New Decision Provides Support for Taxpayers Hoping to Discharge Tax Debt in Bankruptcy
September 2014 saw the United States Court of Appeals for the Ninth Circuit making a landmark decision – one strongly in favor of debtors who are hoping to receive relief by the discharge of tax debt in bankruptcy. The decision was made in relation to Hawkins v. Franchise Tax Board (In Re Hawkins). A taxpayer named Trip Hawkins filed for Chapter 11 bankruptcy and was seeking to discharge approximately 19 million dollars.
Trip is a Harvard and Stanford graduate. He was among the first employees to work at Apple Computers. He later served as CEO of Electronic Arts, a well-known video game manufacturer. His wealth around this time exceeded $100 million.
During the early 1990’s, Hawkins sold a substantial amount of his EA stock to invest in the wholly owned subsidiary of EA called 3DO, which resulted in substantial capital gains. To offset the capital gains liability, he invested in a number of tax shelters; which were challenged by the IRS (2001). Losses Hawkins had taken to offset his capital gains were disallowed which resulted in liability for Hawkins in the millions. His business was also suffering.
In 2003, Hawkins attempted to have his child support obligations reduced. During state court filing, he acknowledged $25 million in back federal income taxes he owed the United States.
Hawkins lived a luxurious and expensive lifestyle. His personal expenses from January 2004 to September 2006 (at which point he filed for bankruptcy) ranged between $500,000 and $2.5 million more than his earnings.
Hawkins didn’t completely ignore the need to reduce his tax liability. In July 2006 he sold his house and paid the $6.5 million net proceeds towards his tax debt. He proposed an Offer in Compromise of $8 million in an attempt to settle the tax debt, but the IRS rejected the offer. After filing for Chapter 11 protection in September 2006 primarily in hopes of discharging his tax debt, Hawkins paid the $3.5 million in proceeds from the sale of a vacation house to the IRS to go towards reducing his tax liability. The IRS also received a distribution of $3.4 million through Trip Hawkins’ Chapter 11 plan. Regardless of efforts to decrease the amount of the tax debt, millions were still owed in the eyes of the IRS so it’s no surprise they objected to his attempt to discharge.
What was a surprise was the Ninth Circuit’s decision. The Ninth Circuit held that the tax debt can be precluded from discharge, but that it would need to be established that the debtor had a “specific intent” to evade payment on tax debt. Overspending on other items while the debt is outstanding was seen as insufficient evidence of the level of “willfulness” they required to categorize him as willfully attempting to evade all payment.
With their reversal of the bankruptcy and district court’s decision, the Ninth Circuit set forth a more debtor-friendly interpretation of willfulness. Specifically, simply overspending is not enough to demonstrate the needed level of willfulness to bar a debtor from discharging tax debt. For overspending to be an acceptable argument, there would need to be evidence that the debtor overspent with the particular intention of avoiding paying the tax liability. The Ninth Circuit brought the focus back to the original purpose of the Bankruptcy Code: providing debtors with a fresh start, which “compels a strict, rather than expansive, interpretation of willfulness.”
If you’d like more information on the specific requirements that govern tax debt in bankruptcy, get in touch with your southern California bankruptcy attorneys at Westgate Law.