I have written before on many occasions about taxpayers who sought a discharge of their tax debts through chapter 7 bankruptcy. For individuals filing chapter 7, the basic discharge provisions exist in BC 727, but I have always previously discussed the exceptions to discharge in BC 523(a)(1) and (7). In the case of Kresock v. United States, 128 AFTR 2d 2021-6995 (BAP 9th Cir.)(unpublished), the bankruptcy appellate panel sustains the decision of the bankruptcy court denying Mr. Kresock a discharge based on BC 727. To get a discharge of taxes based on BC 727 the individual’s behavior must rise to the level that the court feels no need to get to exceptions to discharge because the general provisions denying discharge prevent the debtor from writing off the debt. Maybe this happens more often than I think but I don’t ever remember seeing a BC 727 discharge denial where the focus of the denial was on tax debt.
BC 727(a)(3) provides that a debtor is not entitled to a chapter 7 discharge if he
has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, records, and papers, from which the debtor’s financial condition or business transactions might be ascertain, unless such act or failure to act was justified under all of the circumstances of the case.
BC 727 has other provisions that could deny a debtor a discharge but (a)(3) relates to Mr. Kresock’s case and potentially to other similar cases with major tax issues. If the bankruptcy court denies a debtor’s discharge under BC 727, then no need exists to examine the exceptions to discharge. That’s what happens in this case but in a case in which the debtor does survive the general denial of discharge, something that does not happen with great frequency, then the exceptions to discharge apply and some have specific application to taxes.
BC 523(a)(1)(A) excepts from discharge any tax debt entitled to priority under BC 507(a)(8) which basically covers income taxes where the return due date falls within three years of the filing of the bankruptcy petition, income taxes assessed with 240 days of the bankruptcy petition, income taxes not yet assessed but assessable (unless the statute is open because of non-filing or fraud), taxes based on non-payment of money held in trust (e.g., trust fund recovery penalty for responsible officers) and employment and excise taxes due within the past three years. This covers a lot of taxes but certainly not all. Older income, employment (non-trust fund) and excise taxes are not described here.
BC 523(a)(1)(B) excepts from discharge taxes for which the taxpayer has not filed a return and taxes where the taxpayer late files a return within two years of the bankruptcy petition.
BC 523(a)(3) excepts from discharge taxes which the debtor tried to avoid by filing a fraudulent return or by concealing income and assets to avoid payment.
BC 523(a)(7) excepts from discharge penalties on taxes to the extent the penalty arose within three years of the filing of the bankruptcy petition.
One reason I may not have seen a BC 727 case heavily basing the decision on taxes is that to deny a discharge under BC 727 the taxing authority must affirmatively act within a specified period of time to bring the discharge issue before the court. For exceptions to discharge, the IRS does not need to do anything during the bankruptcy case if one or more of the exceptions apply. Discharge fights under BC 523 typically play out after the bankruptcy case when the IRS starts collecting again and the debtor thinks the tax or penalty the IRS seeks to collect after bankruptcy was discharged. The debtor then brings an action that the IRS has violated the discharge injunction and the parties fight it out, but the IRS did not need to do anything affirmatively.
Mr. Kresock is a cardiologist who appears to believe that normal rules do not apply to him. The court finds that Mr. Kresock failed to keep or maintain financial records, falsified a court order and made false oaths in connection with his bankruptcy case. On that basis the BAP sustains the decision of the bankruptcy court. The court provides lots of details regarding his behavior in support of its conclusion, including this paragraph about his girlfriend:
Ms. Janine Smith is Dr. Kresock’s girlfriend. Since 2009, she has lived with Dr. Kresock and worked at CVC. Ms. Smith is not paid a salary from CVC, but Dr. Kresock pays all of her expenses, including the mortgage interest payments (not disclosed) on four homes titled in her name. For at least six years prior to his bankruptcy, from 2010 to 2015, Dr. Kresock gave Ms. Smith annual gifts of $100,000 and had his CPA prepare gift tax returns to reflect these gifts.
As the IRS and other creditors tried to gather information from him, Mr. Kresock failed to respond to the creditors or to the court orders. He had filed returns for several years prior to bankruptcy reporting that he had no taxable income. The IRS questioned this, considering he purchased numerous homes, vehicles, boats, and other personal property listed in his schedules. From the information it could gather, the IRS determined that he owed $2,293,059.32. The court recounts other actions of Mr. Kresock, which included altering the purchase date of a Hummer, altering an order entered in a criminal case regarding his obligations, and misrepresentations in his bankruptcy schedules including false statements about the amount of gifts he had given prior to bankruptcy.
The U.S. Trustee filed the complaint seeking to deny his discharge which is consistent with my not having seen the IRS do this before. The trustee moved for summary judgment. In his response, Mr. Kresock denied some of the trustee’s allegations in the motion but admitted:
that he “was a highly educated professional who engaged in complex transactions involving millions of dollars of assets,” that given “his education and business history, [he] had the sophistication and forethought to maintain proper documentation of his financial affairs,” and that “to complete its audit, the IRS was required to subpoena third parties in order to obtain financial information in an attempt to recreate [his] financial records.” Dr. Kresock admitted that the “IRS reviewed well over 10,000 documents in its audit…including bank statements, cancelled checks, and deposit slips subpoenaed from the several banks in which CVC, Dr. Kresock, and Ms. Smith did business.”
In sustaining the granting of the summary judgement motion the BAP found that the trustee had proven Mr. Kresock’s failure to keep business records and his false statements under oath. The trustee also proved that he falsified a court order as well as the bill of sale of the Hummer. Because of the proof, the court sustained the summary judgment determination.
Because the IRS generally does not engage at the stage of seeking a BC 727 discharge, few cases exist using taxes as one of the bases for a general discharge denial. Mr. Kresock’s case shows that if your behavior is bad enough, the failure to properly file taxes or to respond to questions from the IRS can play a major role in denying a discharge. The same facts would also support an exception to discharge under 523(a)(1)(C) but thanks to the work of the U.S. Trustee the IRS will not have to defend its decision to except Mr. Kresock’s taxes from discharge since he is denied a general discharge and doesn’t get to the stage of having the exceptions apply.