Business Law

Berkovich v. California Franchise Tax Board (In re Berkovich), 15 F.4th 997 (9th Cir. 2021)

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:

SUMMARY

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 (‚ÄúCourt‚ÄĚ) held that when a debtor‚Äôs 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.

FACTS

Dennis¬†Berkovich¬†(‚ÄúDebtor‚ÄĚ) 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 (‚ÄúRTC‚ÄĚ) section 18622(a)¬†requires a¬†taxpayer to make a ‚Äúreport‚ÄĚ to the¬†Franchise¬†Tax¬†Board¬†(‚ÄúFTB‚ÄĚ) if the IRS changes the¬†taxpayer‚Äôs 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.
REASONING

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¬†‚Äúwith¬†respect to which a¬†return,¬†or equivalent¬†report or notice,¬†if¬†required ‚Äď (i) was not filed or given.‚Ä̬†In¬†a ‚Äúhanging paragraph‚ÄĚ at the end of section 523(a),¬†‚Äúreturn‚ÄĚ is defined to mean ‚Äúa¬†return that satisfies the¬†requirements of applicable nonbankruptcy law (including applicable filing¬†requirements).‚ÄĚ

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 ‚Äúequivalent¬†report or notice‚ÄĚ 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‚Äôs 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 ‚Äúequivalent¬†report or notice.‚ÄĚ

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‚Äôs argument that the¬†report¬†required by RTC section 18622(a) is not by definition a ‚Äúreturn‚ÄĚ and therefore¬†is not an ‚Äúequivalent¬†report or notice.‚ÄĚ 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 ‚Äúreport‚ÄĚ needed to meet the definition of ‚Äúreturn,‚ÄĚ that would¬†render the phrase ‚Äúequivalent¬†report or notice‚ÄĚ meaningless and superfluous. The Court therefore concluded that an ‚Äúequivalent¬†report or notice‚ÄĚ must be something other than a ‚Äúreturn.‚ÄĚ

The Court also¬†rejected Debtor‚Äôs argument that the forwarding of¬†information by the IRS to the FTB constituted an amended ‚Äúreturn‚ÄĚ 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.

AUTHOR’S COMMENTS

As the Court noted,¬†prior to BAPCPA,¬†section 523(a)(1)(B) provided that a¬†tax¬†debt was not discharged if a¬†required ‚Äúreturn‚ÄĚ was not filed. The fact that the statute expressly¬†referred only to¬†returns led to cases such as¬†Blackwell¬†v.¬†Va. Dep‚Äôt 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‚Äô 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‚Äô 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 ‚Äúa formal statement on a¬†required legal form showing¬†taxable¬†income,¬†allowable deductions and exemptions and the computation of the¬†tax¬†due‚ÄĚ),¬†the¬†tax¬†was dischargeable.¬†

In¬†terms of legislative history,¬†the phrase ‚Äúor equivalent¬†report or notice‚ÄĚ 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‚Äôs¬†report was customarily vague as to the¬†reason the language was added. It is entirely possible that ‚Äúequivalent¬†report or notice‚ÄĚ 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 (ehays@marshackhays.com).

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