What Constitutes An Attempt To Evade Or Defeat Taxes For Purposes Of Section 523(a)(1)(C) Of The Bankruptcy Code: The Ninth Circuit Parts Company With Other Circuits (Part 2)

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In yesterday’s post A. Lavar Taylor discussed the case law in other circuits and the bankruptcy opinion in Hawkins v Franchise Tax Board. Today’s post turns to the Ninth Circuit and its decision to part ways with the other circuits. Lavar explains why he believes for both legal and practical reasons the Ninth Circuit’s view is correct. Les

Now I turn to why the Ninth Circuit reached the correct result in Hawkins by concluding that “improper” expenditures, by themselves, do not constitute an attempt to evade or defeat a tax liability. There are both legal and practical reasons why the Ninth Circuit’s holding in Hawkins is the correct one.  I first discuss the legal reasons.

The Legal Reasons Why the Ninth Circuit Is Correct

The Ninth Circuit noted that the purpose of a bankruptcy discharge is to give an individual debtor a “fresh start.” It noted that this “fresh start” philosophy argues for a more narrow  interpretation of the “attempt to evade or defeat” exception from discharge. The Ninth Circuit also concluded that both the structure of section 523(a) of the Bankruptcy Code and its legislative history support a narrow reading of the “attempt to evade or defeat” exception to discharge.


The Ninth Circuit also took note of the Supreme Court’s holding in Kawaauhau v. Geiger, 523 U.S. 57 (1998), in which the Supreme Court narrowly construed the term “willfully” for purposes of section 523(a)(6) of the Bankruptcy Code.

But the key to the Ninth Circuit’s ruling is the fact that the Supreme Court, in Spies v. United States, 317 U.S. 492 (1943),  held that a mere willful failure to file a return, coupled with a mere willful failure to pay the tax, does not constitute a willful attempt to evade or defeat the tax for purposes of section 7201 of the Internal Revenue Code. Section 7201 uses language almost identical to the language in section 523(a)(1)(C) of the Bankruptcy Code.  The Supreme Court held in Spies that the taxpayer must take some sort of “willful commission” (in addition to the willful omissions), or engage in an “affirmative act,” in an effort to evade the tax, in order to commit tax evasion under section 7201.  Whether a particular act taken by a taxpayer is an affirmative act taken in an effort to evade the tax is to be decided by the trier of fact.

Because the language in section 523(a)(1)(C) of the Bankruptcy is virtually identical to the language in section 7201 of the Internal Revenue Code, it makes sense to construe section 523(a)(1)(C) in the same manner in which the Supreme Court construed section 7201 of the Internal Revenue Code in Spies.  The elements discussed above in  in the Fretz case, which were used by Judge Carlson in the Hawkins case and were used by all other Courts of Appeal to consider this issue, are elements required to convict a taxpayer of a willful failure to file or a willful failure to pay under IRC section 7203. See, e.g., United States v. Tucker, 686 F.2d 230 (5th Cir. 1982).

Section 7203 uses very different language than the “willful attempt in any manner to evade or defeat” language contained in IRC §7201 and Bankruptcy Code section 523(a)(1)(C).  The failure by Congress to incorporate the language of IRC §7203 into section 523(a)(1)(C) of the Bankruptcy Code, coupled with the incorporation into section 523(a)(1)(C) of the language contained in section 7201, indicates that the holdings of the other Courts of Appeal were in error.

The Practical Reasons Why the Ninth Circuit is Preferable  

The Ninth Circuit’s approach is also preferable for practical reasons.  The most obvious practical problem for courts relying on the standard used in other Circuits is determining in a principled manner what expenditures by the debtor are “unnecessary” once the duty to pay the taxes arises. Only a principled approach can provide future guidance to courts,  future litigants, debtors who wish to avoid a fight over whether they attempted to evade or defeat the taxes that they owed, and professionals who advise debtors who wish to avoid this fight.

Judge Carlson offered precious little principled guidance  on how to decide what expenditures are “unnecessary” in other factual contexts. We know that a “nuanced approach” should be used, depending on the debtor’s pre-existing income and lifestyle, but we know very little about how to define those “nuances” or about how to apply those “nuances” in future cases where the taxpayer’s circumstances differ from those of Mr. Hawkins.

Can a debtor pay for extraordinary medical expenses for a parent or for a beloved pet, at the expense of not paying their taxes? What about paying modest private school tuition for their children? What about paying tuition for the debtor to obtain an advanced degree in the hopes that the debtor will obtain a much higher paying job? Does the potential level of earnings once the degree is earned make a difference?  Can the debtor pay to go on any vacations at all? What if the debtor’s therapist recommends that the debtor take a vacation because of stress related to a difficult marriage or related to financial difficulties?

What about debtors who owe business debts? Will some of these debts be deemed “necessary” and other “unnecessary?”  Will it matter if payment of the business debt will give rise to a tax deduction which would reduce the amount of taxes owed? If a debtor pays state taxes without paying federal taxes, is that an attempt to evade or defeat the federal taxes? If the debtor pays federal taxes without paying state taxes, is that an attempt to evade or defeat the state taxes? What about payment of alimony and child support?

For those debtors who are living a good lifestyle but are greeted by an overwhelmingly large tax liability, how long do they have to reduce their expenditures before their pre-existing level of expenditures becomes “unnecessary?” Six months?  A year? If they attempt to sell their expensive house and find no buyers at a reasonable price after a year, are debtors required to sell at a fire sale or to stop paying their mortgage?

If the debtor reasonably believes that he owns property that will  appreciate enough for him to fully pay his taxes within several years, must the debtor lower his or her level of living  expenses while waiting for  the property to appreciate? Will the expenses paid while waiting for the property to appreciate be deemed to be “excessive” through hindsight if property values suddenly and unexpectedly decline?

The number of questions regarding “necessary” and “unnecessary” expenses which could arise under the standard employed by Judge Carlson and other Circuits is virtually limitless. Under this standard, courts, debtors and their counsel can look forward to innumerable Circuit splits on all of the exciting issues mentioned immediately above, among many others.

Simply put, if the standard for determining whether a taxpayer/debtor has attempted to evade or defeat the tax is whether the taxpayer/debtor made “inappropriate” expenditures, there is no principled way for courts  to draw the line between what expenditures are “appropriate” and what expenditures are “inappropriate.”  Cases will be decided based on the whims and fancies of individual judges, each of whom will have their own sense of what expenses are “appropriate” and what expenses are “inappropriate.” One judge may conclude that it was entirely proper for a taxpayer to spend $25,000 furthering their education in an effort to significantly increase their earnings capacity instead of paying the money over to the IRS, while another judge may conclude that the taxpayer attempted to evade or defeat the tax by spending $25,000 on educational expenses instead of paying the $25,000 over to the IRS.

In addition, IRS and other tax agencies could invoke the “attempt to evade or defeat” exception merely because they do not like the way the debtor/taxpayer spent their money. Such a standard carries with it a significant potential for abuse of taxpayers by tax agencies.  The potential for abuse drastically decreases if tax agencies are required to prove the traditional elements of tax evasion in order to invoke the “attempt to evade or defeat” exception in section 523(a)(1)(C).

Under the standard used by Judge Carlson, it is impossible for tax professionals to advise their clients on whether the clients can make certain expenditures, assuming that the use of bankruptcy to discharge tax liabilities is  a possibility at the time the advice is solicited.  If the standard used by Judge Carlson applies, no competent professional will ever offer meaningful advice on this subject out of fear of the potential consequences of giving incorrect advice.

The Dissent

As a final note, I have several comments about the dissenting opinion in Hawkins. First, this dissent makes a statement that is downright scary. At page 17 of the Slip Opinion, the dissent states:

At the family court hearing, Hawkins’ bankruptcy attorney “testified that Hawkins’ intent was not to pay the tax debt, but to discharge it in bankruptcy. . . .” Id., p. 19. This testimony is a strong indication of a willful intent to avoid the payment of taxes by hook or by crook.

I am troubled by the dissent’s language, given that, at the time the statement was made by the attorney, Hawkins was insolvent and lacked the ability to pay the taxes in full. (I will ignore the fact that this statement regarding Hawkins’ intent was not made by Hawkins himself.) In addition, 3DO was in financial difficulties and headed for chapter 7. Planning to discharge taxes in bankruptcy at a time when you are insolvent and lack the ability to pay the taxes in full is not an attempt to evade or defeat a tax liability. And Hawkins paid to the IRS and the FTB many millions of dollars between the date of that statement and the date of the bankruptcy petition.

I am also troubled by the dissent’s conclusion that the majority opinion “gives Hawkins a pass.” The majority opinion does no such thing. The majority remands the case so that the trial court can apply the correct legal standard. The trial court may now have to decide the issue previously ducked by Judge Carlson (who has now retired from the bench), namely, whether Hawkins acted with intent to defraud in filing the tax returns in question. At a minimum, the trial court will have to decide whether the actions taken by Hawkins leading up to his chapter 11 bankruptcy were taken with Spies-type intent to evade the tax liability.  Hawkins has not been given a “pass.”  Rather, his conduct is going to be judged under the appropriate legal standard, rather than under a standard that is no standard at all.

For those of you who disagree with my statement that the standard relied upon by Judge Carlson (and by the dissent and by other Circuits) is no standard at all, I invite you to carefully review Judge Carlson’s opinion and tell me how you would apply the “standard” set forth in that opinion to the vast majority of taxpayers whose financial circumstances are much more modest than those of Mr. Hawkins.  I’ve read and re-read Judge Carlson’s opinion.  All I can take away from that opinion is that some expenditures are “appropriate,” some expenditure are “inappropriate,” that Bankruptcy Judges must take a “nuanced approach” in deciding which expenditures are “appropriate” and “inappropriate” for purposes of determining whether the debtor “attempted to evade or defeat” a tax liability, and that, if you continue spending “too much” money in the face of known tax liabilities for “too long,” you will have engaged in an “attempt to evade or defeat” the tax liabilities, regardless of your motives for spending that money.

How you apply that standard to all other taxpayers other than Mr. Hawkins in a principled manner I haven’t a clue. Which is why I believe the Ninth Circuit got it right in Hawkins.



  1. I have often told my students and tax clinic clients that, while bankruptcy may be an option to discharge some tax debts, if the taxpayer only owes tax debts, there is no need to use bankruptcy, since an offer in compromise is likely available instead to “discharge” all tax debts (even those too recent to be dischargeable in bankruptcy). While I am not displeased to see the victory on the standard that Lavar achieved in Hawkins, this now creates a dichotomy between what may be discharged by offers in compromise and what may be discharged in bankruptcy. That, as a policy matter, can’t be a good thing.

    Lavar identifies the host of problems about what are too big or unnecessary expenditures for purposes of the bankruptcy test applied by other Circuits. He thinks the idea of defining what are too big and improper expenditures is unworkable. Yet the IRS, in the IRM, has declared that “dissipated assets” must be added back to the taxpayer’s revenue collection potential in determining what is an appropriate offer in compromise amount. Since the taxpayer no longer has those assets, any dissipated assets, in practical terms, doom any offer in compromise that is not funded by friends or family as to the dissipated assets amounts.

    IRM provides the rules for dissipated assets that answer some of the questions that Lavar poses, though often in obscure ways and giving little practical guidance. Thus, it leaves largely to the whim of the Offer Specialist or CDP hearing officer the decision of what to treat as dissipated assets. And, the courts are very deferential as to the decisions made by CDP hearing officers (the only ones the courts can review).

    Just like the 9th Cir. in Hawkins, I have been unable to determine what the level of expenditures should be for a person who has a tax debt to avoid the finding of dissipated assets. For example, the Manual provision provides the following examples (and more) concerning what constitutes dissipating an asset:

    (1) Dissolving an “IRA or other investment account to pay for specific non-priority items, i.e. child’s wedding, child’s university tuition, extravagant vacation, etc.”

    (2) Refinancing a house and using “the funds to pay off credit card and non-secured debt.”

    (3) Use of inherited funds “for non-priority items (other than health/welfare of the family or production of income).” Note the reference to “priority”, which might mean lien priority or might incorporate the bankruptcy definitions of “priority” expenditures and debts.

    The Manual provides that “funds . . . needed to provide for necessary living expenses . . . should not be included in the RCP calculation [as dissipated assets].” The Manual does not define “necessary living expenses”. Does that term mean expenses beyond the stingy amounts allowed each month as necessary expenses under the Collection Financial Standards? Does that mean no vacations are ever possible, a question Lavar poses in the bankruptcy context? See Tucker v. Commissioner, T.C. Memo. 2011-67 (upholding the IRS treating as dissipated assets certain amounts the taxpayer invested in the stock market [but lost] in an effort to increase the funds he had to pay off his taxes and noting that the IRS may have been generous in not treating as dissipated assets the following items: “$824.64 on May 19, 2003, for an airline ticket for a personal trip to Phoenix, Arizona; $274.84 on June 2, 2003, for the hotel stay associated with this personal trip; $535 on October 24, 2003, for a bartending course; and $236 on August 12, 2003, for a personal cruise on the Hudson River.”), affd. 676 F.3d 1129 (D.C. Cir. 2012). Note: I was counsel for Tucker.

    As the Hawkins court noted, there would hardly be any taxpayers who would have their tax debts be discharged if they were not allowed to overspend their incomes a little or to spend somewhat beyond “reasonable” living expenses. The same is true if one applied the “dissipated assets” rule strictly in offer in compromise situations.

    So, what is now left is a situation where the IRS only dings people (rejecting discharge of tax debts) both in bankruptcy and offers in compromise who the IRS really dislikes — not simply because they overspent. It is impossible to advise taxpayers on what items on which they can spend money or whether they have to live within the Collection Financial Standards expenses once they have a tax debt. To tell them to live within the Collection Financial Standards would be a disservice to them, since probably 99% of people spend beyond those amounts, yet still obtain discharges in bankruptcy or offers in compromise.

    In an ideal world, the offer in compromise and bankruptcy rules on dischargeable debts would be harmonized. Certainly, they need more clarifying to prevent arbitrary assertion of vague rules by the IRS.

    • Lavar Taylor says


      I disagree that bankruptcy rules and IRS OIC rules should be harmonized. Bankruptcy rules on discharging taxes apply to a multitude of different tax agencies. IRS OIC rules apply to only IRS. Each tax agency is going to have its own rules regarding offers in compromise. Some of those rules will be statutory, some rules will be internal rules based on financial considerations, and some rules will be internal rules based on policy considerations. Each agency should be free to define the terms on which it will “forgive” a portion of tax debts, subject to statutory rules imposed by the relevant legislature.

      Bankruptcy rules reflect a judgment by the US Congress, not by the taxing agencies. Filing bankruptcy also has significant consequences unrelated to the fact that tax liabilities will (hopefully) be discharged (from the debtor’s perspective). For that reason alone, I am perfectly comfortable with bankruptcy discharge rules that are different from IRS OIC rules.

      Bankruptcy rules should not be beholden to IRS internal rules. IRS should not be able to define the circumstances under which tax liabilities are discharged in bankruptcy by determining what expenses are “allowable” and “not allowable” for OIC (and installment agreement) purposes. That is what will happen if you start to link IRS OIC rules with bankruptcy discharge rules.

      I agree that the manner in which the IRS administers the OIC program can be vastly improved. That problem won’t be solved by linking IRS OIC rules to the bankruptcy discharge rules, however.

  2. I am trying to digest Carl Smith’s comment that “if the taxpayer only owes tax debts, there is no need to use bankruptcy, since an offer in compromise is likely available instead to “discharge” all tax debts (even those too recent to be dischargeable in bankruptcy).” Perhaps this refers only to those who qualify for assistance from low-income tax clinics.

    Suppose a client has a home with substantial equity, a life insurance policy with substantial cash value, and a retirement account (IRA or 401k) with a high balance. Meanwhile, there is little or no income because of retirement or unemployment. This is not an uncommon situation. Are you saying that an SO won’t consider these bankruptcy-exempt assets when an Offer in Compromise is submitted? My experience (although not recent) has been that the Service answer is “SO what? Go ahead and file bankruptcy.”

    • Bob,

      You make a very good point. I guess I am writing from the perspective of low-income people who don’t own bankruptcy-exempt assets (none of my clients did to any significant extent), so, if the debts were old enough to be dischargeable in bankruptcy, bankruptcy would eliminate their debts and assets (if any) about to the same extent that an OIC would because they would have to offer all their assets in an OIC .


  3. george richard says

    There is some discussion here on dissipated assets being included in the RCP of an OIC, but there is no mention of any statute of limitations on that inclusion. Will the State include a dissipated asset even if itwas dissipated 20 years ago? The State OIC form asks for a listing of all assets sold within the last 5 years. Does this mean the taxpayer will not need to worry about any dissipated assets made more than 5 years ago?

  4. Siobhan Felix says

    Fantastic ideas – I am thankful for the points – Does someone know where my assistant could possibly get ahold of a blank a form form to type on ?

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