually can be discharged in bankruptcy. Perhaps because the topic of bankruptcy itself is taboo, and many of those who engage in discharging their debts are unnecessarily ashamed. That same unnecessary shame accompanies most debt relief mechanisms—including IRS debt resolution. People do not talk about how they got their debt to disappear, and while I have my theories as to why, I am not a sociologist. Regardless as to why, lack of conversation, naturally, leads to lack of understanding and lack of definitive terms. Lack of definitive terms leads to exposure, and that exposure is exactly what happened when tax debt collided with the undefined and esoteric Title 11 of the United States Code—also known as the Bankruptcy Code.
If you have ever read a legal document, you have likely seen a “Definitions” section. Even we lawyers skip over that definition section until we need it. We know what words mean, right? I thought so until I understood the gravity of a case known as In re McCoy (McCoy vs. Mississippi State Tax Commission). Now I know it is ever more apparent that even the smallest of words must be defined to carry out what is meant to be.
Understanding McCoy vs. Mississippi State Tax Commission
Prior to McCoy vs. Mississippi State Tax Commission, the ability to discharge a tax debt in bankruptcy, more often than not, was a slam dunk. You had to look at two things: (1) Did the tax debt in question meet the time period requirement prescribed by law (which I will not outline because it is not fun)?; AND (2) Is the return valid? First of all, to determine if something is “valid,” we must determine what that something is. Here, that undefined something was the term “tax return.”
Believe it or not, the Internal Revenue Code and the bankruptcy code do not define “tax return.” The courts used the age-old “Beard Test” to determine if a stack of papers was, in fact, a valid tax return for purposes of bankruptcy discharge, so long as the time limitation test was met. The Beard Test is all about good faith. In simple terms, the Beard Test asks: Does this piece of paper purport to be a tax return? Is said tax return declared under penalties of perjury (i.e. – is the return signed)? Is the calculation of the tax proper? Lastly, did the taxpayer, in good faith, make a reasonable attempt to satisfy tax law? Basically, did you put the right numbers on the right paper with the right people preparing it with the right signature on the right signature line, and were you a good citizen in doing it? Yes. It is not a hard standard to meet.
Then, in 2008, Judge Easterbrook of the Seventh Circuit Court of Appeals made a passing comment in a dissenting opinion that took our fragile debt resolution world, threw it against a brick wall and shattered all that we knew about tax debt and bankruptcy. Good faith was thrown against the wall with it.
As such, circumstances do not matter anymore. There is no debate allowed when it comes to the definition of the term “tax return.” In today’s world, if you file a tax return one minute late, it is now no longer dischargeable in bankruptcy. This is because if it is late, it is not considered a “tax return,” and if it is not a “tax return,” it cannot be a “valid tax return” in the eyes of the bankruptcy courts. Yes, you read that right. It is mind-boggling. It is especially mind-boggling because the bankruptcy courts will render it invalid for discharge, but the IRS will still render it as valid in order to collect upon it.
The Result of McCoy vs. Mississippi State Tax Commission
Now we know one thing for sure: Most courts now hold that tax debt which originates from late filed returns will not be considered for discharge in a bankruptcy. Don’t get me wrong, the bankruptcy filing itself puts an automatic stay on any collection, including IRS collection. No one can come after you for anything without the court’s permission; but that automatic stay of collection is now a mere child-size bandage on a gaping, bleeding wound. After the conclusion of the bankruptcy, debt from the late-filed tax return still exists, and it must be resolved.
The gist? Those involved in bankruptcy with tax debt must adjust expectations—everything will not be fixed after the discharge of debt. After discharge, hiring a tax attorney or CPA who focuses solely on IRS defense or tax debt resolution to finish the cleanup is imperative. Note that “who focuses solely” is italicized for a reason: IRS defense/taxpayer defense is not something that most CPAs or attorneys practice—it’s a niche facet of the law.
Just to sum things up: If you file your tax return late, it will not be dischargeable in bankruptcy. After the conclusion of the bankruptcy, you must hire a tax professional who focuses solely on tax debt resolution (after all, I doubt any of us would hire a plastic surgeon to perform a triple bypass, right?). The bankruptcy becomes merely the first stop, and that is no fault of the bankruptcy attorney. Instead, blame the guys who wrote the codes and assumed that we all had the same definition of the term, “tax return.”
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.