TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, November 19, 2018

Lesson From The Tax Court: Counting The Days

Tax Court (2017)As a young child I counted the days to Christmas starting December 1st, using advent calendars.  As I grew older, advertisements taught me that not all days were equal; one counted “shopping days” differently than calendar days.  As I now grow old, the Christmas season starts the day after Halloween, briefly tolled by days around Thanksgiving. 

Counting days is important in tax law, both for substance (e.g. figuring holding periods, allocating expenses between business days and personal days) and procedure (e.g. applying limitation periods).  Fortunately, how one counts days in tax has not changed much since I was a child.  So the lesson we find in last week’s case of Randy Richardson and Melisa Richardson v. Commissioner, T.C. Memo. 2018-189 (Nov. 13, 2018), should stick with us for a while. 

Richardson involves a married couple who filed a CDP petition contesting NFTLs filed against them.  Shortly after filing their CDP petition they filed a bankruptcy petition and received a discharge.  When the IRS denied CDP relief, the Richardsons sought Tax Court review, arguing that the IRS did not correctly account for the discharge they got in bankruptcy.  They ended up before Judge Lauber.  The resulting lesson is how counting days can be important to resolving the question of what taxes the IRS can later collect.  Even more important, it’s a lesson on when NOT to use CDP, but to instead request an “Equivalent Hearing.”  Details below the fold.  You can count on it.

Law: Discharge Rules

Debtors typically file bankruptcy to stop creditors and to discharge debts.  The date a debtor files a voluntary petition in bankruptcy is really important.  First, it starts the automatic stay, which stops creditors. §362.  Second, because the petition doubles as an order for relief, §301(b), it is a critical date to determine the discharge of certain debts.  In general, if a debtor has not committed any of the bad acts listed in §727(a), then §727(b) provides that the voluntary filing “discharges the debtor from all debts that arose before the date of the order for relief under this chapter.”

The reader needs to know two basic points about the scope of the bankruptcy discharge to understand this case.

First, notice the language “discharges the debtor.”  A bankruptcy discharge does not affect liens on property of the debtor that were perfected before the petition date.  Put another way, perfected liens ride through bankruptcy, allowing creditors may collect on such debts by seizing or foreclosing on the property “in rem.” Johnson v. Home State Bank, 501 U.S. 78, 82 (1991).

Second, the discharge rules for taxes in §523 work with the priority rules in §507.  Section 507 has rules for which tax claims get priority status in the payout line.  If a tax claim gets priority status, it will generally not be dischargeable either. 

Ken Weil, a prominent bankruptcy practitioner in Seattle, has a really neat way of summarizing this point by putting tax claims into three buckets.  He helped me think through today’s post (and if I continue to be in error, it’s not his fault).  In repayment for that kindness, I will shamelessly steal his idea and give it to you. 

Bucket 1: Claims for tax liabilities that are both priority and nondischargeable

Bucket 2: Claims for tax liabilities that are nonpriority but also nondischargeable

Bucket 3: Claims for tax liabilities that are both nonpriority and dischargeable.

Here is what goes into each bucket.

Bucket 1: The tax liabilities that go into Bucket 1 flow from §523(a)(1)(A), which prevents the discharge of taxes “of the kind and for the periods specified in section ... 507(a)(8) of this title.”  Section 507 is where the Bankruptcy Code sets out the priority of payment for unsecured claims against the debtor.  The eighth priority is for certain tax claims.  As relevant to today’s post, it provides for a priority position (and, hence, no discharge) for two types of tax liabilities. 

First are taxes “for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition.”  §507(a)(8)(A)(i).  Call that the 3-year lookback rule. 

Second are taxes actually assessed within the 240 days before the petition’s filing date.  §507(a)(8)(A)(ii).  Call that the 240 day lookback rule.  That period is then tolled “any time during which a stay of proceedings against collections” That provision also contains some tolling rule that apply in today’s case.

All of the lookback periods in Bucket 1 get tolled for the period of time when the IRS is prohibited from collecting the taxes, plus 90 days.  §507(a)(8)(flush language).  Yes, folks, that would be once a taxpayer files a CDP request. 

Bucket 2:  The tax liabilities that go into Bucket 2 are ones that do not qualify for priority status but may still be non-dischargeable under the rules in §523(a)(1)(B) and (C).  First, §523(a)(1)(B)(i) denies discharge for tax liabilities reported on returns actually filed in the two years before the petition date.  Call that the 2-year lookback rule.  Second, §523(a)(1)(B)(ii) denies a discharge for a tax for which a return is due but for which “a return was not filed.”  Call that the unlimited lookback rule.  Third, §523(a)(1)(C) denies a discharge for any tax for which the debtor made a fraudulent return or willfully tried in any other manner to evade a tax.  Call that the fraud rule.

The unlimited lookback rule is jicky [West Texas slang] because many courts make a bizarre reading of the Bankruptcy Code to hold that a late-filed return is an “unfiled return” for discharge purposes.  They base that conclusion on the definition of “return” that Congress put in §523(a)(flush language).  That language says that a return is a document that “satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).”  Since the due date is one of the applicable filing requirements, these courts reason, a late-filed return does not meet the definition of “return” and, hence, is no return at all.  Hey, presto, no discharge.  Even a return filed one day late is no "return" at all!  Here’s one example of that execrable reasoning: In re: Wendt, 512 B.R. 716 (Bankr. S.D. Fla. 2013):

“The Bankruptcy Code now explicitly requires that a “return,” for purposes of subsection 523(a), is one Section 6012(a)(1)(A) of the Internal Revenue Code requires any individual who has earned taxable income to file a federal income tax return. Section 6072 of the Internal Revenue Code provides that such return must be filed on or before April 15 following the close of the calendar year. A return filed after the applicable deadline does not satisfy the filing requirements of the Internal Revenue Code and thus cannot be considered a “return” for purposes of subsection 523(a). It is hard to imagine Congress intended any other result.”

Yes, you would be correct to think that pretty much eviscerates the 2-year rule!  Keith Fogg has an excellent discussion of this in Chapter 21 of “Effectively Representing Your Client Before the IRS” and has some really good blogs about it over on Proceduraly Taxing. Here's a good place to start.  And the Ninth Circuit Bankruptcy Appellate Panel wrote a really good take-down of courts that apply the “one-day-late” rule.  See In Re Martin, 542 B.R. 479 (2015)(9th Cir. BAP 2015)(hat tip to Ken Weil).  For my reasons why I think BAP opinions ought to be binding on all courts within a circuit, see Bryan T. Camp, Bound By the BAP: The Stare Decisis Effects of BAP Decisions, 34 San Diego L. Rev. 1643 (1997).   

Unfortunately, some circuits have adopted that one-day-late-and-it-is-not-a-return rule.  See In Re Mallo, 774 FR.3 1313 (10th Cir. 2014).  But not all. In Re Smith. 828 F.3d 1094 (9th Cir. 2016)(deciding issue on other grounds). 

Bucket 3: Liabilities that do not fit in Buckets 1 or 2.  In sum, a debtor may be personally discharged from tax liabilities that are nonpriority claims and do not fall within the 2-year lookback period or the unlimited period, the 3-year lookback period, or the unlimited period.  Notice that the 2-year lookback period relates to the actual filing date of a return while the 3-year period relates to the return’s due date or, if the taxpayer had requested an extension, to the extended due date. 

The above rules are all for taxes.  Pre-petition interest is discharged insofar as the tax it relates to is discharged.  Tax penalties are discharged if the tax to which they relate are discharged or if the event creating the penalty occurred more than three years before the bankruptcy petition date.  See In re Burns, 887 F.2d 1541 (8th Cir. 1989).

Now we can look at Mr. and Ms. Richardson’s situation to illustrate those rules and show how the Richardsons perhaps miscounted their days.

Facts.

This was a CDP case involving the question of whether the IRS could properly collect tax liabilities, including assessments for penalties and interest, for the four tax years 2009-2012.  Part of the taxpayer’s argument was that certain of those liabilities had been discharged by a bankruptcy, filed on 3/24/15.  Here is a summary of the years, liabilities and assessment dates of taxes and penalties.   Remember, the request for a CDP hearing was filed at the earliest sometime between January 2, 2015 and March 2, 2015 (the opinion does not say when but only that the CDP request was timely made after the IRS sent a CDP notice “in January”).  The bankruptcy petition was filed later, on March 24, 2015.

Year

Due Date

Return Filed

Tax Liability

Date Assessed

Amount

2009

4/15/10

1/23/12

Deficiency, additions, penalties, interest

12/01/14

$164,192

           

2010

4/18/11

1/23/12

Tax, additions, interest

05/07/12

$55,944

     

additions

06/17/13

$5,350

     

additions, interest

06/02/14

$6,247

     

additions

07/07/14

$32.099

     

Deficiency, penalties

12/01/14

$217,560

           

2011

4/18/12

1/31/13

Tax, additions, interest

09/30/13

$45,160

     

additions, interest

03/10/14

$  2,094

     

penalty, additions, int.

07/07/14

$26,318

     

Deficiency, penalties

12/15/14

$47,991

           

2012

4/15/13

2/24/14

Tax, additions, interest

03/24/14

$14,026

Lesson 1: Counting Right

2009 Taxes:  The Court found these non-dischargeable.  They are Bucket 1 taxes because of the 240 day lookback period, even without counting the tolling.  The assessment was on 12/1/14.  240 days forward from that is July 25, 2015.  So if these taxpayers had walked into your office (and had NOT asked for a CDP hearing) that is the date you would aim for in order to get these taxes out of Bucket 1 and into Bucket 3.  Ya gotta count the days.

2010 Taxes:  The Tax Court found some of the 2010 liabilities were non-dischargeable and decided further information was needed for the others.  I am not sure Judge Lauber properly counted the days. 

The non-dischargeable taxes are in Bucket 1.  As with the 2009 taxes, the $217,500 taxes and penalties assessed on 12/1/14 came within the 240-day lookback period. 

In addition, I think the tolling provisions in 507(a)(8)(flush language) would also make the penalty assessed on July 7, 2014, non-dischargeable (assuming a 150 day tolling period) because of the 240-day lookback period.  240 days from July 7, 2014 is March 4, 2015.  Add 150 days to that and you get August 1, 2015.  That’s the date to wait for.  Count the days.

Judge Lauber, however, decided that the penalty assessed on July 7, 2014 created an issue about the fraud exception.  If so, that's going to be a great issue to see play out.  The assessment was for a 6651(f) penalty, which is a penalty for fraudulent filing.  Note that penalty is not related to a fraudulent return.  It is related to a fraudulent filing.  So the three-year rule for filing a “fraudulent return” in §523(a)(1)(C) does not apply.  Instead, the issue is whether the bad act (filing) amounted to a willful intent to evade or defeat the tax.  Judge Lauber did not have enough information to decide, so he moved that part of the case forward on that issue.

But I don’t think he needed to do that if one applies the tolling rules in §507(a)(8)(flush language).  I could be wrong.  Wouldn't be the first time.

2011 Taxes: The Tax Court found these are not dischargeable.  So sad!  They fall into Bucket 1 because of the 3-year lookback and the 240 lookback periods.  Here is where the taxpayers really missed counting the days.  The due date of the 2011 return was April 18, 2012.  Three years later is April 18, 2015.  Assuming they did not file a CDP request before then, the 3-year lookback period would not apply after April 18, 2015.  And if the taxpayers had waited until August 12, 2015, then the 240 day lookback period would cease to apply to the liabilities assessed on December 15, 2014.

Thus, counting the days, the taxpayers here could have maximized their tax relief by waiting until after August 12, 2015.  Of course, even then if they have property that ride through bankruptcy, such as ERISA-qualified retirement plans, the NFTL would still be attached to that property. 

But here the taxpayers seemed to have panicked and, perhaps lured by the promise of Collection Delay Process, invoked their CDP rights.  That’s our second lesson.

Lesson 2: When NOT to Use CDP

I do not know why the taxpayers filed bankruptcy on March 24, 2015.  If they had come to you, dear reader, you would have urged them to wait until August 12, 2015 because that would get rid of more tax liabilities.  Of course, if they had come to you after requesting a CDP hearing, it would make no difference because now the various lookback periods would all be tolled, plus 90 days to boot. 

But if these taxpayers had come to you in response to the CDP notice and before filing a CDP request, you might have advised them to forgo the CDP hearing and gut it out for about four months to hit the August 12, 2015, bankruptcy date.  You could fend of the IRS collection machine, most likely, by filing a deliberately defective CDP request.  How?  Just file it a couple of days late.  That can get you what is called an Equivalent Hearing which gives you some of the same delay benefits of CDP.  It's not automatic.  Check the rules in IRM 5.1.9.3.2.2 (02-07-2014)("Equivalent Hearing (EH) and Timeliness of EH Requests").

Doing that might well have enabled your clients to wait until August to file the bankruptcy.

The potential downside here, however, is that if you go that route you forgo access to the Tax Court.  That may be important if you are in a jurisdiction that follows the one-day-late rule.  Notice that the IRS did not ask the Tax Court to apply the one-day-late rule here.  Nor did the Tax Court attempt to do so on its own.  That is because the Office of Chief Counsel, as best as I can see, adheres to the view that the one-day-late rule is a horrible misreading of the 2005 BAPCA modification to §523.  If you go to Bankruptcy Courts, however, you do not face IRS Chief Counsel attorneys.  You face DOJ Tax Division attorneys and they appear to have a different take.  Here, these taxpayers lived in Maryland so it is not clear what the Circuit rule would be. 

The bottom line, however, is that CDP is not an automatically good deal for taxpayers.  What you see in this case is that it tolls the applicable bankruptcy lookback periods and that makes it much more difficult to use bankruptcy to shake off old tax liabilities.  

Coda:  The 2012 taxes are all Bucket 1 liabilities as well.  Judge Lauber appears to believe, however, that the relevant dates for determining whether the 2011 and 2012 years fall within the 3-year lookback period are October 15th filing dates.  If the taxpayers had filed an extension for those years, that is correct because the 3-year lookback is keyed to the due date of the return and the statute modifies "due date" with the phrase "including extensions."  But if Judge Lauber is reading the §507(a)(8)(i) language “including extensions” as automatically applying, that is not correct.  The operative date in §507(a)(8)(i) is the “due date of the return” and only once a taxpayer obtains an extension does that due date change to October.  Minor error, if it is indeed error, because I do not think it affects the discharge analysis for those years.

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.

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Comments

I sent Bryan an email this morning, and, he asked me to post it here as a comment. I took issue with how he computed the dischargeability of penalties for the 2010 tax year. He also asked me to say when I thought the optimal time to file for 2010 was, assuming no CDP request. Here is my email with some additional editing.

------

I found your blog post this morning. Kudos for having such a fun, breezy writing style. Thanks for the vocabulary lesson and the nice mention.

I think we are still a bit out-of-phase on penalties. I agree that if the penalty is attached to a dischargeable tax then the penalty is also dischargeable. But, I find in practice it is really the three-year rule that grabs my attention, as the two rules are independent grounds for discharge. McKay v. United States, 957 F.2d 689 (9th Cir. 1992); Roberts v. United States (In re Roberts), 906 F.2d 1440 (10th Cir. 1990); and Burns v. United States (In re Burns), 887 F.2d 1541 (11th Cir. 1989). See also, United States v. Wilson, No. 15-1448, Docket Entry No. 10 (N.D. Cal. 2016) (tax year at issue 2008; petition filed 7/2012; 2008 return filed on extension; parties agreed FTP was discharged; held, FTF not discharged as the three-year date would have been 10/15/12) (opinion withdrawn). The parties settled, and, the opinion was withdrawn. I think the case is worthwhile as I think the district court got it right. The opinion is viewable on Pacer.

So, in Richardson, for 2010. I would say

Failure To File – three-year period starts running 4/15/11, dischargeable after 4/15/14

Failure To Pay - three-year period starts running from 4/15/11, dischargeable after 4/15/14

§ 6651(f) Fraud filing occurred 1/23/12; three-year period starts running from 1/23/12; and, dischargeable, regardless of when CDP hearing requested, after 1/23/15 as there is no CDP tolling provision in § 523.

For the tax, there are four different assessment dates (return filed late on 1/23/12 +2 1/23/14, so 2-year rule n/a here)

5/7/12 dischargeable after 4/15/14

6/7/13 dischargeable after 4/15/14

6/2/14 dischargeable after 1/28/15, which is 240 days from assessment

12/1/14 dischargeable after 7/29/15, which is 240 days from assessment

This means that, without a CDP hearing request, the optimal time to file would have been in August 2015. I am a great believer in putting some time between the first day it is ok to file and the actual filing date.

In counting time, I rely on In re Montgomery, 446 B.R. 475, 483 (Bankr. D. Kan. 2011), aff'd on other grounds, United States v. Montgomery (In re Montgomery), 475 B.R. 742 (D. Kan. 2012). Any day the IRS cannot act to collect is not counted as an applicable day. The bankruptcy court actually miscounted in Montgomery, but, it did not change the result. See Docket Entry No. 52 at In re Montgomery, Bankr. W.D. Kan. No. 10-20869.

Posted by: Ken Weil | Nov 21, 2018 2:49:20 PM