By Jennifer L. Johnson, 2012 J.D. Candidate

Even where student loan obligations were found to be non-dischargeable, the Debtor’s federal income tax obligations (for the years 1994 through 1997) were discharged in Debtor’s 2002 Chapter 7 bankruptcy, because the United States failed to demonstrate by a preponderance of the evidence that the Debtor willfully attempted to evade her tax liabilities.

Case Summary

Anyse Storey, a physician, owed federal income taxes for ten out of twelve years from 1994 through 2005. While Storey filed her federal income tax returns, which showed she owed taxes, she failed to pay any of the taxes due.  In March 2002, Storey filed a Chapter 7 bankruptcy and received a discharge.  Id at 741.  In a separate proceeding, Storey’s request for a discharge of her student loan obligations was denied.

In March 2007, the United States sought to collect the taxes Storey owed.  The dispute, here, is whether Storey’s income tax obligations for the years 1994 through 1997 were discharged in her 2002 Chapter 7 bankruptcy.

Storey argued said taxes were discharged in her 2002 Chapter 7 bankruptcy, pursuant to 11 U.S.C. § 507(a)(8), because she timely filed tax returns, the obligation was more than three years old at the time the petition was filed, and the IRS had not issued a notice of assessment within 240 days immediately preceding the filing of the bankruptcy petition.  Id at 742.

The United States asserted Storey willfully attempted to evade or defeat paying her tax obligations, and thus argued the taxes were non-dischargeable pursuant to 11 U.S.C. § 523 (a)(1)(C), which provides that a discharge under § 727 is not allowed for a tax liability with respect to which the Debtor made a fraudulent return or willfully attempted in any manner to evade or defeat the tax.  Id.

Court’s Decision

The Sixth Circuit Court of Appeals stated the government has the burden of demonstrating by a preponderance of the evidence that the debtor willfully attempted to evade the tax liability. Id at 744. There are two components: a conduct requirement and a mental state requirement.

The Conduct Requirement

The government must demonstrate that the debtor avoided or evaded payment or collection of taxes through acts of omission, such as failure to file returns and failure to pay taxes, or through acts of commission, such as affirmative acts of evasion.  Non-payment of tax alone is not sufficient to bar discharge of a tax obligation.  Id.

The United States’ only evidence was Storey’s non-payment of the tax obligations.  Because non-payment alone is insufficient to render the taxes non-dischargeable, the government had to meet the second component: the mental state requirement. Id.

Note: The Court noted that a failure to pay taxes coupled with a failure to file tax returns can support a finding of non-dischargeability. See Toti v. United States (In re Toti), 2 F.3d 806 (6th Cir.1994).

The Mental State Requirement

The government must prove that the debtor 1) had a duty to pay taxes, 2) knew she had a duty, and 3) voluntarily and intentionally violated that duty. The issue the government must address is whether Storey voluntarily and intentionally avoided paying her taxes.

The Court stated that when it comes to whether the failure to pay taxes was willful, the proof looks backwards in time to the conduct and state of mind of the debtor at the time she failed to pay the taxes. Id at 746.  Some case examples of past conduct that show willful intent to evade taxes are as follows:

• Debtor purchasing vacation timeshares, stock, repaying a $30,000 loan, and donating $81,000 to a church. See United States v. Mitchell (In re Mitchell), 633 F.3d 1319 (11th Cir. 2011).
• Debtor engaged in twenty golfing and vacation trips over a three year span, and placed income and assets in the names of others. See Stamper v. United States (in re Gardner), 360 F.3d 551 (6th Cir.2004).
• Debtor spent money on vacations and private schooling for children instead of paying for taxes.  See Volpe v. IRS (In re Volpe), 377 BR. 579 (Bank.N.D.Ohio 2007)
• Debtor fraudulently conveyed property to wife.  See Griffith v. United States (In re Griffith), 206 F.3d 1389 (11th Cir.2000).
• Debtors attempted to attribute their personal income to their family trust.  See In re Birkenstock, 87 F.3d 947 (7t Cir.1996).

Because the government failed to present evidence showing Storey lived lavishly in lieu of paying   her tax obligations, the government failed to meet its burden of proof on the mental state requirement.  Id at 745.  Thus, Storey’s tax obligations for the years 1994 through 1997 were discharged in her 2002 Chapter 7 bankruptcy.

Pre-Petition Tax Debts vs. Student Loan Debts

This case also distinguishes the presumptions of dischargeability for pre-petition tax debts and student loan obligations and where the burden of proof lies.  For both debts, the burden of proof is by a preponderance of the evidence. Additionally, the Court distinguishes the past or future tense of the proof that must be presented for each type of debt.

Pre-Petition Tax Debts

The presumption is that pre-petition tax debts are dischargeable, and burden of proof is on the government to establish otherwise.  To establish whether the failure to pay taxes was willful, the government must present evidence that looks backwards in time to the conduct and state of mind of the debtor at the time she failed to pay the taxes.  Id at 746.  The evidence is of past conduct.

Student Loan Debts: The presumption is that student loan debts are non-dischargeable, and the burden of proof is on the Debtor to establish otherwise.  To establish whether student loan debts are dischargeable, a court must determine whether repayment of the loans would cause undue hardship on the debtor in the future, which is forward-looking.  Id.

In the present case, the Court found Storey’s present inability to pay her student loan debts would later subside, and that she failed to meet her burden of demonstrating an undue hardship.  Furthermore, the Court noted Storey’s failure to carry her burden to show an undue hardship in the student loan context cannot create a windfall to the United States by establishing willful evasion on tax liability as a matter of law.  Id.

Jennifer L. Johnson is a recent graduate of the Nashville School of Law and is currently studying to take the bar exam. While attending law school, she worked as a legal assistant in a creditor’s rights practice for about two years, and then in the consumer bankruptcy debtor’s practice for about a year and a half. She intends to practice bankruptcy law in her future practice.