Tax Notes logo

Taking Issue With the Ninth Circuit and Lavar Taylor’s View of A Willful Attempt to Evade or Defeat Tax

Posted on Oct. 6, 2014

Today’s post is from Professor Bryan Camp, the George H. Mahon Professor of Law at the Texas Tech University School of Law. Bryan is a prolific scholar whose work on tax procedure and administration is thoughtful and provocative. In this post, Bryan responds to Lavar Taylor’s posts from two weeks ago on the Ninth Circuit Hawkins case. We are thrilled to welcome Bryan as a Procedurally Taxing guest blogger. Les

Bankruptcy Code (“BC”) §523(a)(1)(C) prevents the discharge of a tax when a debtor “willfully attempted in any manner to evade or defeat such tax.” The recent 9th Circuit decision in Hawkins v. Franchise Tax Board, — F.3d – , 2014 WL 4494845 (9th Cir. No. 11-16276, Sept. 15, 2014) interpreted “willfully” to require a specific intent on the part of the debtor to evade taxes, which must be evidenced by some affirmative act of evasion committed by the debtor. All the other circuit courts to consider this issue have interpreted “willfully” to require only that the debtor make a voluntary and conscious choice to use money for non-tax purposes at a time when the debtor has the means to pay on the tax liability now sought to be discharged. In re Fegeley, 118 F.3d 979 (3d Cir. 1997); Matter of Bruner, 55 F.3d 195 (5th Cir. 1995); In re Toti, 24 F.3d 806 (6th Cir. 1994); Matter of Birkenstock, 87 F.3d 947 (7th Cir. 1996).

In particular, if a debtor lavishly spends money on luxuries far beyond the debtor’s means, racking up debts to other creditors at a time the debtor knows about a tax debt, that is sufficient to be a willful attempt to evade or defeat such tax and render the tax debt non-dischargeable.

That is what apparently happened in Hawkins: in the judgment of the bankruptcy court, affirmed by the district court, the Mr. Hawkins’ spending was so over the top that it amounted to a willful attempt to evade or defeat his tax debts. The 9th Circuit reversed because no one had connected the lavish spending to a specific intent in Mr. Hawkins’ mind and willfulness required a specific intent to evade.

The 9th Cir. decision bucks the majority view. It has sparked two laudatory posts from A. Lavar Taylor (Lavar), who authored an amicus brief in the case. Lavar believes the 9th Cir.’s decision was: (1) the right legal interpretation of 523(a)(1)(C); and (2) practically preferable to the majority interpretation because makes for a clearer and more uniform application of the law. Since I respectfully disagree with Lavar on both points, Keith, Les and Steve have kindly lent me their blogspace to give my alternative analysis.

1. The 9th Circuit Misinterpreted 523(a)(1)(C).

Key to both the 9th Circuit’s and Lavar’s legal analysis is an argument built on language used over in the Internal Revenue Code (“IRC”). IRC §7201 makes it a felony to “willfully attempt[ ] in any manner to evade or defeat any tax.” This language is almost identical to the language used in §523(a)(1)(C). In the felony tax statute, the term “willfully” does require the Government to prove that the law imposed a duty on the defendant, that the defendant knew of this duty, and that he voluntarily and intentionally violated that duty. See e.g. United States v. Bishop, 291 F.3d 1100, 1106 (9th Cir.2002). The 9th Cir. thought that the similar language in the Bankruptcy Code should be construed similarly.

The 9th Cir. found nothing in the legislative history of the Bankruptcy Provision to negate its decision to read the Bankruptcy Code provision in pari materia with the IRC. And it explicitly relied on the Supreme Court’s decision in Spies v. United States, 317 U.S. 492 (1943). There, the government had asked the Court to interpret the term “willfully” in the felony tax statute quoted above in the same way that the term “willfully” had been interpreted in a nearby misdemeanor tax statute. The 9th Circuit explained the importance of Spies to its way of thinking like this:

the Court considered the difference between the misdemeanor of willfully failing to pay a tax or file a timely return (§ 7203) with the felony of willfully attempting to evade or defeat a tax or its payment (present § 7201). The Supreme Court rejected the government’s contention, which is similar to the one it takes in this case, that a willful failure to file a return, coupled with a willful failure to pay the tax, constituted a willful attempt to evade or defeat a tax in violation of § 7201. Rather, it interpreted the statute as requiring some willful commission in addition to willful omissions. It then provided some examples of qualifying acts, including keeping double books, making false bookeeping entries, destruction of records, concealment of assets, along with any kind of conduct, the likely effect of which would be to mislead or conceal. Applying the logic of Spies, which was construing language almost identical to the phrase at issue, simply spending beyond one’s income would not qualify as a “willful [ ] attempt[ ] in any manner to evade or defeat such tax. (Internal quotes, citations, omitted)

I think the 9th Circuit’s analysis is deficient. If one is going to look to the IRC and judicial glosses on it, the 9th Circuit looked in the wrong place and, therefore, came to the wrong interpretation.

The 9th Cir. looked at the meaning of the term “willfully” as interpreted for criminal tax statutes, not civil statutes. But BC §523 is a civil statute, not a penal statute. Nor is the greater purpose of the Bankruptcy Code penal. It has two well-known purposes that exist in tension. First, it exists “to provide a procedure by which certain insolvent debtors can reorder their affairs, make peace with their creditors, and enjoy a new opportunity in life, a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt.” Grogan v. Garner, 498 U.S. 279, 286, (1991)(internal quotes omitted). We can call this the “fresh start” purpose. A second purpose is to help competing creditors get the most money they can in an efficient and orderly manner. See generally, Elizabeth Warren, Bankruptcy Policy, 54 U. Chi. L. Rev. 775 (1987). These twin aims of bankruptcy recognize the value of bankruptcy outcomes tracking non-bankruptcy outcomes but justify alteration of those outcomes by the fresh start concerns. Id. Section 523(a)(1) reflects these twin aims in the tax debt context. In particular bankruptcy courts must exercise judgment here on whether and under what circumstances the non-bankruptcy outcomes should be altered to give debtors that fresh start. Put another way, the bankruptcy judge’s job is to discern whether the debtor was honest but unfortunate or whether the debtor was trying to stiff the government. It’s the classic distinction between the unlucky and the unscrupulous, the schlemiel and the schmuck. Either way, the purpose of the Bankruptcy law is not to penalize: the debtor is either relieved of debt or required to still owe it. One might even say the purpose of bankruptcy is remedial, either in favor of the debtor’s fresh start, or in favor of allowing creditors to continue pursuing their non-bankruptcy remedies.

So if one is going to look to the Tax Code for guidance, it would seem to make more sense to look to the civil provisions of the Tax Code that use the concept of “willfully attempt to evade or defeat” rather than the criminal provisions. When one does so, one finds loads of precedent interpreting tax law concepts of “willfully” differently in the civil tax provisions than in criminal provisions, even where the civil and criminal provisions use the exact same language.

Perhaps the best example of this dual construction of the same word (“willfully”) is to compare and contrast IRC §6672 with §7203. Both provisions deal with the duty imposed on several groups of persons to collect, account for and pay over to the government various taxes imposed on other persons. The best known example of this duty is the duty imposed on employers with respect to their employee’s social security taxes and income taxes. See IRC §3102(a)(social security taxes); §3402(a)(1)(income taxes). These taxes are known as “trust fund” taxes because the money collected is deemed to be held in trust for the United States. IRC §7501(a); see United States v. Strebler, 313 F.2d 402, 404-05 (8th Cir. 1963). They are also called “third party” taxes because the duty is to collect someone else’s tax. Slodov v. United States, 436 U.S. 238, 249 (1978).

IRC §6672 imposes a civil penalty on any person who, under a duty to collect a trust fund tax, “willfully fails to collect such tax, or truthfully account for and pay over such tax.” The penalty amount is 100% of the amount not paid. So it is a pretty hefty consequence. Worse, and especially relevant here, Congress has made this 100% penalty nondischargeable in bankruptcy because it is a priority claim under BC 507(a)(8)(C) that is excepted from discharge by BC 523(a)(1)(A).

IRC §7202 is the criminal analog to §6672. It provides that any person who, under a duty to collect a trust fund tax, “willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony.”

So here we have two IRC provisions, one civil and one criminal, that use exactly the same phrase to describe the prohibited conduct. Yet the courts have long interpreted the term “willfully” very differently for §6672 purposes than for §7202 purposes. As the 7th Circuit explained: “in criminal statutes, ‘willfulness’ generally requires bad purpose or the absence of any justifiable excuse . . . . In civil actions, however, these elements need not be present. Rather, willful conduct denotes intentional, knowing and voluntary acts.” Monday v. United States, 421 F.2d 1210, 1215 (7th Cir.), cert. denied, 400 U.S. 821 (1970).

For example, in Domanus v. United States, 961 F.2d 1323 (7th Cir. Ill.1992), Mr. Domanus was convicted of a civil violation of IRC § 6672 for willfully failing to withhold employee social security and income taxes, under a definition of “willfully” as “voluntary, conscious and intentional—as opposed to accidental—decisions not to remit funds properly withheld to the Government.” Id. at 1324. He argued that the government should be required to prove “willfully” according to its settled definition in the companion criminal provision, that is, an intentional violation of a known legal duty. The court held, however, that while Congress had evidenced an intent that the term “willfully” be interpreted strictly for criminal tax statutes, that strict definition was not required in applying civil tax statutes,” because the purpose of the civil remedies was to allow “the United States the ability to collect wayward trust fund taxes.” Id. at 1326.In effect, the different purposes attendant to the civil and criminal parts of the statute warranted different interpretations of the same term.

Nor is the different interpretation of “willfully” in civil and criminal provisions confined to the context of tax statutes. in Laffey v. Northwest Airlines, Inc. 567 F.2d 429 (D.C. Cir. 1976), the issue was whether the term “willful” in a civil provision of the Fair Labor Standards Act (29 U.S.C. §216(d)), had the same meaning as the same term used in a criminal provision, (§216(a)). The defendant had contended that the term “willful” meant the same thing in both provisions: bad purpose or evil intent. The court instead adopted a less strict definition of the term for its use in civil cases.

[Defendant] contends that “willful” in the suit-limitation provision takes on the interpretation given the same word in the criminal provision…. We do not agree that the criminal construction is to be imparted into the civil provision simply because both provisions are part of the same statute. The purposes of the two sections are entirely different; one punishes as criminal certain specified conduct while the other subserves a policy to which punishment in entirely foreign. Laffey, 567 F.2d at 461-462, n230.

Thus, far from being a game-winner, the Spies case—where the S.Ct. was comparing the language in two criminal tax statutes, is just a non-starter in analyzing the proper meaning of “willfully” in BC §523, a civil and remedial provision.

The 9th Circuit just got it wrong; the majority of courts who have decided that “willfully” means only an intentional act—as opposed to accidental—have the better interpretation.

2. The 9th Circuit’s Decision is Not Practically Preferable

Lavar also argues that even under the civil willfulness standard, Mr. Hawkins was not willful under the facts of the case. That very well may be. I do not quarrel with the facts of the case, only with the 9th Circuit’s interpretation of the legal meaning of the term “willfully.” I am not defending the bankruptcy court’s application of facts to the legal standard it used. I am just defending the legal standard: a tax should not be dischargeable if the debtor made a voluntary and conscious choice to use money for non-tax purposes at a time when the debtor has the means to pay on the tax liability now sought to be discharged.

Lavar takes his quarrel with the bankruptcy court’s application of facts a bit further. He argues that reading “willfully” to include behavior such as Mr. Hawkins will create great uncertainty over what expenditures by the debtor a court will find to be unnecessary and therefore satisfy the willfulness requirement for non-discharge. Lavar raises many good questions where there may be difficultly in discerning true need from lavish spending.

The short answer here that Lavar is surely correct that the civil standard for willfulness—the correct legal standard in my view and the view of all but one Circuit Courts of Appeal—leaves more room for more debtors to find their income tax liabilities non-dischargeable. Two thoughts, however, give me comfort that Lavar’s parade of hypotheticals is not so horrible.

First, discernment is what we pay bankruptcy judges to do. They are, after all, paid to “judge” and that means take into account all the facts and circumstances. So a complaint that a legal standard requires a judge to discern and label behavior does not trouble me inherently. The bankruptcy judges must explain their decisions and are subject to at least two levels of review. I presume, as we all presume, that our judges are capable people. Certainly the Supreme Court believes so, leaving to district court the responsibility to discern whether a transfer of property or cash in a business relationship is an excludable gift under IRC §102(a). Duberstein v. Commissioner   (mainsprings of …)

Second, the 9th Circuit’s decision to apply a criminal standard of willfulness to the civil bankruptcy statute does not eliminate the need for discernment. The criminal standard is no more “principled” (to use Lavar’s term) than the civil standard in that regard. If anything, it imposes a more difficult task on judges: to discern the internal mental state of the debtor. And it just shoves the discernment task further down the behavioral line so that fewer debtors will cross that line and fewer taxes will be non-dischargeable.

And that is the meat of the dispute here: do we want our bankruptcy scheme to favor the fresh start here or do we want it to favor preserving the non-bankruptcy relationship between debtors and their tax creditors?   Whatever good reasons there may be to favor the fresh start, the 9th Circuit’s opinion in Hawkins is just not the place to find them.

Subject Areas / Tax Topics
Copy RID