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Spouse with No Control over Couple's Tax Filings Did Not Willfully Evade Payment of Taxes

(Parker Tax Publishing August 2018)

A bankruptcy court held that a Chapter 7 debtor was discharged from her debt to the IRS for unpaid income taxes because she did not willfully evade her taxes under Section 523 of the Bankruptcy Code. The court found that although the debtor knew she and her husband were having problems with the IRS and the couple purchased luxury cars and other discretionary items during and after the years in which they failed to pay taxes, the debtor had no control over the couple's expenditures and depended on her husband to fulfill all of their tax obligations, and the IRS failed to show that she intended not to meet her tax obligations. Conard v. IRS, 2018 PTC 209 (Bankr. E.D. Va. 2018).

Joyce and Tyrone Conard moved to Virginia in 2001 after Mr. Conard was promoted at the insurance company where he worked and was sent to Virginia to open a new insurance agency. The Conards maintained a strict division of responsibilities for the family finances. Mrs. Conard managed household expenses while Mr. Conard controlled the business expenses. Mr. Conard would give Mrs. Conard money when she needed it to pay household expenses. Mrs. Conard knew they were struggling financially, as sometimes when she asked for money, Mr. Conard told her that some bills would have to be paid late.

For several years, Mrs. Conard worked at her husband's insurance firm as a receptionist, but had no role in tracking the company's finances. Before Mr. Conard opened the new Virginia agency, Mrs. Conard was responsible for ensuring that their joint tax returns were timely filed, including gathering the necessary documents and hiring a tax return preparer. When Mr. Conard subsequently went into business for himself, he assumed full responsibility for their taxes because Mrs. Conard was not capable of handling their more complicated business tax obligations. Thereafter, her role was limited to gathering statements regarding household expenses and giving them to her husband. Mr. Conard was responsible for engaging and providing the tax return preparer with the necessary documents.

Mrs. Conard knew she had a duty to file tax returns every year. She also assumed that taxes were owed because of the business. After she relinquished responsibility for having the returns prepared, she knew they were not being filed on time but was not concerned because she signed requests for extensions along with returns prepared by her husband. She did not review the returns before signing them. She did not know how long an extension could last, and did not understand that she and her husband were required to pay estimated taxes throughout the year because of the business.

Mr. Conard told Mrs. Conard that their problems with the IRS occurred because their returns were improperly prepared, but he assured her that he was seeking professional help to resolve the issues. Mrs. Conard knew they owed taxes but did not know the amount. Mr. Conard told her that they had paid taxes, but he did not tell her how much. Mrs. Conard saw no reason to believe that Mr. Conard was lying, and took him at his word.

Between 2004 and 2009, the IRS sent at least 30 notices to the Conards regarding their outstanding tax debt. Mrs. Conard received the notices but gave them to her husband without reading them. Mrs. Conard believed that her husband was trying to address their tax problems and knew that she was not capable of addressing the issues. When she discussed the taxes with Mr. Conard, he would tell her not to worry. They never discussed paying off the tax debt.

According to the IRS, the Conards owed approximately $337,000 for 2004-2009 (excluding interest and penalties). During this period, the Conards failed to file any of their tax returns on time and did not make estimated tax payments. The Conards had paid only around $4,900 in taxes for the relevant years. Despite their failure to pay, the Conards purchased several nonessential items including luxury cars, a motorcycle, a boat club membership, and a vacation to the Bahamas.

The Conards filed a Chapter 7 bankruptcy petition in January 2014 and received a discharge in April 2014. The IRS filed a proof of claim for approximately $706,000 for income tax liabilities for 2003 through 2013. An adversary proceeding was begun in July 2016. The IRS filed a motion for summary judgment which the bankruptcy court granted with respect to Mr. Conard, finding that he willfully attempted to evade payment of his taxes. However, the court denied the motion as to Ms. Conard on her willful evasion of payment, and a trial was held.

Under Section 523(a)(1)(C) of the Bankruptcy Code, a discharge in bankruptcy does not discharge a tax debt if the debtor willfully attempted to evade or defeat the payment of the tax. Courts have interpreted the statute to include a conduct requirement (that the debtor sought to evade or defeat the tax liability) and a mental state requirement (that the debtor did so willfully). To satisfy the mental state requirement, the IRS must prove that the debtor knew of the duty to pay taxes and voluntarily and intentionally violated that duty.

The bankruptcy court held that Mrs. Conard did not willfully attempt to evade payment of her taxes because she lacked the requisite mental state. The court found that the conduct requirement was established because Mrs. Conard admitted that she and her husband failed to timely file their tax returns, and that they made discretionary purchases during and after the years that the tax debts were incurred.

However, in the court's view, the IRS failed to show that Mrs. Conard had willfully evaded the tax liability. The bankruptcy court noted that the payment of discretionary expenditures instead of tax debts known to be owed can amount to voluntary and intentional violation of the duty to pay taxes. However, the court determined that Mrs. Conard did not know the taxes were not being paid. The court found that Mr. Conard told Mrs. Conard he was paying the taxes and that she believed him. The court reasoned that Mrs. Conard had no control over Mr. Conard's expenditures and depended on him to fulfill all of their tax obligations. Moreover, the court found that the IRS failed to present any evidence to show Mrs. Conard intended not to meet her tax obligations. The court therefore concluded that Mrs. Conard did not have the requisite mental state under Section 523(a)(1)(C) of the Bankruptcy Code to be guilty of willfully evading the couple's tax liability.

For a discussion of the discharge of taxes in a bankruptcy, see Parker Tax ¶16,160.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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