Criminals who have been convicted of tax fraud or other tax crimes typically have tax liabilities. But not all tax crimes are the same. Some crimes relate to filing fraudulent tax returns with the intent to evade paying taxes. Other tax crimes relate to willfully submitting to the IRS false returns, statements, or other documents that may or may not relate to any intent to evade paying taxes. From a bankruptcy point of view, these crimes are not equal.
The question arises whether a taxpayer convicted of willfully submitting to the IRS false “returns, statements, or other documents” pursuant to 26 U.S.C. §7206(1) can discharge the related tax liabilities by filing Chapter 7 bankruptcy. This issue was addressed in U.S. v Parker, 578 Fed.Appx. 669 (9th Cir. 2014). In Parker, the IRS filed a summary judgment motion seeking to reduce to judgment the taxpayer’s income tax liability after taxpayer received a bankruptcy discharge. The taxpayer objected claiming there was a triable issue of fact that precluded the entry of a summary judgment on the issue of bankruptcy dischargeability, namely whether the taxpayer ever intended to evade paying the tax. Taxpayer asserted that the tax conviction (and tax liability) resulted from the embezzlement of funds to save a business from bankruptcy and not to evade paying IRS tax.
The 9th Circuit Court of Appeals began its analysis by noting that a taxpayer’s discharge in bankruptcy may be excepted “for a tax… with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” 11 U.S.C. §523(a)(1)(C). The government must demonstrate (1) a knowing falsehood; (2) an intend to evade taxes; and (3) an underpayment of tax.
The Parker court determined that the 26 U.S.C. §7206(1) criminal conviction proved conclusively that the taxpayer had satisfied the first and third element (“a knowing falsehood” and an “underpayment of tax”), but did not conclusively prove the second element (that the taxpayer had intended to evade the payment of taxes). So the court denied the IRS’ motion for summary judgment because an intent to evade taxes creates a credibility determination that is prohibited at the summary judgment stage. A trial is required to determine the taxpayer’s intent.
Practice Pointers: A tax professional must realize that not all tax crime convictions are the same. The tax professional must review the specific elements of the crime committed. Some criminal convictions necessarily would result in the denial of a bankruptcy discharge, while other crimes do not.
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