Monthly Archives: December 2014

Is A Late-Filed Tax Form A “Tax Return” For Dischargeability In Bankruptcy?

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Is an untimely 1040 Form, filed after the Internal Revenue Service has assessed a tax liability, a tax return for the purpose of the exceptions to discharge in § 523(a)(1)(B)(i) of the Bankruptcy Code?  This was the question that the Tenth Circuit Court of Appeals recently decided in the case of In Re Mallo, decided on December 29, 2014  (Appeal from the United States District Court for the District of Colorado, (D.C. Nos. 1:13-CV-00098-LTB and 1:12-CV-03380-LTB).

The case was actually a consolidated appeal from two cases, In Re Mallo and In Re Martin.  The appeal came out of Colorado.  The background to the cases involved situations where bankruptcy debtors had not filed tax returns for certain years.  Edson Mallo and Liana Mallo did not file timely federal income tax returns for 2000 and 2001 as required by the Internal Revenue Code. As a result, the IRS issued statutory notices of deficiency pursuant to 26 U.S.C. §§ 6212 and 6213 for those years. The Mallos did not challenge those determinations.

The Internal Revenue Service assessed taxes, including penalties and interest, against the Mallos for various years of delinquencies.  The IRS began collection efforts in 2006.  In 2007 the Mallos filed additional returns for past due years.  The other appellant, Martin, had a similar history of delinquent returns.  The IRS tried to make collection efforts against him as well.

The Mallos later filed a Chapter 13 bankruptcy case, which was eventually converted to a Chapter 7 case.  They filed an adversary action against the IRS, seeking a determination that the income tax debts had been discharged.  The IRS filed a motion for summary judgment in the case, claiming that because the Mallos had not filed a tax return for certain years at issue, the tax debts should not be discharged.  The bankruptcy court agreed with the IRS and granted the motion.  The Mallos appealed.

Mr. Martin, the other appellant, received a different result.  He also filed an adversary action against the IRS seeking a determination that certain income tax debts were discharged.  In his case, a bankruptcy court found that his delinquent filed Form 1040 did, in fact, qualify as a tax return.  Thus, his tax debts were found to be discharged.  The IRS appealed.  Both the Martin case and the Mallo case were thus consolidated.

The Court of Appeals thus had to decide what actually constitutes a “tax return” for the purposes of dischargeability under Section 523.  The Court found that:

The hanging paragraph [of Section 523] defines “return” as “a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” Id. § 523(a)(*). It then explains which tax forms prepared under § 6020 of the Bankruptcy Code fall within that definition. Thus, the plain language of the statute requires us to consult nonbankruptcy law, including any applicable filing requirements, in determining whether the tardy tax forms filed by the Mallos and Mr. Martin are returns for purposes of discharge.

The Court reviewed some decisions of other circuits on this issue.  What was important to the Court was the idea that filing requirements for tax returns included “deadlines.”  And because the applicable filing requirements include filing deadlines, § 523(a)(*) plainly excluded late-filed Form 1040s from the definition of a return.  In other words, a delinquent Form 1040 did not constitute a “return” for the purposes of Section 523(a)(*).  An untimely filed tax form cannot constitute a “tax return” for the purposes of dischargeability in bankruptcy.  Why?  Because a due date is an applicable filing requirement.  Missing the due date means that a taxpayer has missed a filing requirement.  In sum, the Court stated:

Having considered and rejected the arguments advanced by Taxpayers and the Commissioner, we agree with the Fifth Circuit’s decision in McCoy that the plain and unambiguous language of § 523(a) excludes from the definition of “return” all late-filed tax forms, except those prepared with the assistance of the IRS under § 6020(a).

The ruling of the Court makes sense from a policy perspective as well.  If taxpayers simply file random forms out of time, without requesting extensions, then a burden would be placed on the IRS with regards to what is or is not a “return.”  The lesson here is clear, and has been said before:  always file your tax returns in a timely fashion, even if you cannot pay the tax.  Unexpected adverse consequences can happen when returns are not filed.

Read More:  Domestic Support And Child Support Obligations In Bankruptcy

A Lease Or A Secured Loan: Economic Realities Matter, Not Words

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A common tactic of creditors in bankruptcy litigation is the attempt to characterize the nature of their debt in a way that is the most favorable for them.  It is almost a version of the philosopher Gottfried Leibniz’s old phrase “the best of all possible worlds”:  whatever characterization produces the most favorable outcome, that is generally what the creditor will choose.  We have seen, for example, loan contracts (drafted by creditors) that basically contain enough contract provisions that they can claim to be nearly anything:  a secured loans, a trust agreement, a purchase money security agreement, or a lease.

Such issues have arisen in the context of the issuance of money orders (a trust agreement or a security agreement?) by businesses or “floor plan” arrangements for used auto sales (is it a trust agreement or a secured loan?)  When such contracts are eventually brought before a court during litigation in an adversary proceeding or some other bankruptcy-related proceeding, a creditor may point to any number of various (and sometimes conflicting) contract provisions to try to claim that its debt is somehow “special.”

Not surprisingly, courts will often look past such verbiage to examine the actual nature of the transaction between the parties.  In bankruptcy court, it doesn’t matter what you call it, what matters is the underlying nature of the transaction.  This issue arose recently in a Kansas case in the context of a vehicle contract for the use of a debtor’s car.  The financing company claimed the arrangement was a lease.  The debtor (In Re James, case no. 12-23121, decided in the District of Kansas in November 2014) claimed the arrangement was a de facto secured loan.

Judge Robert Berger, who issued the decision, pointed to the Supreme Court case of Butner v. United States, 440 U.S. 48, 54-55 (1979) for the proposition that property right questions must generally focus on state law.  Following this logic, the Court focused on K.S.A. §84-1-103, which holds that the economic realities of a transaction must be the primary factors in interpreting its essence.  In other words, it doesn’t matter what a party calls something; what matters is the actual nature of the transaction (the “economic realities”) that matters.  Looking at the fine print of the contract, the Court noted that the “lease” agreement actually gave the debtors the option to become the owners of the goods for no additional consideration.

In addition, the vehicle contract did not give the debtors the option to terminate it, which is supposed to be one of the main features of a true “lease.”  Actually, there was a “cancellation” provision in the contract, but it required the debtors to pay the remaining balance due.  For this reason, the cancellation provision was a creditor ruse.  “Early termination” of the lease was an illusion.  Because the so-called “lease” gave the debtors no rational option but to continue making payments until completion of the contract, it was not a true “lease.”  The Court found it to be a security interest, and would treat it as such within the debtor’s Chapter 13 plan. Although the car loan could not be crammed down, the terms of the contract could still be modified somewhat in the Chapter 13 plan (interest rate lowered, different payment terms, etc.).

The James decision highlights a tactic frequently used by creditors:  fill a contract with fine print that has features of nearly any scenario that might arise.  As stated above, we have seen creditors attempt to characterize ordinary, garden-variety commercial loans as priority trust agreements (deserving special treatment), as statutory trusts, as security agreements, as leases, or as other things.  The tactic is also used frequently by payday loan establishments in possession of debtors’ checks.

It is becoming more and more common for large institutional creditors to take advantage of their size and unequal bargaining power to compel debtors to sign agreements that may not be what they appear to be.  The practice also is found in business situations and commercial loans.  Fortunately, the rule here is clear:  it doesn’t matter what a creditor says a contract is; what matters is what the economic realities of the transaction are.  If you have been saddled with a contract or agreement that a creditor claims to be one thing or another, it is critical to get independent legal advice.  Very often, you may have more rights than you think you have.

Read More:  Bankruptcy Debtors Can’t Be Discriminated Against