In the Matter of James and Simona Quezada v. Internal Revenue Service – The Fifth Circuit and the Discharge of Taxes in Bankruptcy

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In the Matter of James and Simona Quezada v. Internal Revenue Service – The Fifth Circuit and the Discharge of Taxes in Bankruptcy

The dischargeability of and the ability to collect taxes by the IRS in a consumer bankruptcy case often turn on the issue of whether and when the taxpayer filed the relevant returns, thereby determining when the statute of limitations on assessment began to run.  In this case, the IRS assessed the taxpayer, James Quezada, in 2014 for tax deficiencies arising for tax years 2005-2008.  Quezada filed for bankruptcy in 2016.  The IRS filed a claim for the alleged 2005-2008 tax deficiency.  Over the taxpayer’s objection, the Bankruptcy Court held that the limitations period never began to run because Quezada never filed “the return,” and the District Court affirmed.  As a result, the taxes were deemed not dischargeable, and the IRS’s claim was upheld.

The taxpayer appealed to the Fifth Circuit, arguing that although he did not file the precise form that the IRS required, that he provided all of the information to the IRS that was necessary in order for the IRS to determine the amount of tax due.  Based on that, Quezada urged that the statute of limitations on assessment expired long before the assessment was made, and therefore the tax was dischargeable and assessment was precluded by the statute of limitations.

Treasury regulations require business owners, like Quezada, to report payments made  for “salaries, wages, commissions, fees, and other forms of compensation for services rendered aggregating $600 or more.”  26 C.F.R. § 1.6041-1(a)(1)(i)(A).  A Form 1099 is required for each person paid $600 or more.

A Form 1099 shows the name and address of the payee and how much he was paid.  Each payee for whom a payor files a Form 1099 must provide a Taxpayer Identification Number” (TIN).  See 26 U.S.C. § 3406(a).  The payor must list the payee’s TIN on the Form 1099.  § 301.6109-1(c).  If the payee fails to furnish his TIN to the payor, the payor is required to withhold a flat rate for all payments to the payee and send the withholdings to the IRS.  26 U.S.C. § 3406(a).  This is called “backup withholding.”  The flat rate the payor withholds acts as a “backup” in case the payee fails to pay taxes on the underlying payments.

This case involves amounts Quezada failed to withhold as backup withholding for payments made to subcontractors for which he did not obtain TINs.  Under treasury regulations, a person required to backup withhold must file a Form 945.  See 26 C.F.R. § 31.6011(a)-4(b).  The Form 945 reflects, among other things, the amount that a person has backup withheld over a given tax year.  Because Quezada was required to backup withhold, he should have filed Forms 945 for the relevant tax years but failed to do so.  This failure led to an investigation by the IRS.  Following the investigation, in 2014, the IRS assessed $1.2 million against Quezada for amounts he failed to backup withhold from 2005-2008, plus penalties and interest.  This assessment came more than three years after Quezada filed Forms 1040 and 1099 for 2008, the last tax year in question.

After Quezada filed for bankruptcy in 2016, the IRS filed its proof of claim for the missing backup withholding.  Quezada, in turn, filed an adversary proceeding to determine his tax liability.  In that proceeding, Quezada contended that the assessment was barred by the three-year limitations period.  Quezada urged that his Forms 1040 and 1099 combined to constitute “the return” that triggered the limitations period.  The IRS argued that, because Form 945 was never filed, the limitations period never began to run.  The Bankruptcy Court agreed with the IRS and entered judgment for the IRS, holding that the assessed taxes were valid, allowed, and non-dischargeable.  The district court affirmed.

On appeal to the Fifth Circuit Court of Appeals, the IRS invoked the decision in Comm’r v. Lane-Wells, Co. 321 U.S. 219 (1944), urging the existence of a per se rule requiring the taxpayer to file the return designated for the tax liability at issue.  That form is Form 945, and because that was not filed, according to the IRS, the analysis should end there.  The Fifth Circuit disagreed.  In analyzing the Supreme Court’s decision in Lane-Wells, the Fifth Circuit noted that, in holding for the IRS in Lane-Wells, the Supreme Court emphasized that “the returns did not show the facts on which liability would be predicated.”  The Fifth Circuit, therefore, rejected the notion that a form other than the one prescribed by treasury regulations could not be found to constitute “the return.”  The Court therefore held that “the return” is filed, and the limitations clock begins to tick, “when a taxpayer files a return that contains data sufficient (1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of that liability.”

Turning to the case at bar, the 5th Circuit analyzed whether the 1099s and 1040 that were filed were sufficient to show “the facts on which liability would be predicated.”  They ultimately concluded that they were.  The IRS could determine that Quezada was liable for backup withholding taxes by looking to the face of the Forms 1099; if a particular form lacked a TIN, then Quezada was liable for backup withholding taxes applied to the entire amount he paid to that subcontractor.  Further, the amount Quezada should have backup withheld could be determined by multiplying the statutory flat rate for backup withholding by the amount Quezada paid the subcontractor, which was also reflected on the Forms 1099.  The Court noted that it was this information that the IRS did, in fact, use to calculate the amount of backup withholding to assess against Quezada.

Accordingly, because Quezada’s Forms 1040 and 1099 contained data sufficient (1) to show that Quezada was liable for backup withholding; and (2) to calculate the extent of Quezada’s backup withholding liability, those forms were found to constitute “the return” that triggers the IRS’s 3-year assessment limitations period.  Because the IRS assessed Quezada’s backup withholding liabilities more than three years after Quezada filed Forms 1040 and 1099 for the relevant tax years, the assessment was barred by the limitations period.