Aggressive bankruptcy planning led a bankruptcy court to deny a couple’s discharges under Section 727(a)(2)(B) for making a post-petition transfer with intent to hinder the chapter 7 trustee.

The district court reversed on appeal. Ruling that the bankruptcy court did not “adequately support” its finding of intent to hinder, the district court directed the bankruptcy court to grant discharges to the debtors.

The IRS Overpayment Elections

The couple were facing daunting problems because the husband’s health was deteriorating from cancer, forcing him to stop working and sell business assets to satisfy creditors’ claims.

The couple’s tax returns were complex because it was unclear how much they would owe in capital gains taxes from the sale of business assets that had depreciated for years.

A tax accountant they had used for 25 years completed and filed their returns almost one year after the April 15 deadline for tax year 2018. The completed tax return showed that they had overpaid their 2018 taxes by about $40,000.

On filing the tax return five months before filing in chapter 7, the couple had their 2018 overpayment applied to their 2019 tax liabilities. The couple testified that they applied the overpayment to 2019, believing they would owe taxes in 2019 but that creditors would garnish a  2018 refund before they could pay 2019 taxes.

The couple filed their chapter 7 petition in August 2020 and filed their 2019 returns about three weeks later. Once again they had a refund, this time about $21,000, which they applied toward their 2020 taxes.

With regard to the election made before chapter 7, the trustee filed an adversary proceeding to deny the debtors’ discharges under Section 727(a)(2)(A) for having made a transfer within a year before bankruptcy with intent to hinder, delay or defraud a creditor or the trustee. With regard to the election made after filing, the complaint sought to deny the debtors’ discharges under Section 727(a)(2)(B) for having made a post-petition transfer of estate property with intent to hinder, delay or defraud the trustee.

The bankruptcy judge saw no violation of Section 727(a)(2)(A) for the pre-bankruptcy election. Finding that the couple intended to hinder the trustee by making the post-petition election, the bankruptcy court denied the couple’s discharges under Section 727(a)(2)(B). See Miller v. Wylie (In re Wylie), 649 B.R. 852 (Bankr. E.D. Mich. April 17, 2023). To read ABI’s report, click here.

No Evidence of Intent

The debtors appealed and won back their discharges in an opinion on March 29 by District Judge Mark A. Goldsmith of Detroit.

Up front, Judge Goldsmith said he was reviewing the bankruptcy court’s finding of intent to hinder the trustee for “clear error” but decided that the bankruptcy court had not “adequately support[ed] its finding.”

Judge Goldsmith said that the only evidence of the debtor’s intent to hinder the trustee was their testimony that they had made the post-petition election to ensure that their 2020 taxes would be paid. From this, he said that the bankruptcy court “inferred intent to hinder the trustee.”

Judge Goldsmith read the bankruptcy court as explaining why the post-petition election could have hindered the trustee, “but,” he said, the bankruptcy court “did not find that the [debtors] were aware of this potential effect.”

Likewise, the bankruptcy court noted that the debtors’ attorney was doubtless familiar with relevant bankruptcy principles, but Judge Goldsmith said that “this finding has no bearing on the [debtors’] familiarity or intent.” Furthermore, he said that “the bankruptcy court cited no evidence that the [debtors] discussed their tax election with their attorney.”

On appeal, the trustee argued that the record showed “badges of fraud.” Judge Goldsmith said that “‘badges of fraud’ is not relevant, especially where the bankruptcy court found an intent to hinder, not defraud, the Trustee.”

In short, Judge Goldsmith said that there was “no evidence that the [debtors] intended to hinder the Trustee — or were even aware that their actions might have that effect.” In contrast, he said that exceptions to discharge are “narrowly construed” and that barring discharge is an “extreme step.”

Judge Goldsmith reversed and remanded with instructions to grant discharges, because he was “left with the ‘definite and firm conviction’ that the bankruptcy court erred in finding that the debtors intended to hinder the trustee.”

Note: Although Judge Goldsmith did not mention the fact, the debtors had turned over the overpayment to the trustee before the bankruptcy court denied their discharges.