Substantial Discretionary Spending Didn't Preclude Discharge of Taxes in Bankruptcy

(Parker Tax Publishing April 2021)

A bankruptcy court held that an individual's tax debts were not excepted from discharge under 11 U.S.C. Section 523(a)(1)(C) despite the taxpayer having high discretionary expenses while not paying taxes. The court found that the Eleventh Circuit, the court to which this case could be appealed, has never held that excessive spending alone can satisfy the exception to discharge. Ransdell v. IRS, 2021 PTC 97 (Bankr. M.D. Fla. 2021).

Background

Jennifer Ransdell and her former husband, Wayne Heath, were 50/50 owners of Wayne T. Heath Farms, Inc. (the "Farm"). Ransdell was also the vice president and secretary of the Farm and was the primary person who assisted the couple's accountant in preparing the company's and the couple's federal tax returns. The majority of Ransdell's and Heath's income from 2012-2014 came from the Farm. Ransdell and Heath filed their 2013 through 2015 tax returns, all of which showed taxes owed, but they did not make any payments.

Ransdell and Heath separated in May of 2013 and Ransdell filed for divorce. Although Ransdell and Heath did not live together after May of 2013, they maintained a joint checking account until 2015. In August of 2013, Ransdell and Heath purchased a pony for their daughter for $18,000. Between July of 2013 and March of 2015, Ransdell and Heath spent approximately $30,000 per month on personal expenses. During that period, Ransdell and Heath spent approximately $1,600 per month to board and care for the pony. Ransdell and Heath owned a house in Virginia, a house in Amelia Island, Florida, and a condominium in Amelia Island, which had a $600 monthly association fee. Between December of 2013 and March of 2015, Ransdell and Heath spent approximately $4,600 at the Amelia Island Club, a resort and golf club. Additionally, their children attended private school from 2012 until 2016 at a cost of $1,500 per month.

Ransdell and Heath were under the threat of levies by the IRS from March of 2014 onward. The income from the Farm came in once a year when the crops were sold and was deposited into the Farm's business account. Ransdell and Heath transferred only the money they needed to pay personal expenses from the Farm account to their personal account. As a result, there was little left each month in the couple's personal account upon which the IRS could levy.

In July of 2014, Ransdell moved from Amelia Island to Atlantic Beach, Florida. In March of 2015, a divorce decree was entered. The divorce decree provided that Heath would be responsible for the 2012-2014 taxes. It awarded the Farm to Heath and provided that Heath was to pay Ransdell $1,000,000 for her interest in the business over a ten-year period. Additionally, the divorce decree required Heath to pay Ransdell $5,000 per month for alimony and $7,000 per month for child support until the couple's youngest child reached the age of 18, which would have been 2021. Heath made child support payments and some alimony payments did not make any payments to Ransdell for her interest in the business.

Ransdell enrolled in college in 2015 and was a full-time student until 2019. After the dissolution of the couple's marriage, Ransdell lived on child support, alimony, and early withdrawals from her IRA. Between May of 2018 and April of 2019, Ransdell sold various pieces of jewelry and a pistol in order to pay rent and buy groceries. Ransdell's 2015-2017 federal tax refunds totaling $6,069 were applied to the couple's 2012 tax liability. Ransdell did not make any other payments on the tax liability. As of September 2020, the outstanding balance owed to the IRS for 2012 was approximately $1,100, the outstanding balance for 2013 was approximately $326,000, and the outstanding balance for 2014 was approximately $110,000.

Ransdell filed for Chapter 7 bankruptcy, which generally allows the discharge of debts that arose before the filing of the bankruptcy petition. Exceptions to the general rule allowing the discharge of prepetition debts are provided in 11 U.S.C. Section 523. Under Section 523(a)(1)(C), a tax debt is nondischargeable if the debtor willfully attempted in any manner to evade or defeat the tax. In order to establish that a debtor has willfully evaded taxes under Section 523(a)(1)(C), the government must prove that the debtor engaged in evasive conduct with a mental state consistent with willfulness. In the Eleventh Circuit, a debtor's failure to pay taxes, standing alone, does not satisfy the Section 523(a)(1)(C) conduct requirement. Large discretionary expenditures when a taxpayer knows of his or her tax liabilities are relevant to the conduct element but, when lavish spending has been held to satisfy conduct element of Section 523(a)(1)(C), such spending is generally accompanied by additional culpable behavior intended to prevent the IRS from reaching the debtor's assets.

The IRS argued that, in addition to Ransdell's and Heath's lavish spending, there was additional culpable conduct in this case because Ransdell participated in structuring the couple's finances to keep assets in the Farm account instead of their personal account to avoid the risk of IRS levies. In other words, Ransdell and Heath transferred only enough money from the Farm account to their personal account, sometimes daily, to cover their outstanding checks.

Analysis

The bankruptcy court held that the IRS failed to establish that Ransdell attempted in any manner to evade or defeat tax with respect to the couple's 2012-2014 individual federal income taxes. Accordingly, the court held that her outstanding tax liability for those years was not excepted from discharge under 11 U.S.C. Section 523(a)(1)(C). In the court's view, Ransdell's spending during the 2013-2015 period did not rise to the level of a lavish lifestyle or excessive personal spending. Even if it did, however, the court did not find that Ransdell engaged in additional culpable behavior sufficient to satisfy the Section 523(a)(1)(C) conduct requirement. The court said that it was troubled by Ransdell's participation in maintaining the bulk of the couple's funds in the Farm account and found this case to be a "very close call." However, the court did not find that Ransdell's conduct constituted an attempt to evade or defeat tax. The court noted that the IRS's inability to levy on the Farm account did not preclude it from collecting on the tax debt because the IRS could have levied on Ransdell's and Heath's stock in the Farm.

Despite having found that Ransdell did not engage in evasive conduct as defined in 11 U.S.C. Section 523(a)(1)(C), the court went on to address the mental state requirement. In the court's view, it was clear that Ransdell had a duty to file income tax returns and pay taxes, that she knew that she had such a duty, and that she voluntarily and intentionally violated that duty. Thus, the court found that the mental state requirement was clearly met, although the conduct requirement was not.

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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