Sometimes one spouse takes the financial reins and handles all the financial aspects of a marriage (like banking, buying cars, preparing tax returns, etc.) while the other spouse handles the day-to-day family issues (like cooking, cleaning, children, etc.). It is not uncommon for the non-financial spouse to sign a tax return without reviewing it. It is a matter of trust. The non-financial spouse trusts the other spouse to prepare an accurate tax return.
In In re Birkenstock, 87 F.3d 947 (7th Cir. 1996), the court was confronted with the issue of whether a wife who signs a joint tax return without reviewing it can be denied a bankruptcy discharge of tax liability for “willful attempt to evade” taxes. The Birkenstock court had no problem finding the husband to be a chronic tax evader who took extraordinary steps to willfully attempt to evade paying the taxes. The husband’s taxes were excepted from the bankruptcy discharge and survived intact at the conclusion of the bankruptcy.
The Birkenstock court had a more difficult time deciding whether the wife also willfully attempted to evade paying the taxes. The court noted that the only relevant evidence upon which the bankruptcy court had determined that the wife had acted willfully was the fact that she had signed the joint tax return.
The Birkenstock court set out the rules for non-dischargeability of tax liability in bankruptcy. The court noted that a Chapter 7 debtor is typically granted a general discharge of all debts owed as of the bankruptcy filing date. However, 11 U.S.C. §523(a)(1)(C) creates an exception to the dischargeability of income taxes when the taxpayer makes “a fraudulent return or willfully attempts in any manner to evade or defeat” the tax.
So the question in the Birkenstock case was what constitutes “willfully attempts … to evade or defeat” the payment of taxes. The 7th Circuit held that §523(a)(1)(C)’s exception comprises both a conduct requirement (that the taxpayer sought in any manner to evade or defeat his tax liability) and a mental state requirement (that the taxpayer did so willfully). The court found that a “willful” determination requires a taxpayer’s attempt to avoid tax liability to be voluntary, conscious, and intentional. In other words, the taxpayer must both (1) know that she has a tax duty under the law, and (2) voluntarily and intentionally attempt to violate that duty. The willfulness requirement prevents the application of the bankruptcy discharge exception to taxpayers who make inadvertent mistakes, reserving nondischargeability for those whose efforts to evade tax liability are knowing and deliberate.
After reviewing the law and apply the law to the facts, the court ruled that the bankruptcy had erred in finding the spouse had willfully attempted to evade the tax liability. The only evidence presented at trial regarding the wife’s willfulness was the fact that she had signed the tax returns. Therefore, the bankruptcy court order was reversed and the wife was granted the bankruptcy discharge as to the tax liability.
Practice Pointers: A spouse should consider not filing a joint tax return if the spouse has any reason to believe the other spouse may be filing a fraudulent return or may be willfully evading the tax liability. Instead, a spouse should consider filing a separate tax return, especially if the spouse has little to no income as the spouse in Birkenstock. The wife in Birkenstock would not have had any tax liability, because she did not work, had she filed separately. The husband would have had all the tax liability and the wife would not have had to worry about any court ruling that her share of the tax liability was nondischargeable. There are some tax disadvantages by filing separately, but none of the those disadvantages would compare to the disadvantage of the wife being held jointly and severally liable for the husband’s tax liability that could later be deemed nondischargeable in bankruptcy.
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