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Court Tightens Restrictions on Discharging Tax Debt in Bankruptcy

A recent federal court decision held that a Maryland resident’s state tax debt was non-dischargeable in bankruptcy because she failed to notify Maryland tax authorities of an IRS adjustment that increased her federal adjusted income for certain tax returns.

Recently, the United States District Court for the District of Maryland overruled a bankruptcy court’s decision to discharge tax debts owed by a debtor in bankruptcy. The court’s reversal was based on the debtor’s failure to notify state taxing authorities of adjustments to her taxable income imposed by the IRS. The court emphasized that its decision was consistent with 2005 amendments to the Bankruptcy Code which sought to “restor[e] personal responsibility and integrity in the bankruptcy system” and close “loopholes and incentives to allow…opportunistic filings and abuse.”

The court’s decision stemmed from adjustments made by the IRS to income tax returns filed by the debtor, a Maryland resident, for tax years 1992 through 1996.  The IRS adjustments, made in 1998, substantially increased the debtor’s federal adjusted income for each of those years.  The debtor failed to report these adjustments to Maryland tax authorities, as required by Maryland law.  The IRS, however, did report the adjustments, and, based on that report, the Maryland Comptroller made adjustments to the debtor’s state tax returns that resulted in over $500,000 in taxes, penalties, and interest.

In its opinion, the court explained that the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act added language to expand the types of tax-payer failures that would render a tax debt non-dischargeable.  This language included a taxpayer’s failure to file a tax return or “equivalent report or notice, if required.”  The court stated that the report required by Maryland law, which notifies state tax authorities of an IRS adjustment, is an equivalent report or notice. Therefore, the debtor’s failure to notify Maryland tax authorities of an IRS adjustment rendered her Maryland tax debt non-dischargeable in bankruptcy.

For more information on this topic, please contact Vincent M. Guida, Jr. at 410-583-2400 or guida@bowie-jensen.com.

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