The recent case of Hugger v. Warfield (In re Hugger), 2019 WL 1594017 (9th Cir. BAP Apr. 5, 2019)(not officially published for citation)(http://cdn.ca9.uscourts.gov/datastore/bap/2019/04/08/Hugger%20-%20Memorandum%2018-1003.pdf), U.S. Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) in an Appeal from the United States Bankruptcy Court for the District of Arizona, illustrates mathematically one of the harshest outcomes to occur when seeking tax debt relief. A debtor sought to discharge $40,000 in tax debt through a chapter 7 bankruptcy. The amount of non-tax debt totaled $569.
As is not untypical, the taxpayer in this case filed late tax returns for 2001, 2002, 2005, 2006, 2009, 2010, and 2012, all in September 2015. Under the bankruptcy discharge of taxes rules, the tax year due date must be at least three years old at the time of at the time of filing the return and as to this, all years qualified except for 2012. The second requirement is that at the time of filing the bankruptcy case, the tax filing date must have been at least two years old.
The September 2015 tax return filing date indicates that September 2017 would have normally been the earliest date that bankruptcy should have been filed. A decent temporal safety factor might have even been added, depending upon potential tolling activity after all taxpayer records were searched and analyzed. Even with no indicated tolling it would have probably have been better to file the bankruptcy October 2017 or later.
Debtors can face significant pressure and financial pain before taking action. However, a bankruptcy filing has significant negative effects and is not easy to undo, and in some cases is impossible to undo. Any bankruptcy filing that is dominated by a desire for tax debt relief should be investigated thoroughly to avoid the type of result that In re Hugger exemplifies.
The In re Hugger debtor filed a chapter 7 bankruptcy case on January 9, 2017, at least 9 months too early (even without tolling). On May 9, 2017, the U.S. Bankruptcy Court for the District of Arizona entered the Debtor’s discharge, and the bankruptcy case was closed a few days later. By September 2017 it was realized that the bankruptcy was filed too early and the debtor began action to re-open the case, undo the discharge, and ask that the bankruptcy case to be dismissed so that taxpayer could have a later “do over,” so to speak.
Requesting and receiving a chapter 7 case withdrawal of discharge followed by a dismissal is not as easily done as in a chapter 13 case. The main standard to be met is that the actions must be shown to benefit, and not harm the creditors. In this case the creditor was the United States. The premature bankruptcy filing benefited the United States, and to allow an unwind would be prejudicial to the creditor interests. Both the bankruptcy court and the BAP denied withdrawal of the discharge and dismissal of the case. The bankruptcy filing and discharge (which did not discharge the tax debt) stands.
Some factors to consider from this case are:
(1) The bankruptcy filing date was so premature that it may be likely that the statute of limitation rules were not understood.
(2) Even if the taxpayer was facing a garnishment, putting up with 9 or more months of garnishment would have been preferable to tossing away the right to discharge the balance.
(3) As in (2) above, any motivation to take quick, thoughtless action should be avoided. Tax debt based bankruptcy filings should be well thought out, carefully prepared, and absolutely complete.
(4) Another reason for a well thought out filing is to make as certain as possible that bankruptcy judges will have no reason to rule against the debtor. Where the IRS insolvency unit indicates that they will oppose a tax debt discharge, the court requires an adversary proceeding by the debtor. Getting IRS insolvency unit assent might encourage debtor’s counsel to forego an adversary proceeding (which still might be risky for the debtor).
(5) It is typical for IRS to simply determine nondischargeability of part or all of the tax debt, and then sit by while a debtor omits having an adversary, then once discharge and case closing occurs, simply re-start collection activities. This is somewhat of a trap as it forces a debtor to either accept the failure, or try and fix it, by re-opening the case for the purpose of filing an adversary proceeding that perhaps should have been filed to begin with.
(6) Where tax debt is greater than fifty percent of all debt (as it was in this case) the means test is not necessary. This might facilitate haste in filing rather than increase the quality of information in the schedules.
Aside from the limitation periods and tolling, the case of Ilko v. California State Board of Equalization (In re Ilko) 651 F.3d 1049 (9th Cir. 2011) (http://cdn.ca9.uscourts.gov/datastore/opinions/2011/06/27/09-60049.pdf) is instructive of dischargeability of derivative taxation before assessment. In Ilko, bankruptcy was filed based upon a contingent debt under California’s Rev. & Tax Code 6829. Debtor believed that a bankruptcy filing based upon a contingent (possible future) secondary debt would result in discharge.
The thought may have been to simply “list” potential creditors for contingent debts in the hope of getting an advance discharge. This case emphasizes that by contrast tax debt cannot be discharged in bankruptcy before it is assessed. What it means is that assuming a tax debt that meets the 3-year, 2-year, and 240 day rule in bankruptcy, that future assessments for that year are not dischargeable.
Thus, a taxpayer making it past the 3 year assessment statute, knowing that some fraudulent amounts have been omitted from the return, may have the added amounts assessed, and they will be nondischargeable unless a further bankruptcy filing occurs more than 240 days after the assessment. So, a bankruptcy filing at year 3.5 followed by later assessed debts based upon fraud will not discharge for at least 240 days after the assessment. So, the timing for filing bankruptcy within any limitations period should always consider the possibility of unassessed (or not yet assessed) tax debt liability potential.
For any later assessment, the prohibition on bankruptcy re-filing will provide an additional obstacle as there are time limits for filing a further bankruptcy that depending upon which chapters were chosen for the first and subsequent bankruptcies. Failure of discharge of tax is more often followed by an offer in compromise if there is a genuine inability to pay, rather than a second bankruptcy. Of course, most secondary assessments are based upon some sort of finding of “responsible person” liability so at least there may be some ability to avoid an assessment on that basis before considering bankruptcy, offers in compromise, etc.
Tax Debt Approach 