|The following is a case update written by John N. Tedford, IV, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent case of interest:|
In Berkovich v. California Franchise Tax Board (In re Berkovich), 15 F.4th 997 (9th Cir. 2021), the U.S. Court of Appeals for the Ninth Circuit (“Court”) held that when a debtor’s federal tax liability is adjusted and the debtor fails to report the adjustment to the California Franchise Tax Board, the additional tax owed to the state is nondischargeable.
To read the full published decision, click here.
Dennis Berkovich (“Debtor”) filed income tax returns with the State of California for the 2003, 2004,and 2005 tax years. Later, in 2008, the IRS assessed about $145,000 of additional federal income taxes for those years.
California Revenue and Taxation Code (“RTC”) section 18622(a) requires a taxpayer to make a “report” to the Franchise Tax Board (“FTB”) if the IRS changes the taxpayer’s federal income taxliability. Debtor, however, did not notify the FTB of the increased federal assessment.
As permitted by the Internal Revenue Code, the IRS notified the FTB of the adjustment to Debtor’s federal tax liability. The FTB assessed about $45,000 of additional state income taxes, plus penalties and interest.
In August 2012, Debtor and his wife filed a chapter 13 petition. They proposed a plan that treated the state tax debt as a general unsecured claim.
The plan was confirmed. Debtors made all required plan payments (less than $1,000 was paid to the FTB) and the bankruptcy court entered Debtors’ discharge.
Thereafter, the FTB filed a complaint asserting that the taxes were not discharged because Debtor had failed to make the report required by RTC section 18622(a). The bankruptcy court granted summary judgment in favor of the FTB.
In October 2020, the BAP published two decisions in appeals relating to reports given (or not given) to the FTB: In re Berkovich, 619 B.R. 397 (9th Cir. BAP 2020); and In re Sienega, 619 B.R. 405 (9th Cir.BAP 2020). In Berkovich, the BAP affirmed the bankruptcy court’s grant of summary judgment infavor of the FTB.
On further appeal, the Ninth Circuit affirmed the BAP and adopted the BAP’s opinion as its own,except for one footnote in the BAP’s opinion referring to the Sienega decision and how the two cases could be read together.
The Court began by noting that Debtors received their discharge under section 1328(a) of the Bankruptcy Code. A discharge under that section explicitly excludes the discharge of any debt of the kind specified in section 523(a)(1)(B).
Section 523(a)(1)(B) provides that a discharge does not discharge an individual debtor from any debt for a tax “with respect to which a return, or equivalent report or notice, if required – (i) was not filed or given.” In a “hanging paragraph” at the end of section 523(a), “return” is defined to mean “a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).”
Turning to applicable state law, the Court examined RTC section 18622 and a related regulation. Under RTC section 18622(a), a California taxpayer must report to the FTB each change or correction made by the IRS, or the results of a renegotiation, to any item required to be shown on a federal taxreturn. The report must be sufficiently detailed to allow the FTB to compute the resulting change inthe taxpayer’s liability to the state. RTC § 18622(c). Regulations promulgated by the state mandate that the taxpayer make the report. Cal. Code Regs. tit. 18, § 19059.
The question on appeal was whether the report required by RTC section 18622(a) is an “equivalent report or notice” within the meaning of section 523(a)(1)(B). The Court concluded that it is. In doing so, the Court agreed with the Fourth Circuit’s decision in Maryland v. Ciotti (In re Ciotti), 638 F.3d 276 (4th Cir. 2011), in which the court determined that a report required by a Maryland statute similar to RTC section 18622(a) was an “equivalent report or notice.”
Based on the plain language of the statutes, the Court had no problem concluding that Debtor’s additional state tax debt was nondischargeable. California law required him to make a report, he did not do so, and therefore the debt was not discharged.
The Court rejected Debtor’s argument that the report required by RTC section 18622(a) is not by definition a “return” and therefore is not an “equivalent report or notice.” The Court pointed out that BAPCPA amended section 523(a)(1)(B) to include equivalent reports and notices, and not just returns. The Court observed that if a “report” needed to meet the definition of “return,” that would render the phrase “equivalent report or notice” meaningless and superfluous. The Court therefore concluded that an “equivalent report or notice” must be something other than a “return.”
The Court also rejected Debtor’s argument that the forwarding of information by the IRS to the FTB constituted an amended “return” that satisfied section 523(a)(1)(B). Among other things, the Court pointed out that under California law the report must be given by the taxpayer.
As the Court noted, prior to BAPCPA, section 523(a)(1)(B) provided that a tax debt was not discharged if a required “return” was not filed. The fact that the statute expressly referred only to returns led to cases such as Blackwell v. Va. Dep’t of Taxation (In re Blackwell), 115 B.R. 86 (Bankr. W.D. Va. 1990), and Cal. Franchise Tax Bd. v. Jackson (In re Jackson), 184 F.3d 1046 (9th Cir. 1999). In Jackson, the IRS reassessed the debtors’ federal income tax liability for certain years, but the debtors did not report the increased federal assessments to the FTB. The FTB filed a claim in the debtors’ bankruptcy case based on the IRS reassessments. The court held that because submission of a report to the FTB is not the equivalent of the filing of a return (which the court described as “a formal statement on a required legal form showing taxable income, allowable deductions and exemptions and the computation of the tax due”), the tax was dischargeable.
In terms of legislative history, the phrase “or equivalent report or notice” first appeared in the Consumer Bankruptcy Reform Act of 1998 when it was reported out of the House Judiciary Committee on May 18, 1998. The committee’s report was customarily vague as to the reason the language was added. It is entirely possible that “equivalent report or notice” was added to address the exact fact pattern presented in Berkovich and to render taxes nondischargeable when a debtor fails to make a report required by state law upon an adjustment of his or her federal tax liability.
These materials were written by former ILC co-chair John N. Tedford, IV, of Danning, Gill, Israel & Krasnoff, LLP, in Los Angeles, California (jtedford@DanningGill.com). Editorial contributions wereprovided by Ed Hays of Marshack Hays LLP in Irvine, California (email@example.com).