Taxes and Bankruptcy: IRS-Prepared Substitute Returns

Share this Article
Facebook Icon LinkedIn Icon Twitter Icon

Freeman Law is a tax, white-collar, and litigation boutique law firm. We offer unique and valued counsel, insight, and experience. Our firm is where clients turn when the stakes are high and the issues are complex.

A taxpayer filing for bankruptcy with unfiled tax returns faces potential pitfalls. In order to ensure that a debtor’s federal tax liability is discharged in the bankruptcy, the potential bankruptcy debtor must know and comply with the requirements of the circuit where the debtor will file their bankruptcy petition. The recent case of In re Forrester demonstrates several of the foot faults that come into play when taxes mix with bankruptcy. In In re Forrester, the bankruptcy court, following Eleventh Circuit law, excepted IRS-prepared substitute returns from discharge in a Chapter 13 bankruptcy. The debtor also filed his own returns for those same years one year after the bankruptcy petition was filed, but the court excepted those returns from discharge as well due to failure to comply with 11 USC § 523(a)(1)(B)(ii).

One issue that arises in bankruptcy proceedings is the validity of tax returns. When a taxpayer fails to file their tax return, the IRS may prepare substitute returns under IRC § 6020. The IRS has the authority to prepare two different types of returns. Under IRC § 6020(a), the Service prepares a return with the aid and signature of the taxpayer. In contrast, the Service prepares a return under § 6020(b) with the information it gathers regardless of the taxpayer’s authorization or aid.

Not all substitute tax returns are included in a bankruptcy discharge. Substitute returns prepared under IRC § 6020(a) may qualify as a return for discharge purposes. But § 523(a)(19) of the Bankruptcy Code specifically excepts those substitute returns prepared under IRC § 6020(b) from discharge in bankruptcy. Additionally, a debtor seeking to include tax returns in their discharge must comply with the timing requirements of 11 USC § 523(a)(1), which generally requires that the taxpayer file the tax returns at least two years before filing the bankruptcy petition.

These issues arose in the recent In re Forrester case. Even though the IRS-prepared, substitute returns were prepared prior to filing for bankruptcy, the bankruptcy court held that, under § 523(a)(19), section 6020(b) substitute returns were not “returns” for the bankruptcy period. The court also excepted from discharge the returns filed one year after the debtor filed for bankruptcy because the returns were not timely filed.