ABI COMMISSION HEARING

1. ABI COMMISSION HEARING 2013 SABA/NAAG BANKRUPTCY CONFERENCE SANTA FE, NEW MEXICO, TAXES Tuesday, October 8, 2013, 1:30PM – 5:30PM Allen Rosenberg Massachusetts Department of Revenue P.O. Box 9564 Boston MA 02114 (617) 626-3874 E-Mail: rosenberg@dor.state.ma.us Disclaimer: The opinions set forth herein are those of the author and are not necessarily the official opinions of the Massachusetts Department of Revenue.

2. LATE FILED RETURN ISSUE BACKGROUND Unnumbered paragraph added as part of BAPCPA in 2005 after Section 523(a)(19)(iii). “For purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law including applicable filing requirements. Such term includes a return prepared pursuant to Section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law.”

3. INTENDED PURPOSE To define what is and what is not a return for purposes of discharge under Section 523(a). Specific terms in Statute as the focus of the controversy and related litigation “applicable nonbankruptcy law” “applicable filing requirements” Specific Controversy and Arguments - Do “applicable nonbankruptcy law” and “applicable filing requirements” include the concept of timeliness of the return? - Does this render Section 523(a)(1)(B)(ii) largely meaningless? - Does it mean that Section 523(a)(1)(B)(ii) requires both the 2-year period and the IRC Section 6020(a) “Safe Harbor?” - If so, then very few late filed returns will ever qualify for a discharge.

4. SPECIFIC PRE-BAPCPA STATUTE AND STANDARD Section 523(a)(1)(B)(ii), enacted pre BAPCPAand not repealed post BAPCPA This section does not discharge the tax shown on a return that is filed or given within 2 years of the petition date, but notwithstanding the current controversy, does otherwise mean that the tax is discharged if the return is filed late and more than 2 years before the petition date. Widely accepted definition of the term “return” pre BAPCPA, The Beard Test 1. The document must purport to be a return. 2. The document must be executed under the pains and penalties of perjury. 3. The document must contain specific information for the tax to be calculated. 4. The document must represent an honest and reasonable attempt to satisfy the requirements of the tax law. The Beard Test does not refer to timeliness as a standard for definition of “return”.

5. OFFICIAL IRS POSITION ON THE MATTER The IRS has taken the position that a literal reading of the unnumbered paragraph is too extreme. (See Office of Chief Counsel notice, September 2, 2010. IRC Section 6020(a) returns are quite rare. IRS position is that late-filed returns if prior to an assessment made by the IRS can qualify for discharge. Returns filed after IRS assessment would not qualify for discharge. Adopts In Re: Hindenlang, 164 F.3d 1029, (6th Cir. 1999) as standard. If late return has tax items not included within original assessment, then additional tax would qualify for discharge as long as the return was filed more than 2 years before the petition. 

6. CASES ADOPTING STRICT VIEW OF AMENDMENT Payne vs. United States of America, 431 F. 3d 1055, 1060 (7th Cir. Ill. 2005). Judge Esterbrook opined that, going forward, under BAPCPA, an untimely return, other than within the safe harbor of IRC, Section 6020(a). could never lead to discharge concluding that timeliness is clearly a part of applicable filing requirements within applicable nonbankruptcy law. Creekmore vs. Internal Revenue Service 401 B.R. 748, 749 (Bankr. N.D. Miss. 2008) “A late filed return, unless it was filed pursuant to Section 6020(a) of the Internal Revenue Code can never qualify as a return for dischargeability purposes because it does not comply with the applicable filing requirements set forth in the Internal Revenue Code”. Creekmore cites to Payne. In the Creekmore case, the IRS determined the amount of tax using IRC, Section 6020(b) before returns were submitted.

7. CASES ADOPTING STRICT VIEW OF AMENDMENT --II Links vs. United States of America, 2009 LEXIS 2921, (Bankr. N. D. Ohio 2009) “The definition of return under Section 523(a) encompasses the filing deadlines for submitting returns contained in the Internal Revenue Code so that a late filed return cannot qualify as a return for purposes of a dischargeability determination,” relying on Creekmore. McCoy, vs. the Mississippi State Tax Commission 666 F.3d 924 (5th Circuit, 2012) “Unless a return is filed under a safe harbor provision similar to IRC Section 6020(a), a state income tax return that is filed under the applicable nonbankruptcy state law is not a return for bankruptcy discharge purposes under Section 523(a).” No assessment by the Tax Department prior to the filing of the return. Scott L. Shinn vs. Internal Revenue Service, 2012 Bankr. LEXIS 1218, (Bankr. C. D. Ill, 2012). While agreeing with IRS that a Form 1040 filed after the due date should still satisfy the applicable filing requirements as long as it was filed pre-assessment, court held it was bound to read statute literally, holding that “the new definition of return, added by BAPCPA to Section 523(a) means that an untimely filed 1040 cannot be considered to be a return for dischargeability purposes, unless the narrow exception of IRC Section 6020(a) applies.”

8. CASES TAKING A LIMITED VIEW OF THE AMENDMENT Opponents to the strict interpretation argue that the result is too extreme and does not work in harmony with Section 523(a)(1)(B)(ii). Opponents also express that such a literal reading of the statute works against the “fresh start” doctrine contained in the Bankruptcy Code and cite to the “Beard Test.” Michael & Holly Wogoman vs. Internal Revenue Service, 2012 Bankr. LEXIS 3031 (10th Cir BAP 2012), IRS assessed the tax prior to the filing of a tax return, but not specifically made pursuant to IRC Section 6020(a). The debtors filed their federal tax return after the assessment was made and more than 2 years before the bankruptcy petition was filed.

9. CASES TAKING A LIMITED VIEW OF THE AMENDMENT II Of important note in Wogomon are the following assertions: a) The court did not discredit the “Beard Test” entirely. But here where the return was filed after an assessment made by the IRS, it served no real purpose and therefore did not satisfy the 4th test, i.e., that it be an “honest and reasonable attempt to satisfy the requirements of the tax law.” b) The unnumbered paragraph does not create a rule that a late filed return could never lead to discharge unless it fell within the safe harbor. c) The goal of bankruptcy is to give the honest but unfortunate debtor a “fresh start” but the law has always provided that certain debts can never be discharged. As a result, the taxes were not discharged. See also Smythe vs. United States of America, 2012 Bankr. LEXIS 1057 (W.D.Wash. 2012), where the court noted that the taxing authority’s claim arises when the debt is assessed, either based on returns, or an assessment.

10. CASES TAKING LIMITED VIEW OF THE AMENDMENT IV Gary Wayne Colsen vs. United States of America, 446 F.3d 836, (8th Cir 2006), the Court ruled that the late returns contained data that allowed the IRS to calculate the tax more accurately and were therefore an honest attempt to satisfy the requirements of the tax laws. The Colsen court also applied emphasis to the “fresh start” doctrine. In Martin vs. United States of America, 482 B.R. 634 (Bankr. D. Col, 2012) the court rejected the notion that the term “applicable filing requirements” refers to timeliness. Instead the court noted in its opinion that “this interpretation says too much, essentially rendering Section 523(a)(1)(B)(ii) superfluous.”

11. LEGISLATIVE HISTORY Legislative history regarding the unnumbered paragraph is virtually nonexistent. However, opponents to the McCoy standard or those taking a limited interpretation of the amendment look to other published commentary regarding the late filed return issue and offer a possible reason for the amendment. It was enacted to: 1. Nullify the effect of In Re: Elmore, 165 B. R. 35 (Bankr. S.D. Ind. 1994) which held that “returns submitted to Tax Court as evidence were filed for dischargeabilitypurposes.”

12. LEGISLATIVE HISTORY II 2. Nullify In re Nunez, 232 B. R. 778 (9th Cir. BAP, 1999) which held that “for dischargeability purposes, a return does not have to have legal significance under nonbankruptcy tax law and for discharge purposes a return must be a return according to the law of the jurisdiction to which the tax is owed.” 3. Codify the result in Hindelang which held that “a return filed too late to have any effect under nonbankruptcy tax law as to an assessment previously made cannot constitute an honest and reasonable attempt to satisfy the requirements of the tax law.” That is, the amendment was to relieve taxing authorities from having to endlessly argue about whether a return filed years after an assessment had some useful purpose, even if it were only to the benefit of the debtor, but was not meant to limit the existing scope of Section 523(a)(1)(B)(ii).

13. OTHER STATE TAX CASES Other than the State of Mississippi, Massachusetts is the only state to litigate the late filed return issue. The Massachusetts cases provide a true test of the McCoy principles because they, like McCoy, do not involve situations where assessments were made prior to the late filed returns. The courts therefore were forced to decide the question of whether a late filed return qualifies as a return under the new statute rather than offering commentary within the boundaries of IRS policy. Thus, they create a true test regarding the meaning of the terms “applicable nonbankruptcy law”, and “applicable filing requirements.” The McCoy case may be unique with respect to the definition of “applicable nonbankruptcy law” and “applicable filing requirements” as compared to federal statute and other state statutes because the Mississippi Code apparently does not recognize “returns” filed after the due date, see Mississippi Code S. 27-7-53(1) and 27-7-53(2).

14. MASSACHUSETTS STATE CASES Massachusetts has 6 cases pending and/or on appeal with similar facts decided on summary judgment. Cases which have held that a late filed return can be a return for dischargeability purposes. Brown, vs. Massachusetts Department of Revenue Ch. 7 Case No. 08-43819, Adversary No. 11-4150, and In re Gonzalez, vs. Massachusetts Department of Revenue, Ch. 7 Case No. 10-41907, Adversary No. 11-4149, both decided on March 11, 2013 Bankruptcy Judge Hoffman analyzed the Massachusetts Assessment Statute to determine whether a late filed return served any legitimate purpose and held that it did unless the Commissioner of Revenue assessed the tax first, see MGL Ch. 62C, S 26(d). Under this analysis, the result is similar to the official IRS position and the result in Wogoman; i.e., the operational dividing line is the taxing authority action, not the lateness per se of the return.

15. MASSACHUSETTS STATE CASES II One court has ruled along the lines of the strict interpretation. Pendergast vs. Massachusetts Department of Revenue, Chapter 7, Case No. 12-14455, Adversary No. 12-1215, also In re: Fahey vs. Massachusetts Department of Revenue Chapter 7, Case No. 10-21154, Adversary No. 12-01204, both decided on June 11, 2013. In these cases, Bankruptcy Judge Hillman disagreed with Judge Hoffman’s decisions and ruled along the lines of McCoy. He noted that as long as there is one situation where an untimely return is still considered a return, referring to the safe harbor under IRC Section 6020(a), the unnumbered paragraph does not render Section 523(a)(1)(B)(ii) superfluous.

16. SUMMARY With its official position on the issue, the IRS will not bring forth a discharge case unless it has either made an assessment prior to the filing of a return by the debtor, or the return is beyond the 2 year window provided in Section 523(a)(1)(B)(ii). As a result, case law may be somewhat settled on this issue with regard to federal taxes. Many of the cases involving federal income taxes have been decided consistent with the IRS position with only side bar commentary regarding whether a late return can ever qualify as a return under the new unnumbered paragraph. In 2 states, judges find themselves on the opposite side of the fence regarding the late filed return issue and this is the cause of much confusion and controversy within the Bankruptcy Bar. The construction of the Mississippi Code seems unique and may support the result in the McCoy case.

17. OPEN QUESTIONS The term “applicable filing requirements” is not defined universally and therefore it is unclear whether or not it must refer to the standard due date of the tax return. It is therefore unclear, if going forward, the courts will still accept the “Beard Test” as a measure to determine the necessary attributes of a “return” and thus “applicable filing requirements.” 48 State Revenue Departments have not taken a position on the McCoy issue. Analysis of the specific filing requirements in each state statute may be critical in determining the issue. Absent subsequent legislation, we may be left with an unclear direction regarding this issue and many more years of uncertainty and litigation. A question remains as to whether a subsequent Legislative amendment to provide further clarification to the terms “applicable nonbankruptcy law” and “applicable filing requirements” will provide direction nationally.

18. BALLOON PAYMENT ISSUE There are significant differences in the Bankruptcy Code’s provisions regarding the payment of priority claims in Chapter 11 and other payment provisions found in Chapter 13. Section 1129(a)(9)(C) Section 1129(a) sets the minimum requirements of the plan in order to be confirmed. Section 1129(a)(9)(C) addresses the requirements for a priority unsecured tax claim, and by incorporation of reference in Section 1129(a)(9)(D) it also sets forth the requirements for a secured claim for a tax that otherwise would meet the prerequisites for priority unsecured status under Section 507(a)(8).

19. Balloon Payment II Absent payment in full up front or consent, Section 1129(a)(9)(C) requires that the holder of the claim receive “regular installment payments” of the total value of the claim, as of the effective date of the allowed amount of the claim. The installment payments can be made over a period ending not later than 5 years after the date of the order of relief. In order to meet the requirement that the total payments be of a total value of the allowed claim, as of the effective date, the payments must include an interest component. Section 511 requires in these circumstances that the interest rate be the taxing authority’s rate as determined under applicable nonbankruptcy law.

20. BAPCPA AMENDMENTS Section 1129(a)(9)(C) was amended by striking the prior term “deferred cash payments” and replacing it with the term “regular installment payments in cash.” The time for payment was also amended under Section 1129(a)(9)(C)(ii), which added the phrase “over a period ending not later than 5 years after the date of the order of relief under Section 301, 302 or 303” and deleted the prior language under Section 1129(a)(9)(C) which stated “over a period not exceeding 6 years after the date of assessment of such claim of value, as of the effective date.” Section1325(a)(5)(B)(iii) BAPCPA Amendment Section 1325 (a)(5)(B)(iii) provides that if a secured claim is to be paid over time through periodic payments they must be in the form of “equal monthly amounts.”

21. HISTORICAL BACKGROUND The pre-BAPCPA language in in Section 1129(a)(9)C) was interpreted by some courts as allowing for balloon payments. Volle Electric vs. United States of America 139 B.R. 451, (C.D. Ill 1992). The court confirmed the Chapter 11 plan because it “represented an accommodation of the business preservation and creditor satisfaction,” and rejected the IRS argument that the payment terms did not provide for what it defined as “normal monthly payments.” Dow Corning vs. United States of America 244 B.R. 718, 1999, LEXIS 1600, (Eastern Dist. of Michigan, 1999) In this case, the IRS unsuccessfully argued that the plan was unclear relative to the payment of interest and was deficient by proposing to pay the priority claim in six annual installments.

22. RECENT CONTROVERSY F.G. Metals vs. United States of America, 2008 U.S. Dist. LEXIS 111451, (M.D. Fl., 2008). The IRS asserted that the Bankruptcy Court had erred by confirming a plan which provided for small monthly payments with a balloon payment several years later. F.G. Metals asserted that under the amendments nothing precluded it from proposing a balloon payment. See also In re: Jerath Hospitality, LLC, 484 B.R. 245 (Bankr. S.D. Ga. 2012). In F.G. Metals, the bankruptcy court reasoned that the term “regular” has a different meaning from the term “equal ” as used in Section 1325(a)(5)(B)(iii). The court stated that the Bankruptcy Code itself does not define what it means by “regular installment payments.” The court further stated that “regular installment payments” means payment made on a recurrent basis over a period of time and therefore concluded that there is nothing in the plain reading of the statute that would indicate that monthly payments, followed by a balloon payment, is not an appropriate payment method under the code.

23. RECENT CONTROVERSY II The court further reasoned that Congress could have prescribed “equal payments” as in Chapter 13 and could have prohibited balloon payments. The court observed that in 1999, within an earlier proposal to Congress, there was an explicit prohibition against balloon payments, and so the court reasoned that the removal of such language was now clear evidence that a plan could now be confirmed if it provided for a balloon payment. The courts have generally upheld the Chapter 13 requirement, see In re: Luckett, 2007 Bankr. LEXIS 3638, (Bankr. E.D. Wis. 2007) where the court denied confirmation of the debtors’ chapter 13 plan reasoning that a balloon payment at the end of the term would not satisfy the requirement of equal monthly payments.

24. FUTURE ACTION There have been no other published decisions regarding this problem. In many cases, the taxing authority has pushed back on feasibility grounds – but that leaves them in the same position as before the amendments. Another amendment may be necessary to create language in Section 1129(a)(9)(C) sufficient to resolve the issue along with a specific prohibition of balloon payment provisions. Suggestion: With respect to a claim of kind specified in section 507(a)(8) of this title, the holder of such claim will receive on account of such claim equal regular installment payments over the term of the plan, not less than quarterly, and without balloon payment(s), in cash….