INTENTIONAL EVASION OF TAX PAYMENT MAY NEGATE BK DISCHARGE OF TAXES

Sections 507 and 523 of the bankruptcy code states that income taxes are discharged in bankruptcy provided they are at least 3 years old, that the assessment of tax due has been made at least 240 days before bankruptcy filing, and no fraud was involved. What if you owe $500,000 of income taxes for 1999, 2003, and 2005 and you file for Chapter 7 bankruptcy today, would you be able to wipe out the half a million of taxes you owed to the IRS? Yes, provided all required conditions were present. But what if the IRS objects to the discharge by alleging that you intentionally evaded payment of income taxes by filing tax returns without any intention of paying taxes due? Is the IRS correct? What do you think?

 While it is true that intentional evasion of tax payment may negate the discharge of taxes in bankruptcy, it is not enough that the IRS makes that allegation; they must prove it by a preponderance of evidence in an adversarial proceeding in the bankruptcy case. Thus, a trial must be had, and the IRS must win at trial. If the IRS loses at trial, the taxes are discharged. Can you discharge $1.0 million of taxes? Sure. I had a client who owed the IRS $1.5 million and the entire amount was discharged in bankruptcy.

In Re United States v. Storey, Dr. Storey filed income tax returns for 1994 through 1997. She never paid any of the taxes she owed on the returns. “Bad, bad doctor”, the IRS said. She filed for Chapter 7 relief in March 2002 and eventually received a discharge without the court making a specific determination as to the dischargeability of the unpaid taxes. In March 2007, the United States sued the doctor to reduce to judgment her income tax liabilities and to foreclose on its tax liens. The doctor responded that her tax obligations were discharged. The United States replied that her taxes were not discharged because she had willfully attempted to evade or defeat their payment.

The district court granted summary judgment for the government, finding that the doctor’s pattern of filing income tax returns and not paying her taxes was evidence of a willful attempt to defeat the tax. The doctor appealed. The 6th Circuit said that, “The government must prove that the debtor 1) had a duty to pay taxes, 2) knew she had a duty, and 3) voluntarily and intentionally violated that duty.”

The doctor conceded that she had a known duty to pay taxes, but argued that there was no evidence that she voluntarily or intentionally violated that duty. The court of appeals agreed, finding little evidence to support a finding that she voluntarily and intentionally violated her known duty to pay taxes.

The government’s only argument to the district court came in response to the court’s request for briefing: “The United States maintains that Storey’s tax liabilities are non-dischargeable based upon her willful attempt to evade or defeat her taxes. The court said no facts were alleged to support the government’s position.

On appeal, the government pointed to the debtor’s purchase of a new home in 1994 as evidence that she made a voluntary and intentional decision against paying her taxes. However, the court said there was no indication that the property was more lavish than her previous home, that it was an unnecessary expense, that it was acquired as an alternative to paying taxes, or that the debtor was even aware that she would be unable to pay her taxes when she bought the home.

The government pointed out that the bankruptcy court did not discharge the doctor’s student loans, but the court of appeals that the treatment of student loans in bankruptcy “differs significantly from the treatment of tax obligations.”

Thus, the court of appeals ruled that the government did not prove by a preponderance of evidence that the doctor had voluntarily and intentionally avoided paying her taxes. Her taxes were discharged.

Lawrence Bautista Yang is a graduate of Georgetown University Law Center and has been in law practice for thirty years. He specializes in bankruptcy, business and civil litigation and has handled more than four thousand successful bankruptcy cases in California. He speaks Mandarin and Fujien and looks forward to discussing your case with you personally. Please call (626) 284-1142 for an appointment at 1000 S Fremont Ave Bldg A-1 Suite 1125 Unit 58 Alhambra, CA 91803.