Behind on Your Taxes? New Court Ruling May Help Taxpayers Discharge Older IRS Debts

New court ruling offers hope for those with old tax debts

Image Source: Flickr User 401(K) 2012

A recent ruling in Tennessee offers good news for bankruptcy filers struggling with income taxes. The accepted practice when it comes to discharging back tax debts in a bankruptcy case is that income tax returns must have been filed on time in order for the taxes to be eligible for bankruptcy discharge. But a new bankruptcy case has shaken up this long-held notion—and it could be a great thing for bankruptcy filers if this ruling takes hold in other bankruptcy districts.

What is an Income Tax Return Under Bankruptcy Law?

Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act (BACPA) of 2005, tax debt was usually excluded from bankruptcy discharge if the return was “not filed or given” (i.e. filed on time). Language added to the code said a tax return “must satisfy the requirements of applicable nonbankruptcy law and be filed in accordance with applicable filing requirements.”

After passage of the BACPA, bankruptcy courts have judged debtors harshly on late tax returns. In most cases in which the IRS has filed a “substitute return” because the consumer failed to file a return and/or the consumer filed their taxes late, the court will reject the discharge of debt. That’s what happened to James and Pamela Biggers in their recent bankruptcy case.

How the Biggers Ruling Could Drastically Change Things for the Better

The recent bankruptcy case in Tennessee involved a couple that had not filed their tax returns for several years. The IRS calculated substitute returns which over-assessed taxes for most years. The Biggers filed returns. although late, which lowered their tax obligations for all but one year in which their return showed higher taxes than the IRS calculated.

The couple then filed for Chapter 7 bankruptcy and asked that the older tax debts be discharged. The bankruptcy court ruled that the tax debts were not dischargeable because it determined the Biggers’ returns were not returns under BACPA standards. The court ruled in favor of the IRS, but the Biggers appealed the ruling and the circuit court flipped on the lower court ruling.

Fourth Circuit Applied the Beard Test

For income taxes to be eligible for discharge in a bankruptcy case, prior to the BACPA, the “Beard” test was the rule of thumb—it was so named for a precedent-setting bankruptcy case. It’s a four-pronged test which includes:

• The return must claim to be a return (that sounds strange, but it’s the law).
• The return must have been filed understanding the penalty of perjury applied.
• The return must provide enough data for the income tax to be calculated.
• The return must be “honest and reasonable” in its intent to meet tax law.

The issue that was critical to the Biggers’ case was the last point of the test. The rationale behind the reversal of the lower court ruling was that if the IRS accepts late-filed returns, which it does, then why shouldn’t the bankruptcy court? The court found that the Biggers’ tax returns filed after the substitute returns were an honest attempt to comply with tax law.

What Does This Mean for You?

North Carolina is not part of the circuit where this ruling took place—it was in the Sixth Circuit, which includes Tennessee, Kentucky, Ohio and Michigan. That means it does not automatically apply to cases in North Carolina, which is part of the Fourth Circuit. The good news is that our circuit could choose to apply it to bankrutcy cases related to late-filed tax returns, and it could become case law in our state as well. 

Do You have Back Taxes You Can’t Afford to Pay?

Chapter 7 bankruptcy can help discharge back taxes, and Chapter 13 bankruptcy can buy you additional time to pay tax debts off over time. To find out more about North Carolina bankruptcy, contact the Law Offices of John T. Orcutt. Call +1-833-627-0115 now for a free NC bankruptcy consultation at one of our convenient locations in Raleigh, Durham, Fayetteville, Wilson, Greensboro or Wilmington.