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PROCRASTINATION AND PENURY: FOR BANKRUPT TAX RETURNS, BETTER LATE THAN NEVER

March 28, 2005

As you gather those 1099s, contribution receipts and other tax data up, you are not only doing your civic duty and staying out of trouble with the IRS. You are also making prudent preparations for a bankruptcy filing.

No, doing your tax return isn't going to make you broke (but failing to do so might). But if you do file bankruptcy - and we really hope you never have to - tax debts that are over two years old may be discharged if they were reported on a tax return.

In Iowa and several neighboring states, this 2-year deal even works for late returns, according to a court decision handed down Friday.
The Bankruptcy Appelate Panel for the Eighth Circuit, which covers Iowa, Minnesota, Arkansas, Nebraska, Missouri and the Dakotas, ruled in favor of a bankrupt taxpayer who had gotten several years behind in filing tax returns.

Gary Wayne Colsen failed to file tax returns for 1992 through 1996. By 1998 the IRS had caught up with him, assessing taxes for 1992 through 1995. In October 1999 Mr. Colsen finally filed all of his returns for 1992 through 1996, getting refunds of some of the taxes originally assessed. In February 2003, Mr. Colsen filed for Chapter 7 bankruptcy.

WHEN CAN TAXES BE DISCHARGED IN BANKRUPTCY?

The bankruptcy law has rules to prevent the use of Chapter 7 as a tax planning tool. Taxes can't be discharged, for example, if a return has never been filed, or if a late return was filed within two years of bankruptcy. The IRS argued that Mr. Colsen's late filings didn't count as "returns" because they had already assessed Mr. Colsen's taxes without returns for 1992-1995. The IRS said the filings were merely administrative refund claims. The Bankruptcy Appelate Panel disagreed:

This result is consistent with a plain reading of
the statutory language which does not contain any
modifiers for the term “return.” It is likewise
consistent with the Supreme Court’s use and
interpretation of the phrase “honest” in connection
with what constitutes a tax return. Additionally, this
result is consistent with the Bankruptcy Code’s intent
with respect to taxes: taxes should not be discharged
unless the taxing authority has had an opportunity to
collect them. The time limitations in the Bankruptcy
Code relating to taxes are designed to ensure that
taxing authorities have the opportunity to collect
taxes before any discharge in bankruptcy... In the
instant case the Internal Revenue Service had an
opportunity to collect the Debtor’s income tax
liabilities for tax years 1992 through 1996.

CONFLICT WITH SIXTH CIRCUIT?

The Sixth Circuit apparently holds that no post-assessment return can qualify for bankruptcy discharge. The Eighth Circuit specifically disagreed with that rule. For the moment, the Eighth Circuit is the place for "better late than never" bankruptcy filings.

Cite: Gary Wayne Colsen, Debtor, v. United States, No. 04-6042 NI

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