The recent case of United States v. Helton, Case No. 20-5686 (6th Cir., 2021) addresses the dischargeability of taxes under 11 U.S.C. § 523(a)(1)(C). The dischargeability of taxes is a somewhat complicated maze of Bankruptcy Code provisions that requires a little bit of analysis.
The Code starts with a general rule that taxes are not dischargeable. See 11 U.S.C. § 523(a)(1).
However, taxes may be dischargeable if three tests can be met. Those tests are summarized as follows:
- The 3-year test;
- The 2-year test; and
- The 240-day test.
3-year test
The 3-year test is found in Bankruptcy Code § 523(a)(1)(B), which works in conjunction with § 507(a)(8)(A)(i). Section 523 is the general “Exceptions to discharge” statute in the Bankruptcy Code, and § 523(a)(1) describes the very first exception to be that of a tax “of the kind and for the periods specified in section 507(a)(3) or 507(a)(8). Turning to § 507(a)(8), we see the kind of taxes deemed to be nondischargeable as those “for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition.”
Therefore, we see that taxes are generally only eligible or a discharge after they are more than three years old. That 3 years is determined from the time when the tax return for the year in question is last due up to
the date that a debtor files for bankruptcy. So, for example, assuming a 2018 tax return is due on April 15, 2019, that 2018 tax liability becomes eligible for discharge only after April 15, 2022. Note that it is irrelevant for purposes of the 3-year rule when the return was actually filed. What matters is when the return was due. For purposes of the three-year rule, it is also irrelevant whether a payment was made – something that we will see did in fact make a difference in this case.
2-year test
Next, we have a 2-year rule. Unlike the 3-year rule, the 2-year rule specifically focuses on when the return is filed. The tax return that generated the income tax debt must have been filed at least two years prior to the filing of your bankruptcy
petition to be eligible for discharge.
It follows, therefore, that failure to file a tax return will prevent a discharge of those taxes in a bankruptcy case. Note also that, if the IRS files a tax return on behalf of a taxpayer – a substitute for return under Section 6020 of the Internal Revenue Code – a debtor also won’t be able to discharge those taxes. Reason being, a substitute for return is not considered a return for purposes of discharge in bankruptcy.
So, whether or not a debtor satisfies the 3‐year rule – in other words, EVEN IF a tax is old enough – he or she cannot receive a discharge of taxes if they haven’t filed the relevant return before the date that is two years prior to the filing of the case.
240-day rule
The last of the three tests, the 240-day rule, relates to taxes that have been assessed by the IRS and how long it’s been since that assessment occurred.
If the IRS assessed the tax by an audit, that assessment must have occurred at least 240 days prior to filing the bankruptcy petition in order for that to be dischargeable.
So, even if a debtor’s taxes are for years that are more than three years ago; and even if the debtor filed her return more than two years ago, if the IRS assessed taxes against you last week (or any time less than 240 days prior to filing for bankruptcy), then that additional amount assessed will not be dischargeable.
In this case, Mr. Helton satisfied all three of these tests. The analysis focused on an additional provision in the text of § 523(a)(1), and that is sub-paragraph (C). Section 523(a)(1)(C) provides an additional barrier to discharge, stating that a discharge may not be obtained for a tax “(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”
Application
In this case, Mr. Helton has been a self-employed attorney practicing law since 1994. His income fluctuated over the years, approaching $100,000 in the late 1990s but spiking to $178,913 in 2004, $250,536 in 2005, and $234,359 in 2006, before declining to about $60,000 in 2007. But Helton failed to make any estimated tax payments for those years, and did not even file tax returns for years 2004- 06 until several years later. And even after Helton filed his returns, he made minimal payments toward his tax debts for those years and (later) for the years 2009 and 2012.
Meanwhile, Helton enjoyed a comfortable lifestyle, driving a Mercedes-Benz sedan, purchasing numerous luxury gifts for his wife, eating at restaurants “almost every day,” enjoying annual vacations, and spending (along with his wife) an average of $10,000 per month on discretionary purchases during some of the years at issue. Helton also donated about $34,000 to charity during the years in which he failed to pay his taxes, and in 2014 spent an unspecified sum in support of his successful campaign to become a part-time state-court judge.
The United States brought this suit in February 2017, seeking to reduce to judgment its assessments against Helton for the years 2004-07, 2009, and 2012, among other requested relief. Helton filed for bankruptcy two months later. The district court then stayed the case until October 2017, when the bankruptcy court entered an order generally discharging Helton’s debts, thereby lifting the stay.
The sole issue in the case here is whether Helton’s tax debts were nondischargeable under 11 U.S.C. § 523(a)(1)(C). The district court held a bench trial after which it found that Helton had done precisely that for the years 2004-07, 2009, and 2012. The district court thereafter entered judgment in favor of the United States in the amount of $347,479 for Helton’s unpaid taxes during those years.
The debtor appealed the decision to the Sixth Circuit, which reviewed the district courts factual findings for clear error and its interpretation of § 523(a)(1)(C) de novo. Looking at relevant Sixth Circuit caselaw, the Court started with the proposition that § 523(a)(1)(C) has both a “conduct requirement” and a “mental state requirement” (citing In re Gardner, 360 F.3d 551, 558 (6th Cir. 2004)). The conduct requirement is met if the government proves that the taxpayer engaged in “acts of omission” or “acts of commission” that themselves amounted to an attempt to evade paying taxes. Here, Helton does not dispute the district court’s finding that his failure to file tax returns and to pay most of his taxes owed for the relevant years satisfied the conduct requirement of § 523(a)(1)(C).
That leaves the mental-state requirement, which is met if the government proves that the taxpayer “(1) had a duty to pay taxes; (2) knew he had such a duty; and (3) voluntarily and intentionally violated that duty.” Id. at 558. Helton concedes that he knew he had a duty to pay taxes for the years at issue here, which left only the question whether he voluntarily and intentionally violated that duty. That element is met when the taxpayer has “the financial means to meet his outstanding tax liabilities” but makes “a conscious decision not to apply” those monies “toward his tax debt.” Id.at 560-61.
Here, Helton’s discretionary spending—lavish when compared to the pittance he allocated toward his taxes—amply supported the district court’s finding that Helton’s violation of his duty to pay taxes was voluntary and intentional. See Gardner at 561; compare U.S. v. Storey, 640 F.3d 739, 745 (6th Cir. 2011) (holding this element was not met because “there is no evidence that Storey lived lavishly during the years she did not pay her taxes, or that she chose to engage in recreational or philanthropic activities instead of paying her taxes”). Helton barely disputes that finding, asserting that he was too busy with work or too depressed during some of the years at issue to pay his taxes. The Sixth Circuit found that the district court did not clearly err when it found those excuses belied by Helton’s ability to maintain his law practice and to run successfully for election as a state-court judge.
Helton’s principal argument, rather, is that § 523(a)(1)(C) requires proof that the debtor acted with “specific intent to evade the tax.” Hawkins v. Franchise Tax Bd., 769 F.3d 662, 670 (9th Cir. 2014). Thus, in Helton’s view, the government was required to prove not only that Helton chose to allocate his funds toward Mercedes-Benz sedans and dinners out each night and luxury gifts, rather than towards his taxes; instead, the government was required also to prove that he purchased or paid for those things specifically to avoid paying his taxes.
The Sixth Circuit emphatically determined that this argument failed and was not the law in the Sixth Circuit, citing to Gardner. Therefore, the Sixth Circuit upheld the finding of non-dischargeability under 11 U.S.C. 523(a)(1)(C).
The takeaway from this case is that simply satisfying the three normal rules related to dischargeability (as described above) may not be enough. Where none of the three rules noted above requires any specific level of payment towards a debtor’s tax liability, this case shows that a debtor’s intentional failure to make efforts to pay taxes when the ability to do so exists may invoke the provisions of § 523(a)(1)(C) to result in non-dischargeability despite otherwise satisfying the applicable rules.
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