Diane Finkle, U.S. Bankruptcy Judge.
The Rhode Island Division of Taxation ("Division") moves to dismiss plaintiff-debtor Jason Boudreau's adversary proceeding in which he seeks a declaration that the claims of each of the defendants are dischargeable in accordance with 11 U.S.C. § 727.
The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157(a) and 1334, and DRI LR Gen 109(a). This is a core proceeding under 28 U.S.C. § 157(b)(2)(A), (B), (I), and (O).
Mr. Boudreau filed his voluntary petition under Chapter 7 of the Bankruptcy Code on January 26, 2015 ("Petition Date"), and received his discharge on April 21, 2015. After discharge was entered, Mr. Boudreau filed a one-page complaint initiating this adversary proceeding. Faced with initial motions to dismiss filed by the Division and the Internal Revenue Service ("IRS"), Mr. Boudreau amended his complaint ("Amended Complaint," Doc. #18) to add more detailed allegations and to reference the general statutory underpinning of his request that the taxes owed to these two governmental agencies be declared
In the Amended Complaint, he alleges that he "has filed his income taxes for the tax years included in his chapter 7 petition" (without indicating when such returns were allegedly filed) and asserts that § 727 of the Code discharges all of his debts, including his tax debts. Amended Complaint ¶ 4. Although the Amended Complaint covers tax liabilities listed on his bankruptcy schedules for the years 2004, 2007, and 2009 through 2011, the Division responded that the only outstanding tax Mr. Boudreau owes is for 2010 in the amount of $3,103.
At the July hearing, Mr. Boudreau stated that he filed his state tax return for the 2010 tax year in 2012, not in 2014 as the Division asserts, but conceded that the return was nonetheless filed late because it was due by April 15, 2011. The Court raised the issue of whether Fahey was dispositive as to the principal tax and interest in light of the parties' agreement that the tax return was untimely, and requested that the parties file supplemental memos addressing the Fahey case. The parties did so (Division's supplemental memoranda, Doc. #37; and Mr. Boudreau's response, Doc. #47), and the Court took the matter under advisement.
The Division maintains that Mr. Boudreau's 2010 tax liabilities are nondischargeable because, regardless of when Mr. Boudreau actually filed his 2010 tax return, he agrees that the return was not timely filed under the applicable Rhode Island tax statute. See R.I. Gen. Laws § 44-30-51. Hence, the claim (inclusive of tax and interest only) is not dischargeable under § 523(a)(1)(B), noting the similarities in the applicable Massachusetts statutory filing requirement considered in Fahey and its counterpart in the Rhode Island tax statutes, both of which constitute an "applicable filing requirement" under § 523(a)(*).
Mr. Boudreau filed his objection to the motion, arguing that Fahey is limited to Massachusetts tax law and is therefore not binding on this Court. He zealously and quite articulately presents various arguments why he believes the Fahey decision and its statutory construction of Bankruptcy Code § 523(a)(*) is faulty, noting a number of cases in which courts reached the opposite conclusion. Unfortunately for Mr. Boudreau, the First Circuit rejected such opposing views and this Court is duty bound to follow Fahey, which the Court concludes is controlling as to the underlying 2010 state taxes and interest he owes.
When considering a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6), the Court must accept the well-pleaded facts of the complaint as true, but the Court need not accept as true any allegations that are no more than "labels and conclusions" or "formulaic recitation of the elements of a cause of action." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007); see Ashcroft v. Iqbal, 556 U.S. 662, 678, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) ("Nor does a complaint suffice if it tenders `naked assertion[s]' devoid of `further factual enhancement.'"). Instead, a complaint must "state a claim to relief that is plausible on its face," rather than merely conceivable. Twombly, 550 U.S. at 570, 127 S.Ct. 1955. The Court must also "give the plaintiff the benefit of all reasonable inferences therefrom." Ruiz v. Bally Total Fitness Holding Corp., 496 F.3d 1, 5 (1st Cir. 2007) (citing Rogan v. Menino, 175 F.3d 75, 77 (1st Cir. 1999)).
Bankruptcy Code § 727(a) generally "grants the debtor a discharge"; but "[s]ection 523 addresses the nondischargeability of certain types of debts, including three categories of tax debts that are excepted from discharge." Berry v. Mass. Dep't of Revenue (In re Berry), Adv. No. 15-4045-CJP, 2016 WL 3676528, at *2 (Bankr. D. Mass. June 30, 2016) (citing 11 U.S.C. § 523(a)(1)(A)-(C)). "If the debt for such taxes meets the standard under § 523(a)(1)(A), (B) or (C), then the debt is nondischargeable." Nilsen v. Mass. Dep't of Revenue (In re Nilsen), 542 B.R. 640, 643 (Bankr. D. Mass. 2015). "The party seeking to establish an exception to the discharge of a debt bears the burden of proof.... by the preponderance of the evidence" that its claim falls "squarely within an exception to discharge ...." Id. at 645; N.H. Supreme Court Prof'l Conduct Comm. v. Richmond (In re Richmond), 351 B.R. 6, 10 (Bankr. D.N.H. 2006) (citing Palmacci v. Umpierrez, 121 F.3d 781, 786 (1st Cir. 1997)). The relevant portion of § 523(a)(1), subsection (B)(ii), provides
(1) for a tax or a customs duty — ...
"[S]ubsection (ii) sets forth the so-called `two year rule'" that excludes from discharge taxes filed late but within two years of the petition. In re Nilsen, 542 B.R. at 644 (citing McBride v. City of Kettering (In re McBride), 534 B.R. 326, 331 (Bankr. S.D. Ohio 2015)).
Much litigation under this provision has ensued because of a lack of a statutory definition of "return" applicable to this provision. Congress attempted to address this shortcoming in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") by adding a "hanging paragraph" to § 523(a) following subsection (19), commonly cited to as § 523(a)(*). It states,
With this definition, Congress intended "to settle the dispute over late filed tax returns against the debtor." Fahey, 779 F.3d at 10. As is not infrequently the case, "[i]n actuality, the `hanging paragraph' has been the crux of many bankruptcy appeals, raising more questions about the definition of `return' and thus leaving circuit courts to clarify the murky waters of the Bankruptcy Code." Nilsen v. Mass. Dep't of Revenue, 557 B.R. 1, 4 n.3 (D. Mass. 2016) (citations omitted).
In Fahey the Court of Appeals cleared these murky waters for the courts within this Circuit. The decision involved four consolidated, similarly situated cases involving debtors who owed taxes to the Commonwealth of Massachusetts for which their state tax returns were filed late but more than two years before the filing of their respective bankruptcy cases. The First Circuit ruled that a Massachusetts state income tax return filed late under applicable Massachusetts tax laws, does not qualify as a "return" under § 523(a)(*) because a "straightforward reading of Massachusetts law" must acknowledge that the "command that returns `shall' be made [on or before the fifteenth day of the fourth month following the close of the tax year] certainly seems like a `filing requirement.'" Fahey, 779 F.3d at 4-5 (citing Mass. Gen. Laws ch. 62C, § 6(c)). "[A] return filed after the due date is a return not filed as required, i.e., a return that does not satisfy `applicable filing requirements.'" Id. at 5. This statutory interpretation has been coined "the `one-day late rule' because it prohibits discharge of a tax debt with respect to which a return was filed even one day late." Justice v. United States (In re Justice), 817 F.3d 738, 743 (11th Cir. 2016). In rendering what is essentially a per se rule for late-filed tax returns, the First Circuit joined the Fifth and Tenth Circuits on the issue. See Mallo v. IRS (In re Mallo), 774 F.3d 1313 (10th Cir. 2014); McCoy v. Miss. State Tax Comm'n (In re McCoy), 666 F.3d 924 (5th Cir. 2012).
Bankruptcy Code § 523(a)(7) governs "the dischargeability of debts that come in the form of a penalty or fine.... [It] initially creates a class of debt that is
11 U.S.C. § 523(a)(7)(A)-(B); see United States v. Zidehsarai, 2016 WL 6666823, at *5 (discharging "a fine, penalty, or forfeiture" owed to the government, if it is "(1) `compensation for actual pecuniary loss'; (2) a type of tax penalty ... not mentioned in subsection (1), which addresses a `tax of customs duty'; or (3) a tax penalty that is based on an event that happened before the three-year lookback period."). These subsections are "separate and disjunctive exceptions." In re McCarthy, 553 B.R. at 465. "[N]ormally the particular penalty must serve some `punitive' or `rehabilitative' governmental aim, rather than a purely compensatory purpose." Whitehouse v. LaRoche, 277 F.3d 568, 573 (1st Cir. 2002) (citing Kelly v. Robinson, 479 U.S. 36, 52, 107 S.Ct. 353, 93 L.Ed.2d 216 (1986)). "The test for the determination of the dischargeability of a tax penalty is based on the date of the underlying transaction or event that gave rise to the penalty, not the dischargeability of the underlying tax." In re Allen, 272 B.R. 913, 916 n.1 (Bankr. E.D. Va. 2002); see Aikman v. IRS (In re Aikman), 554 B.R. 95, 99 (Bankr. W.D. Pa. 2016) ("[O]ther courts similarly faced with the dischargeability of a tax penalty pursuant to 523(a)(7)(B) have found the applicable "transaction or event" is the date the returns were due.").
Judge Boroff's decision in In re McCarthy, 553 B.R. 459 (Bankr. D. Mass. 2016) is, as far as the Court can discern, the first published case in this Circuit to address the impact, if any, of Fahey on the dischargeability of tax penalties. There the debtors alleged that the efforts of the Massachusetts Department of Revenue ("MDOR") to collect pre-petition tax penalties assessed on taxes for which the returns were untimely filed violated the discharge order. The MDOR defended its actions on the basis that the penalties were nondischargeable pursuant to § 523(a)(7) because the underlying taxes for which returns were filed late had been held non-dischargeable in accordance with Fahey. But Judge Boroff determined that Fahey was not controlling on the penalty issue because it did not address tax penalties and it remained to be determined "whether the penalties associated with such taxes [were] also non-dischargeable." McCarthy, 553 B.R. at 460. This Court agrees. "The distinction between a tax, a penalty and a debt has a well-established history in bankruptcy practice .... The penalties on the unsecured priority taxes are evaluated under § 523(a)(7). They are not taxes. They are penalties.... [that] are not in compensation for an actual pecuniary loss." In re Allen, 272 B.R. at 915-16.
As earlier discussed, there is no dispute that Mr. Boudreau's 2010 state tax return was due on April 15, 2011 and was filed late, whether in 2012 or 2014. See R.I. Gen. Laws § 44-30-51(a). For purposes of
To the contrary, this footnote simply recognizes that for the discharge determination, each jurisdiction's "applicable filing requirements" must be reviewed to determine if a debtor has satisfied them for the filed return to qualify as a "return" under Bankruptcy Code § 523(a)(1)(B). No matter how harsh the outcome may be, under the doctrine of stare decisis
Like its Massachusetts counterpart, Rhode Island General Law § 44-30-51(a) provides, "On or before the fifteenth day of the fourth month following the close of a taxable year, a Rhode Island personal income tax return shall be made and filed...." (emphasis added).
The determination of the dischargeability of the penalties assessed by the Division for the outstanding 2010 taxes is quite another matter, and the Court concludes that the penalty is dischargeable and falls within the scope of the discharge Mr. Boudreau has already been granted. The Division asserts that the tax penalty is equally nondischargeable as the underlying tax liability because Rhode Island General Laws § 44-30-85(g) requires the Court to treat tax penalties the same as the nondischargeable taxes. And it attempts to distinguish McCarthy on the grounds that it is "unclear ... what the Massachusetts law on tax penalties [was] and how they should be treated," while the Rhode Island law directs tax penalties to be treated as taxes. Doc. #37 at 6. This portion of the Rhode Island statute appears not to have been specifically interpreted by any Rhode Island state or any federal court. Mr. Boudreau challenges the Division's reading of this tax provision, maintaining that it would impose a statutory, unsupported "double taxation" on the 2010 tax liability he already owes. Doc. #47 at 36. Thus, he argues, the penalties are dischargeable under Bankruptcy Code § 523(a)(7)(B) because they were imposed more than three years prior to the Petition Date.
The plain language of the statute does not support the Division's argument. Generally, Rhode Island General Laws § 44-30-85 grants the Division the authority to impose a late-payment penalty for an untimely filed return "unless it is shown that the failure [to timely file] is due to reasonable cause and not due to willful neglect." R.I. Gen. Laws § 44-30-85(a)(1)-(2). Subsection (g) provides, "The additions to the tax and civil penalties provided by this section shall be paid upon notice and demand and shall be assessed, collected, and paid in the same manner as taxes...." By the Court's reading of the provision, it does not transform the penalties into a tax as the Division would have it. Rather, it provides for the assessment, collection, and payment of such penalties in the same manner as the underlying tax due. The penalty does not become automatically nondischargeable because the underlying tax may be nondischargeable. See In re Allen, 272 B.R. at 916 n.1 ("It is possible for the underlying tax to be discharged but the penalty not to be discharged."). The Division concedes that § 523(a)(7) would otherwise discharge Mr. Boudreau's 2010 tax penalties "because the transaction date for both the late filing penalty for the nonpayment of taxes would have been at the time the tax return was due, April 15, 2011," more than three years before the Petition Date. Doc. #37 at 6-7.
Under the binding First Circuit precedent of Fahey, the Amended Complaint fails to state a claim against the Division upon which the requested relief may be granted with regard to the 2010 tax liability and accrued and accruing interest because they are not dischargeable under § 523(a)(1)(B). It does, however, state a claim upon which relief may be granted as to the 2010 penalties assessed as these are dischargeable under § 523(a)(7). Accordingly, the Motion is GRANTED IN PART
