The following is a case update analyzing a case of recent interest.
In In re Shek, 947 F.3d 770 (11th Cir. 2020), issued January 23, 2020, the U.S. Court of Appeals for the Eleventh Circuit ruled that a late-filed tax return qualified as a return under 11 U.S.C. § 523(a)(1). Where all the other requirements for discharge were satisfied as stated in Section 523(a)(1), the tax debt could be discharged. This ruling disagreed with holdings by three other Courts of Appeal. Those courts held that a return which is filed late does not fall within the definition of “return” added to Section 523 by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”). To read the full decision, click here.
John Shek filed his 2008 Massachusetts tax return seven months late. He filed a Chapter 7 bankruptcy petition in Florida six years later. In the bankruptcy, he sued the Massachusetts Department of Revenue (“State”) and prevailed on his assertion that the taxes related to the late-filed return were discharged in the Chapter 7. On appeal, the district court affirmed, persuaded by the logic of the dissenting opinion in In re Fahey, 779 F.3d 1 (1st Cir. 2015). Appeal was taken by the State.
The State argued that the definition of “return” added to Section 523 by BAPCPA requires that a tax filing be timely under applicable law. This is because BAPCPA added a “hanging paragraph” to Section 523 which defines a return as “a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” The State argued that the deadline for filing a return is an “applicable filing requirement.” It noted that its view was adopted by the First, Fifth and Tenth Circuits.
The Eleventh Circuit did not find the arguments of the State persuasive. It elegantly applied rules of statutory construction to the State’s proposition. It found, based on the statements of the IRS in other appeals (the IRS was not a party in Shek), that requiring a return to be timely filed in order to be a return would have the effect of nearly writing out of existence Section 523(a)(1)(B)(ii). Prior to BAPCPA, that provision allowed taxes arising from late-filed returns to be discharged under particular conditions. The Eleventh Circuit quoted the IRS as saying that if a late return is not a “return” for purposes of Section 523(a), only a minute number of taxpayers whose returns are late could discharge those taxes. The Eleventh Circuit invoked the rule of construction that bars any interpretation of a statute that renders another portion of the statute “inoperative or superfluous, void or insignificant.”
The State alternatively argued that Massachusetts state law requires timely filing for a return to be a return. The Court easily dispensed with that argument by citing Massachusetts tax statutes that do not differentiate between a late or timely return. It concluded that timeliness is not a component of the definition of a return under Massachusetts law.
The opinion is striking in many ways. It parts company with three other circuits. Its logical structure is never strained. It makes a persuasive case that two of the other three circuits did not adequately weigh the fact that their rulings effectively neutered a provision of the Bankruptcy Code without Congress expressly revoking it, and that the third other circuit did not even recognize the conflict between the two provisions.
In re Smith, 828 F.3d 1094 (9th Cir. 2016), is the closest case on point in the Ninth Circuit. It disallowed the discharge of taxes arising from a late-filed return on the basis that the taxpayer had not made an honest and reasonable effort to comply with tax law. It did not squarely discuss if lateness alone made the taxes nondischargeable.
Shek may reopen the door to discharge for many tax debtors. Lateness can arise in many ways. There can be paralysis generated by having to file a return stating a large unpayable tax debt. Sometimes, the taxpayer lacks the records or skills needed to file the return timely. Often, the taxpayer relies on another person, including a CPA, business partner or spouse, to file the return that is not timely filed. Pure naivete or misunderstanding can lead to an untimely filing.
Note that taxes that are in any way tainted with dishonest conduct are not dischargeable. 11 U.S.C. § 523(a)(1)(c). Returning to the standard of tax debt discharge per the original Bankruptcy Code will not enable new forms of chicanery. Congress already policed that.
Interestingly, the court took pains in a footnote to thank Professor John Pottow of the University of Michigan Law School for his amicus brief which it said illuminated the issues and provided analysis that the court adopted.
It does not appear that Shek has been appealed to the U.S. Supreme Court based on the conflicts between the circuits. This may be because the State (which is located in the First Circuit) does not want to appeal the Eleventh Circuit’s decision in Shek and risk that the Supreme Court overturns the First Circuit’s decision in Fahey.
For additional information about the Ninth Circuit’s Smith decision, please click here to review John Tedford’s October 2016 e-Bulletin discussing Smith and courts’ differing interpretations of section 523(a)(1) and the hanging paragraph added by BAPCPA to the end of section 523(a).
These materials were written by Michael T. O’Halloran of the Law Office of Michael T. O’Halloran in San Diego (firstname.lastname@example.org). Editorial contributions were provided by John N. Tedford, IV, of Danning, Gill, Israel & Krasnoff, LLP, in Los Angeles (jtedford@DanningGill.com).