The Importance of Filing Tax Returns Well Before Filing Bankruptcy

The importance of filing one’s tax returns well before filing bankruptcy cannot be stressed enough.  This important lesson was reiterated by the First Circuit Court of Appeals in the recent case In re Kriss Terrence, a case appealed from the United States District Court for the District of New Hampshire.  

Terrence Kriss failed to file income tax returns when due for 1997 and 2000.  He also did not pay the taxes that were owed. In March of 2003, without the benefit of a return the Internal Revenue Service (“IRS”) assessed the tax believed to be due, including penalties and interest, for tax year 1997, in the amount of $30,568. Six months later, it calculated $46,344 in tax, penalties, and interest due for tax year 2000. The IRS then unsuccessfully attempted to collect what was due and owing.  Subsequently, in 2007, Kriss filed Forms 1040 for years 1997 and 2000, but did not pay the long-overdue taxes. Five years later, Kriss filed a chapter 13 petition for bankruptcy. After he received a discharge in 2017, Kriss and the IRS joined issue on whether his discharge covered his debts to the IRS for the taxes due for 1997 and 2000. The bankruptcy court held that the tax liabilities relevant here had not been discharged, and the district court affirmed.  

Resolution of this issue turned on the interpretation of a rather confusing section of the Bankruptcy Code.  11 U.S.C. § 523(a)(1)(B)(i)–(ii), which provides:

A discharge . . . does not discharge an individual debtor from any debt– – 4 – (1) for a tax or a customs duty– . . . (B) with respect to which a return, or equivalent report or notice, if required– (i) was not filed or given; or (ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition[.]

Until 2005, the Bankruptcy Code did not define “return” for purposes of this section.  Then, as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, (“BAPCPA”) Congress added the following unenumerated subsection, denoted as section 523(a):

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.

This section required the First Circuit to decide whether Kriss’s returns satisfied “the requirements of applicable nonbankruptcy law (including applicable filing requirements).”

In 2015, the First Circuit decided a case presenting a similar issue in In re Fahey, 779 F.3d 1 (1st Cir. 2015). In that case, the debtor owed Massachusetts income tax.  As a result, the First Circuit turned to Massachusetts ztate law as the applicable nonbankruptcy law. That law included a requirement that returns be filed by a specified date. The debtor in that case filed his tax return after that specified date.  The First Circuit held that the return was not a “return” within the meaning of section 523(a) otherwise known as the “one-day-late”.  The importance of getting an extension from both state and federal governments cannot be emphasized enough here.  

However, in the case at hand, the First Circuit did not need to decide whether Fahey applied to the federal returns.  The First Circuit stated that at least on its face, Fahey did not control because this was a federal tax issue and not state.  Rather, even if Fahey does not control, Kriss “loses because his much belated filings did not qualify as returns under section 523(a) even under the alternative test put forward by Kriss in the bankruptcy court.” See United States v. Lara, 970 F.3d 68, 78 (1st Cir. 2020) (“We – 6 – need not decide which standard applies in this case, as [appellant’s] challenge fails under either standard.”); United States v. Burgos-Montes, 786 F.3d 92, 105 (1st Cir. 2015).  

In short, if you are a debtor getting ready to file bankruptcy and you want those taxes discharged via the bankruptcy process, absent very extenuating circumstances which are too enumerated to discuss here, file those tax returns on time when they are due otherwise, you run the very real risk of those “returns” not being considered “returns.”  

In re: Kriss, Terrence P. (Kayatta, J.) Appealed from the United States District Court for the District of New Hampshire (Docket No. 21-1206) (Nov. 22, 2022)

What is a fraudulent conveyance in bankruptcy court?

What is a fraudulent conveyance?

Section 548 of the Bankruptcy Code provides for the avoidance of fraudulent transfers based on actual or constructive fraud. 11 U.S.C. § 548. The purpose of the fraudulent conveyance section of the Bankruptcy Code is the preservation of the bankruptcy estate. In short it prevents bad actors from profiting from fraud by recovering property that was transferred to defraud creditors. Under Section 548, the bankruptcy estate may recover two types of transfers made within two years of a bankruptcy petition: 1) a transfer made by the debtor with actual intent to defraud creditors in making the transfer (actual fraud); or 2) a transfer from which the debtor received less than reasonably equivalent value in exchange , and was or became insolvent when the transfer was made (constructive fraud).
Actual fraudulent transfers are those made with actual intent to hinder, delay, or defraud present or future creditors. 11 U.S.C. § 548(a)(1)(A). Because evidence of actual fraud is difficult to prove, courts look to what are known badges of fraud when determining intent. These include the following:

  • The lack of or inadequacy of consideration;
  • Any close relationship between the parties including family or friends
  • The retention of possession, benefit or use of the conveyed property
  • The financial condition of the party the property was conveyed
  • The chronology of events and transactions in question.

See McCord v. Ally Fin., Inc. (In re USA United Fleet, Inc.), 559 B.R. 41, 57-58 (Bankr. E.D.N.Y. 2016).
On the other hand, the debtor’s intent to harm or defraud its creditors is irrelevant. Rather, the inquiry focuses solely on whether the debtor received reasonably equivalent value in exchange for the transfer. Harrison v. N.J. Cmty. Bank (In re Jesup & Lamont, Inc.), 507 B.R. 452, 470 (Bankr. S.D.N.Y. 2014). The term value means “property, or satisfaction or securing of a present or antecedent debt” of the debtor. 11 U.S.C. § 548(d)(2).

Defenses to a Fraudulent Conveyance Action

Section 548(c) of the Bankruptcy Code provides a defense to avoidance of fraudulent conveyances. A transfer is voidable if the transferee takes 1) for value; and 2) in good faith has a lien on or may retain any interest transferred, to the extent that such transferee gave value to the debtor in exchange for the transfer. 11 U.S.C. § 548. These defenses are applicable to both actual and constructive fraud.

What is a Preference in Bankruptcy and Why It Matters to Your Business?

What is a Preference in Bankruptcy and Why It Matters to Your Business?

What is a Preference in Bankruptcy and Why It Matters to Your Business?

There are perhaps few things more frustrating than when one of your customers files for bankruptcy leaving you with the tab. However, is this really the worst thing that can happen? Unfortunately, it is not. Even though your customer has filed bankruptcy and perhaps even paid you, Section 547(b) of the Bankruptcy Code permits the debtor-in-possession or a trustee to recapture those payments from you. These payments made by a customer right before filing bankruptcy are known as preference payments. Put simply, the customer preferred to pay you rather than someone else. Although it is not always achieved in practice, the policy goal underlying the preference statute is to further the goal of equality of treatment of creditors of the debtor. Accordingly, the Bankruptcy Code authorizes the recapture of these payments for the benefit of the bankruptcy estate.

What are the elements of a preference?

The elements of a preference payment set forth in Section 547(b) of the Bankruptcy Code are as follows:

  • The transfer was made to or for the benefit of a creditor (i.e., creditor receives a check from the debtor, goods are returned by the debtor to the creditor or an obligation of the creditor is reduced by the debtor);
  • The transfer was made for or on account of an antecedent debt owed by the debtor before the transfer was made (this is merely a payment or transfer made on an old debt, i.e., not a cash on delivery or cash in advance payment);
  • The transfer was made while the debtor was insolvent;
  • The transfer was made 90 days before the date of the filing of the bankruptcy petition (extended to one year if the transfer was made to an insider); and
  • The transfer enables the creditor to receive more than it would have received if the case were a Chapter 7 liquidation. A payment received within 90 days of the bankruptcy filing almost always enables a creditor to receive more than it would have received in a Chapter 7 case. Indeed, the only time this would not be true would be in the unusual case where creditors were receiving 100% on their claims pursuant to a plan of liquidation.

Keep in mind that there is no value judgment linked to a creditor receiving a preferential payment. It is neither wrong of the debtor to make a preferential payment nor wrong of the creditor to accept it. It is almost always better to get paid and deal with efforts by a trustee to recover the payment.

What happens when the customer files bankruptcy and I received a payment?

Typically, a preference action is often preceded by a “demand letter” from the debtor or the trustee. The demand letter sets forth the trustee’s claims and demands payment. More often than not, the trustee is willing to settle the preference action for a reduced amount if the settlement is reached before the lawsuit is filed. As a result, depending on the amount of the payment, when the creditor receives a “preference demand letter,” the creditor should have an experienced bankruptcy attorney review the case to determine whether the creditor has valid defenses. Often times a favorable settlement can be negotiated which will allow the creditor to avoid having to expend large sums of money in litigation.
However, if the parties cannot reach a settlement, the preference action is initiated with a complaint filed with the bankruptcy court. The preference complaint is similar to any other lawsuit with the exception that it is filed in bankruptcy court instead of federal district or state court.

Are there defenses to a preference action?

Yes, there are several affirmative defenses to a preference action. Three of the major affirmative defenses which can be asserted by the creditor/defendant are:

  1. the new value defense;
  2. the ordinary course of business defense; and
  3. the contemporaneous exchange defense.

Each of these affirmative defenses will be discussed in detail in upcoming blog posts so stay tuned!