Nonpayment of Tax Liabilities Can Be Evasion and Defeat Discharge in Bankruptcy (12/10/12)

A recent district court case denying a discharge in bankruptcy serves as a warning for taxpayers and practitioners.  Rossman v. United States, 2012 Bankr. LEXIS 5615 (Bkr Ct D MA 2012), here.  11 USC § 523(a)(1)(C), here, titled Exceptions to Discharge, provides in part relevant that a discharge does not apply to any tax "(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax."  The question is whether nonpayment can constitute an attempt to evade or defeat tax.

The opinion is long, so I won't try to summarize it here.  The tax arose from a tax shelter investment in the 1980s.  The tax was thus a 1980s tax with resulting substantial interest now well exceeding the amount of the tax liability.  The aggregate liability was now substantial.  The shelter was a hokey shelter that has been litigated over many years, but by the early 2000s, although the taxpayer's case had not yet resulted in an assessment, the liability was clear and the assessment was only a matter of time.  The assessment was made  by 2004.

After the date that he knew of the liability and after the assessment was made,  the taxpayer earned substantial amounts of income.  Taxpayer made no payments.  And, although there appeared to be no evidence of a profligate lifestyle, the taxpayer failed to explain why he could not have made substantial payments during the period, given the amount of his income.

After making extensive findings of facts,  the Court concluded as follows:

The record is devoid of any direct evidence of the Debtor's willful intent to evade taxes in the form of implausible or inconsistent explanations of behavior; inadequate financial records; transfers of assets that greatly reduce assets subject to IRS execution; and transfers made in the face of serious financial difficulties. See Beninati, 438 B.R. at 758. Similarly, the Debtor did not engage in any manipulative conduct by failing to make estimated payments or failing to pay annual taxes after 1986 when due, and there was no evidence that he routinely applied for extensions of time within which to file returns. See Lacheen v. IRS (In re Lacheen), 365 B.R. 475, 484-86. Indeed, the Debtor testified, and the IRS did not dispute, that, with the exception of his tax liabilities from Rancho Madera Partners and Vista Ag-Realty Partners, Rossman paid all federal and state taxes on time and in full from 1987 to the commencement of his bankruptcy case.

IRS Issues new Bankruptcy Tax Guide, Publ 908 (10/27/12)

The IRS has issued a new version of the Bankruptcy Tax Guide, Publication 908 (October 2012).  The pdf version is here and the html version is here.

The following is the discussion of discharge of tax liability in bankruptcy:

Discharge of Unpaid Tax 

If you are a debtor in a bankruptcy case, the bankruptcy court may enter an order providing you with a discharge of debts. However, not all of your debts may be discharged. The scope of the bankruptcy discharge depends on the chapter you are in and the nature of the debt. Many tax debts are excepted from the bankruptcy discharge. 

If you are an individual under chapter 7, the following tax debts, including interest, are not subject to discharge: taxes entitled to eighth priority, taxes for which no return was filed, taxes for which a return was filed late after 2 years before the bankruptcy petition was filed, taxes for which a fraudulent return was filed, and taxes that you willfully attempted to evade or defeat. Penalties in a chapter 7 case are dischargeable unless the event that gave rise to the penalty occurred within 3 years of the bankruptcy and the penalty relates to a tax that is not discharged. Corporations and other entities that are not individuals do not receive a discharge in chapter 7 cases. 

The same exceptions to discharge that apply to individuals in chapter 7 cases apply to individuals in chapter 11 cases. Different rules apply for corporations. A corporation in chapter 11 may receive a broad discharge when the plan is confirmed, but secured and priority claims must be satisfied under the plan and there is an exception to discharge for taxes for which the debtor filed a fraudulent return or willfully attempted to evade or defeat, for bankruptcy cases filed after October 16, 2005.