Section 727(b) of the Bankruptcy Code provides for the discharge of an individual chapter 7 debtor’s prepetition debts unless such debts are excepted from discharge pursuant to 11 U.S.C. §523. Section 523(a)(1)(C) excepts from discharge any debt “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”
The issue of willful evasion was addressed in In re Looft, 553 B.R. 910 (Bankr. N.D.GA 2015). In Looft, an IRS audit resulted in the disallowance of partnership losses taken by an individual taxpayer on Form 1040. The IRS then assessed tax liability of approximately $319,000. The taxpayer struck back by hiring attorneys to sue the tax professional who advised the taxpayer to include the partnership losses on the tax returns. Taxpayer submitted a request for a collection due process hearing and filed a petition in the US Tax Court. The IRS issued notice of intent to levy. Taxpayer filed an offer in compromise to settle the tax liability. Ultimately, taxpayer sought bankruptcy relief to discharge the tax liability.
The Looft court considered the taxpayer’s behavior after the IRS audit to determine if the taxpayer willfully attempted to evade paying the taxes. On the negative side, and instead of paying the tax liability assessed, taxpayer paid more than $88,000 in college tuition so his child could attend the University of Virginia. Taxpayer also purchased an $18,500 BMW for taxpayer’s daughter to use during college and another BMW for $9,800 when she graduated. Taxpayer also gave cash gifts to his children and bought them cell phones and a laptop computer. Taxpayer also spent $68,000 on his country club and more than $16,000 on trips and vacations.
On the positive side, the court noted the following about the taxpayer: (1) asserted he was victim of bad tax advice; (2) made voluntary payments towards the assessed taxes, including $2,500 obtained through a home equity loan; (3) took no action to stop the IRS from intercepting taxpayer’s refunds; (4) did not change tax withholdings to reduce future refunds; (5) withdrew money from a 401(k), paying tax penalties to do so, and paid $22,000; (6) took no effort to change bank accounts or withdraw money from bank accounts after receiving the IRS’ notice of intent to levy; (7) taxpayer continued to direct deposit his paychecks into the same bank account after the levy; (8) did not avoid keeping money in the bank account; and (9) timely-filed tax returns and timely-paid tax obligations relating to all tax years after the tax assessment resulting from the audit.
The Looft court noted that the IRS has the burden of proof and that exceptions to discharge are strictly construed in favor of the taxpayer. The Looft court identified IRS burden. The IRS must show that taxpayer engaged in (1) evasive conduct with (2) a mental state consistent with willfulness.
Evasive conduct requires a showing that the taxpayer engaged in affirmative acts to avoid payment or collection of the taxes, either through commission or culpable omission. The conduct requirement is not satisfied by mere nonpayment of taxes.
The 11th Circuit in Zimmerman v. IRS (In re Zimmerman), 262 Fed. Appx. 943, 946 (11th Cir. 2008) supported a finding of nondischargeability when the conduct included: (1) failure to timely-file tax returns: (2) failure to pay taxes; (2) intra-family transfers for little or no consideration; (3) titling a house solely in the spouse’s name while the debtor remains on the mortgage and makes all the payments; (4) characterizing earnings so they are not subject to tax withholding; (5) making large discretionary expenditures; (6) failure to file tax returns while maintaining a luxury lifestyle. Other issues to consider are: (6) use income to pay off other burdensome debts; (7) behavior intended to prevent IRS from reaching taxpayer’s assets; (8) under-withholding of taxes from paychecks; (9) failure to pay estimated taxes; (10) failure to accrue assets by opting to lease assets instead; (11) dealing primarily in cash transactions; (12) excessive spending; and (13) discontinuance of direct deposit of wages into an account subject to a levy.
The Looft court considered all these factors as they related to taxpayer and found that the tax payer did not willfully attempt to evade paying the taxes. Important to the court was the fact that the only steps the taxpayer took to prevent the IRS from collecting the tax liability were through official channels (i.e. offer in compromise, tax court, collection due process hearing). The court found that taxpayer’s actions were not consistent with an intentional failure to pay.
Practice Pointers: Whether a taxpayer willfully evaded paying taxes is a fact intensive analysis. If in doubt, a taxpayer should establish a pattern of action that would support a conclusion that the taxpayer has the desire to pay without the ability to pay.
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