9th Circuit: Former rich guy can discharge $15 Million in income taxes

Posted on Sep 20, 2014

Hawkins graduated Harvard with a degree in "Strategy and Applied Game Theory" and got an MBA from Stanford. He was one of the first Apple employees, and became Director of Marketing, He started several computer businesses, made millions and had his own jet and a large private staff. To save on taxes he had accountants put him into sketchy tax shelters, which the IRS eventually disallowed. Then business went south, and he filed bankruptcy to discharge the income taxes. Hawkins v. FTB, IRS, 9th Cir. 2014.

Income taxes can be discharged in bankruptcy if they meet 5 tests: (1) the taxes must be more than 3 years old, measured from the due date of the tax return; (2) the taxpayer must have filed the return more than two years before filing bankruptcy, and before the IRS filed a return for him or her; (3) taxes cannot have been assessed within 240 days before filing bankruptcy; (4) the taxpayer cannot have filed a false or fraudulent tax return; and (5) the taxpayer cannot have "willfully attempted to evade or defeat the tax."

The IRS conceded to all the elements except #5. They argued in this case that the taxpayer lived above his means (by a lot) after he realized that he would be liable for millions in taxes, therefore he willfully attempted to evade or defeat the taxes, by spending money (a lot) that could have gone to pay taxes.

The bankruptcy court agreed with the IRS, finding the taxes not discharged in bankruptcy. On appeal, the U.S. district court agreed. On further appeal to the 9th Circuit Court of Appeals, the court sided with the taxpayer.

The Court stated:

Given the structure of the statute as a whole, including its object and policy, legislative history, case precedent, and analogous statutes, we conclude that declaring a tax debt nondischargeable under 11 U.S.C. § 523(a)(1)(C) on the basis that the debtor “willfully attempted in any manner to evade or defeat such tax” requires a showing of specific intent to evade the tax. Therefore, a mere showing of spending in excess of income is not sufficient to establish the required intent to evade tax; the government must establish that the debtor took the actions with the specific intent of evading taxes. Indeed, if simply living beyond one’s means, or paying bills to other creditors prior to bankruptcy, were sufficient to establish a willful attempt to evade taxes, there would be few personal bankruptcies in which taxes would be dischargeable. Such a rule could create a large ripple effect throughout the bankruptcy system. As to discharge of debts, bankruptcy law must apply equally to the rich and poor alike, fulfilling the Constitution’s requirement that Congress establish “uniform laws on the subject of bankruptcies throughout the United States.” U.S. Const., art. I, § 8, cl. 4.

This is a very pro-debtor opinion on this issue to come out of the 9th Circuit, in my opinion. As they say, if just spending beyond one's mean meant that income taxes could be held to be non-dischargeable, than many or most of my clients would never be able to do it. The bankruptcy laws were intended to give people a fresh start, and just because someone was rich, shouldn't mean that they don't get the same chance at a clean slate.

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