Willful Tax Evasion and a Tale of Two Spouses

The Bankruptcy Code contemplates the filing of a joint petition to commence a bankruptcy case for a married couple under § 302(a). Such spouses enjoy the benefit of a single filing fee[1] and the convenience and cost savings of the joint administration of their case for everything from using a single docket for the two estates, compiling the filed claims against both estates and the combining of notices to each of their creditors.[2]

Typically, joint debtor-spouses might each expect the same outcome from their petition as well, but that is not always the case.[3] Even in a jointly administered case, the substantive rights of each of the debtors remain intact and can lead to dramatically different results for spouses who likely pursued the filing of a joint bankruptcy to ensure that they, together, would reap the benefits of a fresh start for their household, not to mention their marriage.

Recent companion opinions issued as part of a single adversary proceeding in the Eastern District of Virginia provide a telling example of this principle as the Court sought to evaluate whether the conduct of each of the joint chapter 7 debtors fell within the ambit of the willful evasion exception to the discharge of tax debts under § 523(a)(1)(C).[4] Interestingly, the two memorandum opinions entered Dec. 14, 2017, by Judge Keith L. Phillips (“Conard I”)[5] and July 6, 2018, by Judge Klinette H. Kindred (“Conard II”)[6] reached opposite conclusions as to the fate of each of the debtor-spouses, notwithstanding the fact that they were married, lived together, filed joint tax returns and sought relief as joint debtors under chapter 7.

By the conclusion of the adversary proceeding in this tale of two spouses, “it was the best of times, it was the worst of times.”[7]

What Happened?

The Conards filed their adversary proceeding against the IRS in 2016 to determine that their federal tax liabilities for the tax years 2004 through 2010 were dischargeable under their chapter 7 case. The IRS opposed the complaint and sought a determination that the tax claims were, in fact, nondischargeable under § 523(a)(1)(C). That subsection excepts from a debtor’s bankruptcy discharge “any debt for a tax or customs duty with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”[8]

The IRS pursued its willful evasion claim and filed a Motion for Summary Judgment on April 10, 2017. Judge Phillips wrote the initial opinion, Conard I, granting the IRS’s summary judgment motion as to Mr. Conard only.[9] The Court found that the uncontroverted evidence established that Mr. Conard willfully evaded payment of his taxes but at the same time explained that the IRS failed to demonstrate that no genuine issue of fact remained as to Mrs. Conard’s actions.[10] Ultimately a second opinion was issued after the trial as to the dischargeability of the taxes owed by Mrs. Conard. In that second opinion, Conard II, Judge Kindred sided with Mrs. Conard and determined that her tax liability would in fact be discharged.[11]

Why the Difference?

In a nutshell, both Mr. and Mrs. Conard may have evaded their tax obligations, but did Mrs. Conard really mean to? To understand the rulings, one must better understand how the Conards’ household functioned.

Evidence Before the Court

Mr. and Mrs. Conard resided in northern Virginia during the period of the tax liabilities in question, with Mr. Conard owning and operating a life insurance sales agency and Mrs. Conard primarily serving as a homemaker during this time. Although Mrs. Conard had worked briefly at her husband’s insurance firm as a receptionist, the evidence would show that she had a limited role in the business. The Conards managed their household in a very traditional fashion, with Mr. Conard handling the business and tax issues and Mrs. Conard focusing on their household expenses. Mr. Conard managed the purse-strings, and when his wife needed money to pay household bills, she would request it from Mr. Conard.

The evidence showed that Mrs. Conard knew that they were having problems with the IRS. Mr. Conard, however, would explain to her that he was seeking professional help to resolve the issues. Although Mrs. Conard admitted to knowing that they owed taxes, she claimed not to be aware of the extent of the debt and she simply gave to her husband any notices from the IRS that she received in the mail.

Eventually, the Conards amassed a tax bill of over $337,000 plus interest and penalties for tax years 200-09. Notwithstanding this crippling debt, the Conards never filed any of their required returns on time, failed to pay any estimated quarterly payments and paid less than $5,000 in total toward their tax obligations for the years in question.

Against that backdrop, the IRS provided evidence of the most significant discretionary purchases of nonessential items during and after the tax periods under review, including a $86,281 Mercedes Benz SL500, a $47,590 2012 BMW 640i coupe, a $50,613 Buick Lacrosse, a Harley Softail motorcycle, $48,000 worth of tuition for their son, membership in a boat club for $360 per month, weekly golf outings and a Bahamas vacation.[12]

Dual Conduct and Mental-State Requirements

In light of this evidence, the Conard I court dispensed with the conduct element (that the debtor sought “in any manner to evade or defeat” his tax liability) of § 523(a)(1)(C) without great difficulty as to both Mr. and Mrs. Conard, relying on the premise that such element may be satisfied by a failure to file returns coupled with nonpayment of taxes.[13] The court, however, explained that the willful evasion of tax debts under § 523(a)(1)(C) encompasses “both a conduct requirement and a mental state requirement (that the debtor did so ‘willfully’).”[14]

It was the mental-state requirement that would save Mrs. Conard, at least. To satisfy the mental-state requirement, the IRS needed to prove that the debtor “(1) had a duty to file income tax returns; (2) knew that he had a such a duty: and (3) voluntarily and intentionally violated that duty.”[15]

Ultimately, the Conard II court was convinced by the testimony of Mrs. Conard that she was dependent on her husband to fulfill their tax obligations, she had no control over his expenditures, and she in fact believed her husband was paying the taxes. Mrs. Conard’s testimony that her husband handled all tax matters and that she was unaware that he was not paying their tax obligations was convincing to the court.[16] As such, the IRS was unpersuasive in proving that Mrs. Conard voluntarily and intentionally violated her duty to pay taxes.

Mr. Conard was not so fortunate. In the view of the Conard I court, Mr. Conard clearly and conscientiously chose to pay for discretionary items over his taxes and understood the extent of his growing tax liabilities. Such knowing and deliberate actions proved to satisfy the mental-state element of § 523(a)(1)(C) according to the Conard I opinion, and the full extent of the taxes owed to the IRS for the tax years in question were determined by the court to be nondischargeable.

A Split Decision?

Where do these decisions leave the joint debtors? For spouses that remain married, Mrs. Conard’s “solo” victory may be a distinction that makes limited practical difference, particularly when her husband, the apparent “breadwinner” in the Conard household, will continue to face active collections by the IRS. Such circumstances likely motivated Mr. Conard’s appeal of the summary-judgment ruling against him currently pending before the U.S. District Court in the Eastern District of Virginia.[17] Of course, neither party to this action was particularly satisfied, and the IRS filed its own notice of appeal as to the final trial decision in favor of Mrs. Conard.[18]

The decisions nonetheless serve as a reminder that an objecting creditor in an action against joint debtors needs to satisfy all elements against each spouse. A debtor does not waive his or her right to defend himself or herself simply by joining the petition of a spouse. As these cases demonstrate, even a married couple operating as a single economic unit and jointly filing all tax returns, may each have his or her own unique defenses to a dischargeability action. Facts matter, and proving a party’s mental state is always difficult. Even in the face of seemingly overwhelming damaging facts and circumstances that may support inferences as to a party’s mental state, clear, credible and contrary testimony may still prevail, even if just as to one spouse in a joint bankruptcy.