Federal Income Tax Discharged in Bankruptcy Unless Non-payment was Intentional, Appeals Court Says

29 May Federal Income Tax Discharged in Bankruptcy Unless Non-payment was Intentional, Appeals Court Says

TheU.S. Court of Appeals, Sixth Circuit,recently ruled that an Ohio doctor could discharge her federal income taxes in chapter 7, based upon the government’s inability to prove that her failure to pay the income taxes was intentional. This case, Beneficial Mortgage Corp., et al. v. Storey, No. 09-3848 (6th Cir. May 16, 2011), involved the U.S. government’s attempt to obtain tax liens upon the doctor’s real estateafter her chapter 7 case was discharged.

Tax returns the doctor filed for 1995, 1996, 1997, 2000, 2001, 2002, 2003, 2004, and 2005, showed taxes owed, but the taxes were not paid. In 2002, the doctor filed chapter 7 and listed the IRS as a creditor. The appeals court noted that the bankruptcy law’s section 507(a)(8) allows income taxes to be discharged if (1) a return is filed, (2) the taxes are more than three years old, and (3) the taxes were not assessed within 240 days before the chapter 7 was filed.

The appeals court also noted that section 507(a)(1) prevents the discharge of any income tax for which a fraudulent return was filed, or where the debtor “willfully attempted in any manner to evade or defeat the tax.” The government argued that the simple facts that the doctor had filed tax returns showing that she owed income taxes, and had purchased real estate in 1994, and had earned income during the years in question, provedthat she had willfully evaded her income taxes by failing to pay them.

The appeals court disagreed, holding that while non-payment of taxes is relevant evidence, standing alone it cannot constitute willfully evading income taxes. “Mere nonpayment, without more, evidences not dishonesty but the defining characteristics of all debtors — honest and dishonest, alike — insufficient resources to honor all of one’s obligations,” said the court. The non-payment had to be “knowing and deliberate” to constitute willfully evading or defeating income taxes within the meaning of bankruptcy code section 507(a)(1).

Accordingly, the appeals court ordered that the doctor’s income taxes were discharged for the years for which she otherwise qualified, 1994 through 1997.

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Craig Andresen is a Minnesota bankruptcy attorney who represents both consumers and small business owners in chapter 7 and chapter 13 cases. With thirty years experience, Mr. Andresen is a frequent speaker on the topics of stopping mortgage foreclosures, and stripping off second mortgages in chapter 13. His office is located in Bloomington just across the street from the Mall of America. Call his office at (952) 831-1995 for a free consultation about protecting your rights using bankruptcy.
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