Late Filed Tax Returns: Are They Dischargeable?

Filing a tax return late is forever a risky proposition. However, when one is planning to file for bankruptcy, it is even riskier. Most tax debts are not dischargeable in bankruptcy, but there are exceptions. However, if a return is filed late, the dischargeability of the debt on that return may go up in smoke. The position of the IRS on these debts is complex.

What Is A Return?

If a tax return for a certain year is not filed, any tax debts from that year are not dischargeable. This is not negotiable. However, the Two-Year Rule, found at 11 U.S.C. §523 (a)(1)(B)(ii), states that if the return for that year was filed up to two years late, the taxes due on it are still dischargeable. This leads to considerable debate about what a “return” is, given that the IRS puts out several forms which are accepted as filings, not only the standard 1040.

In 2005, however, Congress sought to clear the record. The Bankruptcy Abuse Protection & Consumer Protection Act (BAPCPA) added what is referred to as the “hanging paragraph” at the end of 11 U.S.C. §523. It states that a return is an appropriate tax form that “satisfies the requirements of applicable non-bankruptcy law (including applicable filing requirements).” This is an issue for debtors, because applicable non-bankruptcy law states that tax returns must be filed before April 15 (or October 15, with extensions). Thus, many courts have held that for dischargeability purposes, late tax returns do not count as true ‘returns.’

The Loophole

Despite this dogmatic ruling, the IRS does not always follow this path. The general rule seems to be that if a Notice of Delinquency has been issued, and they must make an estimate or official assessment on it, then the window for the debt to be dischargeable has passed. If the IRS has to devote time and effort to your case, your debts will likely be deemed non-dischargeable. This is largely because if enough time has passed that a Notice of Delinquency has been sent, good faith on the part of the taxpayer can no longer be presumed.

There is, despite the fairly extensive discussion of the hanging paragraph at the federal level, surprisingly little jurisprudence about whether New York tax law applies. In theory, the state will follow the federal lead, but they are not required to do so. It would be wise not to assume, and simply make certain to get one’s tax return in to the IRS in a timely manner.

There is an alternative provision in federal tax law that gives an alternative method of filing a return, found in the I.R.S. Code. 26 U.S.C. §6020 provides for what is referred to as involuntary assessment, or ‘substitute for return.’ Basically, a taxpayer states that they cannot file a return, but they can provide sufficient information for the IRS to draw one up. This will still count as a return for purposes of dischargeability if it is filed on time, and some may have better luck with this method than mailing in a return.

Enlist An Attorney To Help

Further case law regarding the dischargeability of tax debts in New York will have to come later. In the meantime, it is best to consult an expert for all your bankruptcy and tax needs. The professionals at the Law Offices of Stephen B. Kass, P.C. work hard to give clients the successes they deserve. Contact our Manhattan office for a consultation today.