The Eleventh Circuit Court of Appeals, affirming a district court, has held that a married couple could not discharge in bankruptcy their multimillion-dollar tax liability because the couple willfully attempted to evade or defeat their tax debt.
Background.
Chapter 7 debtors receive a general discharge (“fresh start rule”) from all debts that arose before they filed a bankruptcy petition. (11 USC §727(b))
This “fresh start” is available to the “honest but unfortunate debtor.” (In re Fretz, (CA 11 2001) 87 AFTR 2d 2001-1380)
To ensure that only the honest but unfortunate debtor receives the benefits of discharge, Congress has enumerated several exceptions to the fresh start rule. For example, there is no discharge “for a tax with respect to which the debtor… willfully attempted in any manner to evade or defeat such tax.” (11 USC §523(a)(1)(C))
To prove that a tax is not dischargeable under 11 USC § 523(a)(1)(C), the IRS must show that (1) the debtor “attempted in any manner to evade or defeat [a] tax,” (“evasive conduct test”) and (2) the attempt was done “willfully” (“willfulness test.”) (In re Fretz)
To show that a debtor acted “willfully,” the IRS must demonstrate that the debtor “engaged in affirmative acts to avoid payment or collection of taxes either through commission or culpable omission.” (In re Jacobs, (CA11 2007) 490 F.3d 913)
The universe of evasive acts or omissions is broad: “Congress did not define or limit the methods by which a willful attempt to defeat and evade might be accomplished and perhaps did not define lest its effort to do so result in some unexpected limitation.” (In re Fretz)
Facts.
In 2001, the Feshbachs submitted to the IRS an “offer-in-compromise” (“Offer 1”) to settle their outstanding 1999 tax debt for $1 million, about half of what they owed. The Feshbachs proposed an initial payment of $200,000, a payment of $300,000 upon the sale of their home in Bellaire, Florida, and payment of the balance over the next five years. After making the initial payment of $200,000, the Feshbachs withdrew Offer 1 because their collection potential exceeded their offer.
The Feshbachs made the initial $200,000 payment by selling securities. Those securities sales in turn yielded capital gains that contributed to a $3,247,839 tax liability for the 2001 tax year. By the time they filed their 2001 tax return, the Feshbachs owed the IRS a total of $5,198,156.
In 2002, the Feshbachs made another offer-in-compromise (“Offer 2”). On their Form 433-A, Collection Information Statement, the Feshbachs represented they were earning $180,000 annually; but, on their 2002 tax return, they reported $611,413 of income and had a domestic payroll of $58,832.90 and household and personal expenses of $383,587.85.
The IRS rejected Offer 2 because it determined that the Feshbachs had the ability to full pay their tax debt. For the next three tax years after they submitted Offer 2, the Feshbachs reported more than $10 million in income.
By 2008 Mr. Feshbach’s health had declined so the Feshbachs made a third offer-in-compromise (“Offer 3”) of $120,000 on their unpaid 2001 balance of $3.6 million. They proposed monthly payments of $2,500 for 48 months. Along with this offer they submitted another Form 433-A representing that they earned $9,996 annually. At this time, their monthly household expenses were over $12,000 and they claimed income of $193,205 on their 2008 tax return.
In 2008, while Offer 3 was pending, the Feshbachs spent between $1,400 and $1,500 per month on entertainment, more than $4,000 per month for groceries, $4,000 per month for domestic help, and $4,500 per month on rent, in addition to other expenses. In 2009 and 2010, the Feshbachs spent about $90,000 on household employee wages and $143,000 in charitable contributions.
In May 2011, the Feshbachs filed for Chapter 7 bankruptcy and sought a determination from the bankruptcy court that their 2001 tax liability was dischargeable. The IRS opposed discharge, arguing that the Feshbachs willfully attempted to evade and defeat their tax liability by deliberately submitting low-ball offers-in-compromise that (1) only served to delay the collection of their past due taxes; and (2) obfuscated their true financial status.
Bankruptcy court’s decision.
The bankruptcy court found, while spending lavishly on personal luxuries instead of paying their taxes, the Feshbachs willfully engaged in affirmative acts to avoid payment or collection of taxes by submitting multiple low-ball offers-in-compromise with documentation that didn’t reflect their true financial status. (Feshbach, (Bktcy Ct FL 2017) 120 AFTR 2d ¶2017-5402)
District court’s decision.
The Feshbach’s appealed the bankruptcy court’s decision to the district court, which affirmed, finding that the evidence of the taxpayers’ excessive discretionary spending and lavish lifestyle, while avoiding payment of their mounting tax debts, supported the bankruptcy court’s finding that the Feshbachs willfully attempted to evade their tax debt. (Feshbach, (DC FL 2018) 122 AFTR 2d 2018-6661)
Appeals Court affirms finding of attempt to evade tax debt.
The Appeals Court affirmed the district court’s finding that the Feshbacks’ tax debt was not dischargeable because they willfully attempted to evade paying it.
According to the Appeals Court, there was ample evidence that the Feshbachs approached the IRS with inadequate and unrealistic offers-in-compromise given their income and spending, and that they used the offer-in-compromise process to delay the collection of their taxes.
The Feshbachs tried to justify their lavish personal spending, such as $1,400 and $1,500 per month on entertainment, more than $4,000 per month for groceries, $4,000 per month for domestic help, and $4,500 per month on rent, in addition to other expenses, as business expenses. However, the bankruptcy court found that these alleged business expenses had no business purpose whatsoever.
The Appeals Court also noted that the bankruptcy court concluded, from Mr. Feshbach’s testimony, that the couple likely never intended to sell their home in Florida, but merely offered to do so to delay the collection of their tax debt.
Also, there were vast disparities between the income the Feshbachs reported to the IRS on Forms 433-A and the income they actually earned. For example, in 2002, the Feshbachs represented on their Form 433-A that they were earning $180,000 annually; but, on their 2002 tax return, they reported $611,413, over three times as much. In 2008, the Feshbachs represented on their Form 433-A that they had annual income of $9,996, but they reported over 19 times as much income, $193,205, income on their 2008 tax return.
The Appeals Court found that the discrepancies between their Forms 433-A and their tax returns bolstered the bankruptcy courts’ finding that the Feshbachs used the offer-in-compromise process as a delay tactic.
The Feshbachs argued that they accurately reported their income on their Forms 433-A, but delays in the IRS review process and volatility in their business led to disparities with their tax returns. However, the Appeals Court found that the notion that the Feshbachs faced such difficult times that they needed to settle their tax debt for cents on the dollar was difficult to reconcile with their consistently excessive spending and lavish lifestyle, which at times included $106,150.42 on clothing and personal care, $16,283.58 on entertainment, $40,080.94 on groceries, and $56,497.01 on personal travel, among other expenses.
To continue your research on determining tax claims in bankruptcy, see FTC 2d/FIN ¶U-4802.
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