On August 2, 2016, Judge Brendan L. Shannon of the Delaware Bankruptcy Court issued an opinion (the “Opinion”) in the Refco Public Commodity Pool, L.P. bankruptcy, Case No. 14-11216.  A copy of the Opinion is available here.  The Opinion holds that this Debtor’s failure to file its taxes was due to reasonable cause, and the associated tax penalties are, therefor, claims that can be excused and disallowed.

Judge Shannon provides extensive background in this case, as the legal issues are highly fact specific and require him to adjudicate the debtor’s tax liability.  Opinion at *6.  The history of the debtor reads like a painful drama.  The partnership invested nearly everything into a managed futures fund (“SMFF”).  Then, SMFF failed, filing for bankruptcy in 2005.  At that point, SMFF’s financial reports and accounting system fell into disarray.  The debtor, claiming that they could not rely upon the financial reports of SMFF, failed to file tax returns for 2006-2008.  Opinion at *16.

The IRS filed a claim asserting a general unsecured claim of $4,112,000 for the fines incurred for failing to file tax returns.  Opinion at *5.  As provided by the Bankruptcy Code, the Court “may determine the amount or legality of any tax, any fine, or penalty relating to a tax…”  Opinion at *6.  According to the Internal Revenue Code, a taxpayer can obtain a waiver of penalties for failing to file a partnership return if the failure was “due to reasonable cause and not due to willful neglect.”  Opinion at *8.

Here, Judge Shannon held that the debtor’s failure to file its tax returns was reasonable and “arose from events beyond its control.”  Opinion at *12.  The debtor had two options in this instance, file tax returns it believed to be extremely inaccurate, or file no returns.  Because a filer must declare that its tax return is “true, correct, and complete” under penalty of perjury, the debtor was reasonable in not filing its return.  Opinion at *15-16.  Not only was it reasonable before failing to file, it was reasonable after failing.  Opinion at *17.  Both the IRS and the debtor agreed that this was not a case of willful neglect and Judge Shannon agreed.  Opinion at *17.

This is one of a few rare cases in which tax penalties were denied by the Bankruptcy Court.  And as a review of the Opinion shows, it is a highly fact specific inquiry and, if this case is any indicator, requires debtors to meet a high evidentiary burden.  I would recommend that anyone considering filing bankruptcy in an effort to avoid penalties for failing to file their taxes have a thorough discussion with a legal professional as this is a very risky proposition.