I have discussed the exception to discharge under BC 523(a)(1)(c) previously here, here and here. These cases usually merit some discussion because they contain the kinds of facts that allow us to get a little riled up and actually root for the IRS. The case of United States v. Harold, No. 16-05041 (Bankr. E.D. Mich. 2020) proves no exception to the general rule of these types of cases. The IRS does not pursue this exception to discharge often but when it does the facts usually make for a mildly interesting blog post.
Dr. Harold, the debtor here, is a medical doctor with an OB/GYN practice. The court says that she has a successful, busy practice and works long hours. At issue in this case are unpaid federal tax liabilities for 2004 through 2012 and 2014 which she could discharge in her chapter 7 case unless the exception for attempting to evade payment applied. The court spends a paragraph talking about her husband, a former CPA who lost his license as a result of a conviction for a false statement on a bank loan application, bank fraud, tax evasion and filing a false return. These actions took place prior to their marriage in 1993 and he now owns a consulting firm, Fidelity Refund Services. Dr. Harold did not have experience in financial matters, and her husband handled all of her tax matters.
Their returns were routinely filed on extension or late. She owed liabilities ranging from $5,000 to $42,000 for the years at issue despite averaging about half a million dollars in gross revenue from her practice during those years. There appears to be some dispute as to the amount owed but it is at least $250,000. During the years at issue the IRS sent at least 84 collection notices, very few of which Dr. Harold saw, because she worked long hours and her husband usually picked up the mail and handled the tax matters. She did, however, know there were outstanding tax liabilities for many years.
The court then described the spending of money during the years at issue. Spending drives these cases. Many people owe the IRS but those who have enough money to spend on items that support an affluent lifestyle while not paying the taxes receive the scrutiny of the IRS in discharge cases. The court first described the purchase of a new home in 2005 along the Detroit River waterfront. This purchase created financial problems, because they could not sell their prior home and carried two mortgages until finally losing the original home to foreclosure in 2009. They sent their children to private grade schools and high schools paying a total of $64,247 in tuition for their daughter and $ 89,474 for their son. Then they sent their children to private colleges paying $118,390 for their daughter to attend Boston University and $53,088 for their son to attend Loyola University.
During these years the family took multiple family vacations to Mexico, Alaska, Puerto Rico, Orlando, Washington, D.C., Paris, Las Vegas, Hawaii, and Dubai in addition to numerous trips to go and visit colleges. They drove expensive cars: a Jaguar, a Mercury Mountaineer, two Cadillacs, to Lincolns, a Lexus and a Harley Davidson motorcycle. The debtors also actively sought to place their home beyond the reach of the IRS through a sale and leaseback scheme described by the court.
The court then worked through the existing Sixth Circuit law regarding BC 523(a)(1)(c) and the evidence needed to show an attempt to evade or defeat payment of the tax liability. The court found that the evidence “overwhelmingly demonstrates that the Debtor engaged in conduct to evade or defeat the payment of her tax liabilities for the years 2004-2012 and 2014.” The court recounted all of her pre-bankruptcy expenditures but seemed even more convinced by the post-filing efforts to insulate the family home from the federal tax lien.
Her actions convinced the court that she willfully intended not to pay her taxes. It pointed out that all of her expenditures resulted from “voluntary, conscious and intentional choices.” It did not matter that she delegated the handling of tax matters to her husband. She knew his past tax issues and she knew the choices she was making regarding the non-payment of taxes. The court applied her knowledge and action to the standards established by the Sixth Circuit in the case of Stamper v. United States (In re Gardner), 360 F.3d 551 (6th Cir. 2004). The Gardner case established the mental state requirement of proof that the debtor had a duty to pay, knew of the duty and voluntarily or intentionally violated the duty.
Dr. Harold argued that she did not voluntarily or intentionally violate the duty to pay her taxes because she had a strong religious need to send her children to Catholic schools and she relied on her husband to manage the family financial affairs. The court quickly rejected these arguments.
The use of 523(a)(1)(c) to deny a debtor a discharge for willful non-payment of taxes began in a Sixth Circuit case almost 15 years after the adoption of the “new” bankruptcy code in 1978. The case of Toti v. United States, 24 F.3d 806 (6th Cir. 1994) was the first circuit level court to approve of the use of the discharge exception in this way. Since that time courts have struggled at times to decide both the standard for holding the taxpayer liable for the taxes and the amount of lavishness necessary to cause the bankruptcy court to say enough. Here, the IRS clearly established that Dr. Harold went too far. The case provides another lesson on the perils of maintaining a high lifestyle while putting off payment of taxes. I seem to write about it every couple of years simply as a reminder that high personal expenditures while failing to pay taxes serves as a recipe for losing the ability to discharge old taxes in a bankruptcy case.