If I Do Not Pay My Property Tax Will The County Take My Property?

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If you do not pay your property taxes for quite a few years your county can conduct a tax lien sale to sell your house out from under you to pay back the unpaid property taxes. When does a property owners’ legal and equitable interests in their property terminate so that filing for bankruptcy protection cannot stop a tax lien sale in California? To ask the question a different way, when can a homeowner file bankruptcy and stop the tax lien sale of their home? This article will focus on California property tax law and how real property can be sold to pay unpaid property taxes.

California Property Tax Law

In California real property taxes (land) are secured by and serve as a lien on the real property for which they are assessed. Property taxes that are secured that remain not paid at the end of the fiscal year (June 30 of each year) are deemed to be in default. See California Revenue and Tax Code Section 3436. For residential properties if the property taxes are defaulted and not paid for five years then the county has the right to satisfy the outstanding defaulted taxes by selling the property at a tax lien sale. See California Revenue and Tax Code Section 3691. For a nonresidential commercial property only three years has to go by before the county and sell the real property. The real property will be sold at public auction, which now includes the internet, to the highest bidder.

Homeowners that are behind on their property taxes have a right to redeem the property by paying all prior defaulted taxes in full with penalties, costs and fees. When does the right to redeem terminate? California Tax and Revenue Code Section 3707 governs termination of the redemption period. Section 3707(a)(1) provides the right of redemption terminates at the close of business on the last business day prior to the date of the sale. After the tax lien sale is determined or deemed complete a homeowner’s right to redeem the tax defaulted real property cannot be revived under California Tax and Revenue code Section 3707. After the tax lien sale is completed the county tax collector will execute a deed to the purchaser. This tax deed will convey title to the purchaser free of all encumbrances (loans or other liens) of any kind existing before the sale.

What Is California Law Regarding Voluntary and Involuntary Foreclosure Sales?

This question can is answered by looking further at California law as it relates to the Bankruptcy Code. As soon as a bankruptcy petition is filed the automatic stay takes effect stopping any and all collection activity including tax liens sales if the bankruptcy filer still has the right to redeem the property. Section 541 of the Bankruptcy Code governs what is property of the bankruptcy estate upon the filing of a petition for relief. A bankruptcy filers right to redeem their real property is a distinct property right from the bankruptcy filers legal and equitable interests in the real property. See Harsh Inv. Corp. v. Bialac (In re Bialac), 712 F.2d 426, 431 (9th Cir. 1983). Section 541 provides the definition of property of the bankruptcy estate is very broad. The California Tax and Revenue Code says that legal title to a tax defaulted real property will transfer after the tax sale with the recording of a tax deed by the tax collector. California Tax and Revenue Code unfortunately does not provide when equitable title to the tax defaulted real property transfers to the purchaser during the tax lien sale process.

In an ordinary non-tax lien sale of a piece of real property to a third party under California law provides the transfer of legal title at the time of execution of the contract of sale, the grantee acquires an equitable title to the estate being sold and the person selling the property, the grantor, retains the legal title as security for the purchase price. The legal title passes to the purchaser, grantee, at the time of their completion of the conditions precedent…..

In an involuntary sale like a foreclosure sale equitable title under California law is transferred to the purchaser at the foreclosure auction with acceptance of the highest bid and at the time a trustee’s sale is completed. See In re Richter, 525 B.R. 735, 745 (Bankr. C.D. Cal. 2015) (citing Nguyen v. Calhoun, 105 Cal. App. 4th 428, 441 (Cal. Ct. App. 2003). These cases provide the trustee’s sales is completed upon acceptance of the highest bid. Legal title remains with the owner or debtor and if the owner/debtor files for bankruptcy protection after the foreclosure sale there are grounds to not allow the bankruptcy to stop or stay the foreclosure sale process to allow the equitable owner to obtain legal title to the foreclosed real property. Bankruptcy attorneys have to find out the exact sequence of events to determine the debtor’s legal rights at the time the bankruptcy case is filed.

At What Point Can A Homeowner File Bankruptcy But Not Stop the Tax Lien Sale?

So, at what point can a homeowner file bankruptcy but it will not stop the tax lien sale? The Ninth Circuit Bankruptcy Appellate Panel on February 3, 2017, published an opinion, In re RW Meridian, LLC; BAP Case No. SC-16-1227-JuFY, that addresses this question. The bankruptcy petition has to be filed prior to the tax lien sale being completed.

The 9th Cir. BAP held that the bankruptcy filer was not divested (lost) of its legal or equitable interests in the underlying real property by operation of law upon the expiration of the bankruptcy filers right to redeem the real property under California law. The Court further held t6hat before a bankruptcy filer (debtor’s) equitable interests in the real property could transfer the tax lien sale process requires the taxing collector to hold an auction, and at the very least accept the highest bid, or at most, the tax collector receive the purchase price before the sale can be considered “complete.” California Tax and Revenue Code Section 3707(c) says that a tax sale is not complete until the purchase price has been paid in full which is a later point in time than in a foreclosure sale when it is acceptance of the highest bid which passes equitable title.

SO, if the auction or there is no acceptance of the highest bid before the bankruptcy petition is filed the tax lien sale was not completed and the bankruptcy filer can stop the tax lien sale. In the RW Meridian, LLC, bankruptcy case the Ninth Cir. BAP held neither the auction or acceptance of the highest bid took place prior to the property owner filing for bankruptcy protection. There was no transfer of the debtors/bankruptcy filers legal or equitable interests in the real property prior to filing the bankruptcy petition by the owners bankruptcy lawyer. The 9th Circuit Bankruptcy Appellate Panel held that there are no provisions of the California Tax and Revenue Code about tax lien sales provides that the expiration of the right to redeem prevents a bankruptcy filer of their equitable or legal interests in the real property upon filing of bankruptcy protection.
The key to all of this is that the alleged tax lien sale took place after the real property owner filed for bankruptcy protection.

County Argued Ministerial Acts Exception to The Bankruptcy Automatic Stay

Given the 9th Cir. BAP concluded the bankruptcy filer had equitable and legal interests in the real property the tax collector county violated the automatic stay that took effect when the bankruptcy case was filed. The county tax collector argues the postpetition sale of the real property falls within the narrow ministerial exception to the automatic stay. The Ministerial Acts exception says the automatic stay does not prohibit ministerial acts or automatic occurrences that entail no deliberate, discretion or judicial involvement on the part of the actor. See McCarthy, Johnson & Miller v. N. Bay Plumbing, Inc. (In re Pettit), 217 F.3d 1072, 1080 (9th Cir. 2000). The Ministerial Acts exception can apply to the simple recording of a tax deed after a tax lien sale was completed after a bankruptcy petition is filed. Completing the actual tax lien sale process by accepting the highest bid is not a ministerial act.

If The Person or Company I Sued Filed Bankruptcy Can I Continue My State Court Lawsuit?

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The greatest grant of power to the bankruptcy court is the automatic stay stopping any and all collection activity including lawsuits. As soon as the petition for bankruptcy is filed the automatic stay takes effect. Section 362 of the Bankruptcy Code governs the automatic stay and relief from the automatic stay to continue collection activity with the bankruptcy court’s permission. So what circumstances need to exist to obtain relief from the automatic stay and continue prosecution of a state court lawsuit?

What Is The Automatic Stay?

The automatic stay among other things, prohibits creditors from continuing to prosecute prepetition litigation against the bankruptcy filer. § 362(a)(1); see also In re Conejo Enterprises, Inc., 96 F.3d at 351. This aspect of the automatic stay protects both the debtor and the debtor’s creditors. The entire point is to not allow one creditor to continue collection to the detriment of another creditor. The assets of the bankruptcy filer, once a case is filed, if any assets, are to be distributed equally to creditors at the time the case is filed.

Grounds For Relief From The Automatic Stay To Continue State Court Lawsuit

This issue arises quite a bit under many different circumstances. The most common lawsuit that exists at the time a bankruptcy case is filed is breach of contract lawsuits. Rarely will a breach of contract case satisfy the requirements for relief from stay to continue. Relief from the automatic stay can be obtained for “cause.” The Bankruptcy Code unfortunately does not define what “cause” is though. Courts have had to interpret circumstances and create factors to evaluate. The Ninth Circuit uses the Curtis factors. See In re Curtis, 40 B.R. 795, 799–800 (Bankr. D. Utah 1984).

The Curtis factors consist of the following twelve nonexclusive factors:

(1) Whether the relief will result in a partial or complete resolution of the issues;
(2) The lack of any connection with or interference with the bankruptcy case;
(3) Whether the foreign proceeding involves the debtor as a fiduciary;
(4) Whether a specialized tribunal has been established to hear the particular cause of action and whether that tribunal has the expertise to hear such cases;
(5) Whether the debtor’s insurance carrier has assumed full financial responsibility for defending the litigation;
(6) Whether the action essentially involves third parties, and the debtor functions only as a bailee or conduit for the goods or proceeds in question;
(7) Whether the litigation in another forum would prejudice the interests of other creditors, the creditors’ committee and other interested parties;
(8) Whether the judgment claim arising from the foreign action is subject to equitable subordination under Section 510(c);
(9) Whether movant’s success in the foreign proceeding would result in a judicial lien avoidable by the debtor under Section 522(f);
(10) The interests of judicial economy and the expeditious and economical determination of litigation for the parties;
(11) Whether the foreign proceedings have progressed to the point where the parties are prepared for trial, and
(12) The impact of the stay on the parties and the “balance of hurt.”

The burden of proof on a motion to modify or for relief from the automatic stay is a shifting one. To obtain relief from the automatic stay, the bankruptcy attorney and party seeking relief must first establish a prima facie case that “cause” exists for relief under § 362(d)(1). Once a prima facie case has been established, the burden shifts to the debtor to show that relief from the stay is unwarranted. If the\ movant fails to meet its initial burden to demonstrate cause, relief from the automatic stay should be denied.

Unfortunately there are not clear guidelines for what constitutes a prima facie case given the analysis is on a case by case basis. A party’s production of enough evidence to allow the fact-trier to infer the fact at issue and rule in the party’s favor. See Black’s Law Dictionary (10th ed. 2014); see also In re Planned Sys., Inc., 78 B.R. 852, 860 n.7 (Bankr. S.D. Ohio 1987).

Congress’ legislative comments provide their desire to permit an action to proceed to completion in another tribunal may provide . . . cause” for stay relief, and “it will often be more appropriate to permit proceedings to continue in their place of origin, when no great prejudice to the bankruptcy estate would result, in order to leave the parties to their chosen forum and to relieve the bankruptcy court from many duties that may be handled elsewhere.” H.R. Rep. 95-595, 341, as reprinted in 1978 U.S.C.C.A.N. 5963, 6297

The bottom line is bankruptcy attorneys need to be aware that the bankruptcy court’s focus on whether the continuation of the state court lawsuit screws up the administration of the bankruptcy estate. In some circumstances insurance is liable for any damages if the lawsuit is successful. Therefore, none of the assets of the bankruptcy estate are at risk either way. So why not let the lawsuit continue?

Why Continue With State Court Lawsuit?

To get a judgment and hopefully paid on the judgment. The most common lawsuit that exists at the time a bankruptcy case is filed is breach of contract lawsuits. Rarely will a breach of contract case satisfy the requirements for relief from stay to continue. There are other types of issues though that can continue and not disrupt the administration of the bankruptcy estate.

Should I Try Some Sort of Debt Consolidation?

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No. Hell no. Absolutely no. Just spend some time on the Federal Trade Commission website and read all of their warnings. It is more than likely just a scam. You have no idea who you are doing business with and when they rip you off you are not going to sue them in the state they are doing business in. You are going to call me to file bankruptcy for you and have wasted anywhere from $1,000 – $6,000 of your hard earned money. That is what we see, as bankruptcy attorneys, time and time again. Here are four simple rules of thumb to avoid ever getting scammed by a debt relief company of any kind.

1. Do not do business with any company you hear about on the radio or has a television commercial regarding debt relief;
2. Do not do business with any company that is not doing business in your general area; that means never ever do business with a debt relief company that is from another state;
3. Do not do business over a website with a company that does not even list what state they are doing business in;
4. Do not do business with a debt relief company that will not put in writing when you will be 100% debt free; and if you are not 100% debt free they will give you all of your money back.

Fortunately the Federal Trade Commission continually fights for your rights and shuts down these fraudulent debt and mortgage relief companies. The FTC recently shut down some companies from Florida that ripped off people in need of debt relief for millions of dollars. Go to: https://www.ftc.gov/system/files/documents/cases/160907paydayorderirby.pdf the stipulated judgment. The FTC charged PSC Administrative, LLC f/k/a Payday Support Center, LLC, Coastal Acquisitions, LLC d/b/a Infinity Client Solutions, Infinity Collect, LLC, Jared Irby, an individual, and Richard Hughes, an individual with violation of the Telemarketing and Consumer Fraud and Abuse Prevention Act; 15 U.S.C. Section 6101. The defendants in this case, instead of admitting fault, entered into a stipulated settlement agreement with the FTC. The agreement provided the defendants are permanently restrained and enjoined from advertising, marketing, promoting, offering for sale, or selling, or assisting others in the advertising, marketing, promoting, offering for sale, or selling, of any secured or unsecured debt relief product or service. The laws regarding debt consolidation just be to be more stringent.

California State Attorney General

Student Loan Debt Consolidation Scams

https://oag.ca.gov/news/press-releases/attorney-general-kamala-d-harris-issues-consumer-alert-student-loan-debt

Telemarketing Fraud

https://oag.ca.gov/news/press-releases/attorney-general-lockyer-announces-189-million-settlement-telemarketing-fraud

Your Credit Rating

https://oag.ca.gov/consumers/general/your_credit

Coping With Debt

Based upon my real world experience and a bankruptcy attorney involved in thousands of bankruptcy cases I do not agree with everything in this list. But it is sure better than getting ripped off. https://www.consumer.ftc.gov/articles/0150-coping-debt

Advertising and 2016

Every time I hear a commercial on the radio or a commercial on the television about debt relief it makes me sick. The station airing the station is making money off of airing the criminals commercial and the criminal advertising their fraudulent services makes money because advertising like that unfortunately works. If you have never been told this before here we go: “The worst attorneys and businesses have to advertise their services over and over again to get new clients.” They do not build a real business based upon the goodwill of their past clients. There are none to be found. So these criminals have to spend thousands of dollars a month to get new people to rip off to stay in business and make money. Sadly it works. Every now and again there becomes a critical mass of ripped off people and the bad reviews on the internet and possible prosecution from the angels at the Federal Trade Commission or the Consumer Financial Protection Bureau shut down the criminals forever. Many times unfortunately, before the heat gets too hot, the criminals just change the company name and contact information to keep the ball rolling. It is just horrible.

What We Do For People In Need of Debt Relief

Not every case is easy for different reasons. At least all we have to do IS BE HONEST WITH OUR CLIENTS AND HOW BANKRUPTCY CAN HELP THEM TO OBTAIN A DISCHARGE OF THEIR DEBTS OR REORGANIZATION OF THE DEBTS BASED UPON THE LAW, THE BANKRUPTCY CODE. How wonderful is that? Some debts are dischargeable. Some are not. Some debts can be reorganized to make the terms of repayment more favorable for our clients. It all depends upon your income, expenses, assets and debts. All you have to do is be truthful and honest about your income, expenses, assets and debts and you are entitled under the law to have debt relief. It is wonderful. Debt consolidation is completely unregulated and is the wild, wild west. There is little recourse when you are fooled out of your hard earned money.

Can A Chapter 13 Trustee Make My Employer Pay My Chapter 13 Plan Payment?

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The answer is an absolute yes. How that is accomplished is a different story though. But yes, a Chapter 13 Trustee after confirmation of your Chapter 13 Plan can make your employer pay the monthly Chapter 13 Plan payment directly to them each month. The key part is that this could happen after confirmation or approval of your Chapter 13 Plan of reorganization. Most of the time the bankruptcy filer makes the plan payment directly to the Chapter 13 Trustee by money order, cashier’s check and now in some jurisdictions or directly from their checking account through the TFSbillpay.com system. The Chapter 13 Plan payment has to be paid in some form of certified funds. The point of this article is about how a Chapter 13 Trustee can make your employer pay the monthly Chapter 13 Plan payment though. If you do not want this to be an issue, then never ever miss or pay your Chapter 13 Plan payment late. The trustee is not trying to make sure you are successful in reorganizing your debts by timely paying the chapter 13 plan payment you agreed to pay each month and the Court confirmed or approved by Court order.

Where Does The Bankruptcy Code Allow This?

I think Bankruptcy Code Section 1325(c) is a little known and less talked about provision of the Bankruptcy Code. As a bankruptcy attorney we focus more on the requirements for confirmation listed in Section 1325(a) and Section 1325(b). Section 1325(c) provides: “After confirmation of a plan, the court may order any entity from whom the debtor receives income to pay all or any part of such income to the trustee.” That is all it says. There are no notice provisions. No other guidelines for how the court or standing chapter 13 trustee may administer Section 1325(c) of the Bankruptcy Code. It merely says the trustee may after confirmation of the plan make any entity from whom the debtor receives income to pay all or any part of such income to the trustee. Section 101(15) of the Bankruptcy Code defines “entity” as including a person, estate, trust, governmental unit, and United States trustee. Section 1325(c) specifically says “entity.” So it would seem that a bankruptcy filer’s employer may not be an entity as defined by the Bankruptcy Code and no other language exists in Section 1325(c) that specifically says employer. This is how the is interpreted or how parties add things to the law to obtain a result they believe is correct. Is the bankruptcy filer’s employer part of the definition of a “person?” Well, the Bankruptcy Code also defines the term “person.” Section 101(41) defines a “person” includes an individual, partnership, and corporation, but does not include governmental unit with some exceptions. Section 1325(c) could and should have both person and entity in the language, but it does not.

So again, how can a Chapter 13 Trustee make the bankruptcy filer’s employer pay the monthly Chapter 13 Plan payment of reorganization? It truly seems that Section 1325(c) applies to all third parties the bankruptcy filer receives monthly income from and income not received on a monthly basis. Most people filing for bankruptcy protection under Chapter 13 do not receive income from a trust, an estate or government unit. It seems Section 1325(c) is for obtaining funds the debtor may or may not receive after confirmation of a chapter 13 plan of reorganization.

What Is The Proper Procedure To Force An Employer To Pay A Chapter 13 Plan Payment?

As mentioned before there is no procedure that I am aware of that is directly on point to let us know. I will also mention that the practice of forcing an employer to pay a monthly Chapter 13 Plan payment is rare. I will provide my opinion of what the proper procedure to force an employer (“entity” or “person”) to pay a monthly chapter 13 plan payment is later. It is just my opinion though. It seems to me at a minimum a chapter 13 debtor and their bankruptcy attorney should be given notice and an opportunity to be heard on the matter before the debtor’s employer is contacted or just receives an order in the mail to pay a certain amount to the chapter 13 trustee. The issue here is privacy and confidentiality given the bankruptcy filer’s employer usually never actually finds out their employee filed for bankruptcy protection at all. There is really no reason for an employer to ever get notice of the bankruptcy filing since the employee usually does not owe their employer any money. This is almost always the case, so an employer does not get notice of the case. Why would they? There should be a motion filed, a hearing scheduled or any opportunity to object to the requested relief, and proper notice of the requested relief served on the bankruptcy filer and their attorney before any order is served on the bankruptcy filer’s employer or an “entity” as defined under Section 101(15), Section 101(41) and Section 1325(c). Bankruptcy filings are unfortunately a public record. For someone to access bankruptcy records they must have a PACER account and pay $0.10 a page for this public right.

What Has Happened In The Real World To Force Employers To Make Chapter 13 Plan Payments?

I have rarely heard of heard of Section 1325(c) being used to force an employer to pay the monthly Chapter 13 Plan payment directly to the Chapter 13 Trustee each month. It is very rare. In the case I have heard of this process was initiated by a Chapter 13 Trustee only after the bankruptcy filer failed to timely pay the monthly Chapter 13 Plan payment voluntarily as they agreed to do each month. Let me say this again. The bankruptcy filer had every opportunity to pay the monthly Chapter 13 Plan payment in the Chapter 13 Plan they proposed that was confirmed/approved by the Court for their benefit to reorganize their debts. Failure to make plan payments happens though. Even though someone seeks relief from the Bankruptcy Code under Chapter 13 for whatever reason they fail to meet their obligation to pay the monthly Chapter 13 Plan payment each month. In this case the Chapter 13 Trustee merely uploaded an order for the Bankruptcy Court to sign, the Bankruptcy Court signed the order and then the order was served on the bankruptcy filer’s employer. No notice. No hearing. That was it. It would seem this procedure is deficient, but at the same time the reorganization of the bankruptcy filer’s debts are what the bankruptcy filer wanted and obtaining the monthly Chapter 13 Plan payment each month directly from their employer ensures the desired relief is obtained. Once the wages are in the bankruptcy filer’s hands they may or may not spend the money as directed and may or may not actually be able to pay the monthly Chapter 13 Plan payment if an emergency expense comes up like healthcare expenses or a new set of tires to get to work.

The moral to the story is if you file a Chapter 13 bankruptcy reorganization case just pay the monthly plan payment according to the terms of the Chapter 13 plan you propose and subsequently have confirmed by the Bankruptcy Court and you will not have any problems. If you fail to make the monthly Chapter 13 Plan payments the Chapter 13 Trustee administering your case could have your employer pay the Chapter 13 Plan payments directly from your pay check each month whether you like it or not.

Ninth Circuit Court of Appeals Upholds In re Hatton Test Regarding Definition of Return in Martin Smith Appeal

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The issue in these cases is the effect of the Internal Revenue Service or other taxing authorities filing a Substitute Filed Return (“SFR”) and then the taxpayer voluntarily files their own tax return after that. Does the subsequent honest, accurate and voluntary filed tax return by the tax payer satisfy the definition of a “return” under the Bankruptcy Code and Section 523(a)(1)(B)(i)? A SFR is filed by a taxing authority (Internal Revenue Service or Franchise Tax Board) when a taxpayer fails to timely file their tax return on their own. A SFR is created and filed by the taxing authority. If a taxpayer has a SFR for a tax year and owes taxes for that year, and then files for bankruptcy protection the taxes owed for the SFR year, if normally dischargeable, are exempt from discharge (not discharged) given any debt for a tax with respect to which a return was not filed is nondischargeable pursuant to § 523(a)(1)(B)(i). But this is the bankruptcy world and not the real world. The Bankruptcy Code changes creditors rights to try and treat all parties fairly when the debtor has limited resources or no resources to pay their debts as the come due or at all.

Like many laws Congress passes certain terms that are extremely important are not defined within the law. I wish this was not so common and the undefined terms regularly are extremely important to interpreting the law. The Bankruptcy Code is no different. A “return” was not defined sufficiently and still is not even though Congress in the 2005 BAPCPA reforms amended Section 523(a) to include [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.] So the argument is a return filed after the SFR is a tax return that satisfies the requirements of applicable nonbankrutpcy law and the taxes for that year should therefore be dischargable.

As background, and you probably know this, any time a return is filed a form is used like 1040EZ or 1040a. So after a SFR is filed by a taxing authority the person that did not file their return uses the pre-printed form provide by the taxing authority. So for bankruptcy purposes and after the 2005 BAPCPA amended Section 523(a) to include for purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law the use of a preprinted form provided by the taxing authority meets this requirement. It apparently does not.

In the Martin Smith v. United States Internal Revenue Service case Mr. Smith and his Bankruptcy Attorneys attacked the fourth prong of the Hatton test and tried to argue Mr. Smith’s voluntary filed tax return filed after the SFR is a “return,” therefore the underlying taxes owed are dischargeable and not governed by § 523(a)(1)(B)(i). While the original bankruptcy court agreed, unfortunately the District Court and now the Ninth Circuit Court of Appeals disagreed.

In Hatton in 2000, pre-2005 BACPA, the Ninth Circuit Court of Appeals developed a four prong analysis as to what a “return” is pursuant to § 523(a)(1)(B)(i) and the Bankruptcy Code. See In re Hatton, 220 F.3d 1070 (9th Cir. 2000) The test for a “return” under Hatton is: (1) it must purport to be a return; (2) it must be executed under penalty of perjury; (3) it must contain sufficient data to allow calculation of tax; and (4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law. The 9th Circuit Court of Appeals noted that a number of sister circuits have agreed with the Hatton case. See In re Ciotti, 638 F.3d 276,280 (4th Cir. 2011); In re Justice, 817 F.3d 738, 740–41 (11th Cir.2016) The Ninth Circuit Court of Appeals also noted that the Tax Court has not wavered. See Estate of Sanders v. Comm’r of Internal Revenue, 144 T.C. 63 (2015) Wait, Congress changed Section 523 and added: for purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). So is this non-hanging parentheses language why there was no analysis of the Section 523 language change in 2005? Was Mr. Smith’s late filed return not in compliance with applicable filing requirements?

From my perspective a SFR does not meet the Hatton test. The taxing authority more or less makes up the numbers based upon what they have and not real world numbers. So while requirements 1-3 are met in the Hatton test, again we are left with prong 4. Does a SFR represent an honest and reasonable attempt to satisfy the requirements of the tax law? Subjectively yes. The Internal Revenue Service takes 1099’s or other documents provided by employers and does its best to put together a return on behalf of the tax payer who does not timely file their return. At the same time the tax payer subjectively believes when they do file their return after a SFR is filed they also make an honest and reasonable attempt to satisfy the requirements of the tax law. It would seem both parties are making a an honest and reasonable attempt to satisfy the requirements of the tax law. The courts have analyzed this issue objectively though.

Mr. Martin’s Bankruptcy Attorneys argued that the Smith facts were different then the Hatton facts and therefore distinguishable and I have to agree. I have not read all of the pleadings, but Mr. Martin filed his 2001 tax return seven years after it was due. Mr. Smith reported a higher income than the IRS used in their SFR which increased his tax liability. One issue that is not up for argument is whether the increased tax liability above the amount due on the SFR is dischargeable. The increased tax liability evidenced by Mr. Smith’s actual late filed return is dischargeable. So the late filed return is a partially recognized “return” under the Bankruptcy Code then? Just not the entire return? In Smith, Mr. Smith unfortunately falls prey to the holding in Hatton that belated acceptance of responsibility was not an honest and reasonable attempt to comply with the tax code. I have to disagree with this analysis in Smith. Not only did Mr. Smith file a return, but he honestly listed his income and deductions so that his tax liability increased and subjectively made an honest and reasonable attempt to satisfy the requirements of the tax law. So what if it was seven years after the actual taxes were due. Where is there any temporal requirement in the Hatton test or the new language in Section 523(a) resulting from the 2005 BAPCPA? The Hatton test is not even the law, but another appellate case and a created test prior to the statutory change in Section 523(a) to help define the term “return.” Statutory interpretation/construction requires a court take the plain meaning of the words used within their context. The court must focus on the language of the statute. Must give each word its ordinary meaning unless the statute or the context requires otherwise, and must interpret not only the individual words, but also the provision as a whole along with related provisions. See Lamie v. U.S. Tr., 540 U.S. 526, 534 (2004); Friedman v. P+P, LLC (In re Friedman), 466 B.R. 471, 479 (9th Cir. BAP 2012); Foxgord v. Hischemoeller, 820 F.2d 1030, 1032 (9th Cir. 1987) The court must interpret not only the individual words, but also the provision as a whole along with related provisions. United Sav. Ass’n of Tex. v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 371 (1988) Where is the analysis of how Mr. Smith’s accurate, honest, reasonable, partially relied on and tax liability increasing return does not meet the requirements of applicable nonbankruptcy law (including applicable filing requirements)? The Hatton case was decided in 2000 and before the 2005 BACPA which became effective in 2005.

Unlike Mr. Smith, Hatton merely met with the IRS and capitulated into an installment agreement with the IRS without making any affirmative action to honestly and reasonably comply with the tax code. Mr. Smith clearly did honestly and reasonably not only make the effort, but did comply with the tax code and then filed a return that met the requirements of applicable nonbankruptcy law (including applicable filing requirements) by increasing his tax liability. Mr. Smith should have been rewarded for filing his tax return upon seeking bankruptcy protection under the Bankruptcy Code. An honest debtor deserves a discharge under the Bankruptcy Code. I believe this and believe the holding in the Smith case sends the wrong incentive and message to debtors and their attorneys.

So, somehow the Internal Revenue Service is allowed recognize the validity of a late filed return regarding the increased taxes owed while at the same time arguing the late filed return is not actually a “return” for purposes of §523(a)(1)(B)(i) as the late filed return does not meet the requirements of applicable nonbankruptcy law. I suppose the only reason to file a return after a SFR is to decrease the alleged tax liability in the SFR, but the return is still not a “return” for bankruptcy purposes. The Hatton case and now Smith decision more or less provide a penalty for not voluntarily filing a tax return within a certain amount of time. Well, then what is a reasonable time frame in which the fourth prong of the Hatton Test can be satisfied? One year? Two years or days after the SFR is filed? Some arbitrary time limit after the SFR is filed that if you are a day over you cannot discharge the taxes when filing bankruptcy? I still want to know how a return filed after a SFR does not satisfy the requirements of applicable nonbankruptcy law (including applicable filing requirements). I am going to have to dig deeper into these two cases……….

The Oral Arguments Before the Ninth Circuit Court of Appeals

Wow, what a pressure cooker. After listening to the oral arguments before the three judge panel I still believe the decision here is wrong as the law and Bankruptcy Code are written. It is about interpretation though and past decisions. The Ninth Circuit Court of Appeals just could not get over that the debtor filed the 1040 tax return so late after the IRS had given him so many chances to file his own return. The debtor in this case did not actually file his own return until after the IRS spent the time to file the Substitute Filed Return. I will assume the application of the Hatton test was the correct choice even with the addition to Section 523(a) of a definition of a “return” under the Bankruptcy Code. So we are stuck with the IRS and Ninth Circuit Court of Appeals somehow telling us the tax return filed by a debtor after a Substitute Filed Return is a “return” as to the amount the debtor filed return increases the assessed taxes from what the Substitute File Return assessed, but that same “return” is not a “return” as to the previously assessed taxes owed from the Substitute Filed Return. The Smith case did not nothing to explain how a portion of a “return” can be an honest and reasonable attempt to satisfy the requirements of the tax law and part of a “return” not be at the same time.

The Smith case really just ignores the issue of what the definition of what a “return” is under the Bankruptcy Code or what an honest and reasonable attempt to satisfy the requirements of the tax law (including applicable filing requirements). The Court just took the IRS position that since the IRS filed the SFR then a debtor in this case, Martin Smith, under the circumstances in his case could never subsequently file a return and have the portion of the taxes owed according to the SFR discharged in a bankruptcy case. Mr. Smith just waited far too long to file his “return” that by every measure was complete and accurate. In theory there can still be a set of facts in which a court can determine a return filed by the debtor after a SFR is in fact a “return” and discharge all of the taxes assessed for that year. This case was just not it. What is troubling is the Hatton case represented a debtor that made no good faith effort to file a “return” unlike in the Smith case. Mr. Hatton filed a late return in which he provided true and accurate information resulting in his tax obligation given his tax liability increased from the Substitute Filed Return the taxing authority created. That is by definition a honest and reasonable attempt to satisfy the requirements of the tax law (including applicable filing requirements). What does “including applicable filing requirements” even mean? We still do not know. It would have been nice for the Smith case to have gone this direction and helped to define how to apply the actual words of the Section 523(a) of the Bankruptcy Code.

So, the moral of the story really is to timely and honestly file your tax returns and not let a taxing authority file a return on your behalf. Do not ignore the letters a taxing authority sends in the mail to file your returns and this will never be a problem.