COURTS, CONGRESS AND TAX DEBTS: AN ANALYSIS OF THE DISCHARGE OF TAX DEBTS BEFORE AND AFTER THE ENACTMENT OF THE BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT OF 2005, THE

Fordham Journal of Corporate & Financial Law, 2007 by Power, Brian

I. INTRODUCTION

For nearly 100 years, judges and scholars have understood that one of the most important features of bankruptcy protection is the fresh start afforded by a discharge pursuant to the Bankruptcy Code.1 Indeed, bankruptcy laws play a crucial role in our national economy.2 "When the economic structure of a country embraces risk-taking and entrepreneurship, the legal system needs to provide a means to address financial failures."3 The United States's modem codification of bankruptcy laws has one basic goal-to promote the role of bankruptcy law in adding to social stability in our society.4 Two ancillary goals are: (1) to provide an equitable distribution of assets among creditors, and (2) to provide debtors a fresh start via discharge of their debts.5 "Both goals promote stability in dealing with the financial difficulties of people and businesses,"6 and thus "add stability to financial transactions and commerce, which in turn provides stability to society as a whole."7

Not all debtors, however, are able to avail themselves of the fresh start that bankruptcy law protection provides. Recent developments in the courts and Congress have resulted in a barrier to the discharge of tax liabilities. Although all citizens subject to the income tax have to file a tax return and pay the tax they owe, 8 not all are able to pay that tax.9 The recent developments discussed below have resulted in obstacles that may prevent those debtors who were unable to pay their tax debts from getting those debts discharged through bankruptcy. This article will discuss one specific tax issue-the discharge of tax debts for taxpayers who file returns after the Internal Revenue Service has already prepared their own returns and assessed taxes against them.

Part II of this article will describe the goals of bankruptcy protection, and statutory rules governing the dischargeability of tax liabilities.10 Part III will describe the Internal Revenue Service's authority to prepare returns on behalf of taxpayers and how courts have treated these returns in deciding the discharge of tax debts.11 Part IV will describe congressional action and discuss several critiques that were intended to solve a split among the circuit courts on this issue. 12 Finally, Part V will argue how courts should rule on this issue in pre-reform cases, and will propose that Congress should repeal portions of the Bankruptcy Act and return deference to the courts while ensuring that the goals of bankruptcy protection are met.13

II. DISCHARGEABILITY OF TAXES

A. Of "Death and Taxes"14

The Internal Revenue Code15 (the "IRC") requires all individuals subject to tax under the Code to file a "return."16 A return must be filed, for calendar year taxpayers, on or before the 15th day of April the following year.17 Unfortunately for both taxpayers and judges the term "return" is not defined in either the IRC or the Bankruptcy Code.18 The issue of what constitutes a "return" has been the subject of much litigation under both the IRC and the Bankruptcy Code.19 This Part will discuss the statutory requirements governing the dischargeability of tax debts under the Bankruptcy Code before the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.20

B. Tax Debts Meet the Bankruptcy Code

Although everyone has to file a tax return and everyone can apply for bankruptcy protection if they need it, there are some restrictions on what tax debts can be discharged. As discussed above, the Bankruptcy Code allows citizens who have fallen into economic hardship to petition for a discharge of their debts. Once a debtor has sought bankruptcy protection and a discharge is granted, the debtor should be freed from all of their tax debts.21 This, however, is not always the final result. For instance, a case may be reopened by a creditor whose debts have been discharged, or by a debtor who feels that a debt should have been discharged but was not.22 Either party may seek to have a court evaluate and decide whether or not a certain debt was rightfully discharged.23 The "party seeking to establish an exception to discharge of a debt bears the burden of proof."24 As for the burden of proof in such actions, the Supreme Court has held that a party seeking an exception must prove that the debt is exempted by a preponderance of the evidence.25 Although this rule is applicable to all types of discharged debts, a narrower tax-related ruling can provide more relevant guidance. In cases contesting the dischargeability of tax debts, the 11th Circuit has held that "the Government has the burden to prove that Section523(a)( I)(B), the exception to discharge provision concerning tax liability, applies to the debtor's delinquent tax return."26 There are a number of statutory requirements that must be satisfied in order to have tax debts discharged through bankruptcy.

To determine whether a tax debt is dischargeable, a debtor must make sure that his debts pass a number of tests. The first step in determining the discharge of debts under the Bankruptcy Code presents itself in Section 727.27 Section 727 provides that the court shall grant the debtor a discharge unless the debts in question fall under one of the exceptions found in the Bankruptcy Code.28 Section 523 is one such exception, and lists certain debts that are excepted from discharge.29 Under Section 523(a)(1), four types of tax debts are not dischargeable under Section 727.30