Some not-so-clear amendments to the bankruptcy code in 2005 have opened the door to widely varying interpretations, resulting in different courts around the country issuing different opinions about whether income tax debt on a late-filed tax return can ever be discharged in a Chapter 7 bankruptcy. The IRS says that in order for a tax return to be considered a “tax return” for legal purposes, it must satisfy all the requirements of non-bankruptcy law, including the “timely filing requirement”. Therefore, a late-filed return may not satisfy all filing requirements, and therefore may not be considered to be a legal return that would start the 2-year clock running. Ultimately, this would have the result of a tax year with a late-filed return would never be dischargeable in bankruptcy.
This interpretation is somewhat counter-intuitive—if courts don’t consider a late-filed tax return to be a “return” under the law, the result is that the Two-year rule would never be applied. Why even have a Two-year rule? It is clear (to me, anyway) that the drafters of the 2005 amendment to the bankruptcy code did not intend to disqualify all late-filed returns from discharge under the Two-year rule, and recent court decisions around the country which ruled to the contrary were strained and twisted in order to obtain the desired result. Until lately, even the IRS agreed that it set a bad precedent. However, I have seen a few indicators that the IRS, even here in the 9th Circuit, may be following that path and objecting to discharge of late-filed returns.