MARTIN SMITH V. IRS (14-15857) 07/13/2016  Link to Case:

This was supposed to be the 9th Circuit's big chance to adopt the "One Day Late Rule" (for income tax filing) that would have made tax debt for a year in which a return that is late even by only one day, non-dischargeable.

This is important because a "One Day Late Rule", if adopted by the 9th Circuit, would have blocked a major pathway to discharge of unpaid taxes and might have led to increased holdings of fraud and tax evasion.

In the government's brief, they directed attention to, but did not directly urge the 9th Circuit Court to follow  the three main "One Day Late Rule" 1st, 5th & 10th circuits.  These cases are: (1)  In re Fahey, 779 F.3d 1, 4 (1st Cir. 2015); (2)  In re Mallo, 774 F.3d 1313 (10th Cir. 2014) cert. denied in Mallo v. I.R.S., 135 S. Ct. 2889 (2015); & (3) In re McCoy, 666 F.3d 924, 932 (5th Cir. 2012).

The Martin Smith holding was just seven pages long and focussed upon In re Hatton,  220 F .3d 1057, 1059 (9th Cir. 2000), and did not even mention the cases in other circuits that adopted the "One Day Late Rule".

This means that the 9th circuit remains as it has been the past 5-10 years where the main concern is to file your tax return with the IRS before the IRS can prepare and file a Substitute for Return (SFR).  SFRs can be especially damaging for small businesses because SFRs they don't take to account the deductions that a taxpayer actually had and thus it sets income at the high amount.

This can be cured from an IRS standpoint by filing a late tax return, even after the SFR. However, for bankruptcy purposes the income level reported in the SFR sets a threshold level below which tax owings cannot be discharged.

As an example, if a small business received $100,000 gross and $80,000 of expenses, that business would have a schedule C income of $20,000.  A single taxpayer might owe $2500 (excluding self-employment).  But if the taxpayer fails to file, and if the IRS has notice of the $100,000, it will prepare a return showing $100,000 of income, apply the standard deductions and formulate a tax owing of over $18,000.  If a taxpayer files a return for that year after receiving the SFR, his amount owing to IRS will be $2500, but he can never deduct it, or any amount less than $18,000 for that tax year.

If the "One Day Late Rule" had been adopted, then the taxpayer could never discharge taxes for any year in which he or she filed late, even if by only one day.  This would have forced a taxpayer to be limited by only IRS relief, which is largely Offer-In-Compromise.  Late filing taxpayers need the ability to balance and then take advantage of the more advantageous of the bankruptcy and Offer-In-Compromise options.  The balance between these two options is dynamic and changes over time.