Hawkins et al v. The Franchise Tax Board et al

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-1-	Memorandum Decision
UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re
WILLIAM M. HAWKINS, III, aka
TRIP HAWKINS; and LISA WARNES
HAWKINS, aka LISA A. HAWKINS,
Debtors.
WILLIAM M. HAWKINS, III, and
LISA WARNES HAWKINS,
Plaintiffs,
vs.
THE FRANCHISE TAX BOARD,
A DIVISION OF THE GOVERNMENT OF
THE STATE OF CALIFORNIA; and the
UNITED STATES OF AMERICA, INTERNAL
REVENUE SERVICE,
Defendants.
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Case No. 06-30815 TEC
Chapter 11
Adv. Proc. No. 07-3139 TC
MEMORANDUM DECISION
In this action, the Internal Revenue Service (IRS) and the
California Franchise Tax Board (FTB) seek to have unpaid income tax
liabilities excepted from the discharge that Debtors Trip and Lisa
Hawkins received in their chapter 11 case. 	The IRS and the
Signed and Filed: April 22, 2010
________________________________________
THOMAS E. CARLSON
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
April 23, 2010
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
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28 1 This Memorandum Decision shall constitute the court’s
findings of fact and conclusions of law.
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FTB (collectively the Government) assert that the tax liabilities
should not be discharged, because Debtors filed fraudulent returns,
and because Debtors attempted to evade collection of tax. 	It is
unnecessary to determine whether Trip Hawkins filed fraudulent
returns, because I determine that he attempted to evade collection
of tax by dissipating his assets on unnecessary and unreasonable
expenditures while he knew he owed taxes and knew he was insolvent. 1
I determine that Lisa Hawkins neither filed fraudulent returns nor
attempted in any way to evade tax.
BACKGROUND
A. 	The Debtors
William M. “Trip” Hawkins (Trip) is a very sophisticated
businessman. 	He received an undergraduate degree in Strategy and
Applied Game Theory from Harvard College, and an M.B.A. from
Stanford University. 	He was an early employee of Apple Computer,
where he rose to director of marketing. 	In 1982, he left Apple and
became one of the founders of Electronic Arts, Inc. (EA), which
became the largest supplier of computer entertainment software in
the world. 	By 1996, Trip had a net worth of approximately $100
million, primarily from his holdings of EA shares.
Lisa Hawkins (Lisa) married Trip in 1996. 	She received a B.A.
in communications from Notre Dame de Namur University. 	Prior to
her marriage, she worked as a leasing agent for a car dealership
and prepared her own tax returns. 	After her marriage, she worked
in the home and cared for the two children she had with Trip and
the two children Trip had from his first marriage.
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B. 	The Tax Shelters
In 1990, EA created a wholly owned subsidiary, 3DO, for the
purpose of developing and marketing the devices on which computer
games are played. 	Trip Hawkins left EA to run 3DO. 	3DO went
public in 1993. 	In 1994, Trip began to sell large amounts of his
EA common stock to invest heavily in 3DO.
In 1996, KPMG, the accounting firm that prepared Debtors’ tax
returns, advised Trip that Debtors would recognize very large
capital gains upon the sale of the EA shares, and suggested an
investment that would create capital losses that Debtors could use
to offset those capital gains. 	Pursuant to this advice, Debtors
invested in a transaction called FLIP (Foreign Leveraged Investment
Portfolio) in 1996, and invested in a transaction called OPIS
(Offshore Portfolio Investment Strategy) in 1998.
FLIP worked in the following way. 	In September 1996, Trip
purchased 1,551 shares of the United Bank of Switzerland (UBS) for
$1.5 million. 	He also purchased an option to acquire shares of
Harbourtowne, Inc. (Harbourtowne), a Cayman Islands corporation.
At the same time, Harbourtowne contracted to purchase 30,750 shares
of UBS treasury stock from UBS for $30 million. 	UBS received an
option to repurchase those shares before the sale closed. 	UBS
exercised that option, and the UBS shares were never transferred to
Harbourtowne. 	Trip received an opinion letter from KPMG stating
that Trip could add to the tax basis of his UBS shares the $30
million Harbourtowne had contracted to pay for its UBS shares. 	The
KPMG opinion letter stated that it was more likely than not that
UBS’s repurchase of its shares would be considered a distribution
to Harbourtowne (which was not taxable because Harbourtowne is a
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foreign corporation), and that an appropriate treatment of this
transaction would be to transfer Harbourtowne’s basis in its UBS
shares to Trip’s basis in his UBS shares.
OPIS worked in a similar way. 	In October 1998, Trip purchased
9,200 shares of UBS for $1.99 million. 	He also purchased an option
to acquire an interest in Hogue, Investors LP (Hogue), a Cayman
Islands limited partnership. 	Hogue contracted to purchase 145,760
shares of UBS treasury stock for $40 million. 	Pursuant to a call
option, UBS repurchased those shares before the shares were
transferred to Hogue. 	Trip received opinion letters from KPMG and
Brown & Wood stating that he could add to the tax basis of his UBS
shares the $40 million Hogue had contracted to pay for its UBS
shares.
Debtors claimed losses from the FLIP and OPIS shelters on
their 1996-2000 tax returns. 	In December 1996, Trip sold 310
shares of UBS stock, and Debtors claimed resulting losses of
$6,027,306. 	In December 1997, Trip sold the remaining 1,241 UBS
shares involved in the FLIP transaction, and Debtors claimed
resulting losses of $23,396,798. 	In December 1998, Trip sold 5,900
of the UBS shares involved in the OPIS transaction, and Debtors
claimed resulting losses of $20,570,283. 	In December 1999, Trip
sold an additional 1,000 UBS shares acquired in the OPIS
transaction, and Debtors claimed resulting losses of $3,566,297.
In December 2000, Trip sold the remaining 2,300 UBS shares acquired
in the OPIS transaction, and Debtors claimed resulting losses of
$8,244,602.
In July 2001, the IRS challenged the validity of basis-
shifting tax shelters, such as FLIP and OPIS. 	In Notice 2001-45,
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28 2 The 1996 return was not audited because the limitation
period had already expired for that year.
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the IRS rejected the central concept upon which those tax shelters
are based. 	The IRS Notice states in substance that when a U.S.
taxpayer owns shares of a foreign corporation, and also owns an
interest in an offshore entity that holds shares of the foreign
corporation, the U.S. taxpayer’s basis in his shares should not be
increased to include the offshore entity’s basis in its shares of
the foreign corporation when the offshore entity’s shares are
redeemed by the foreign corporation.
In July 2001, the IRS also commenced an audit of Debtors’ 1997
tax return, focusing its inquiry upon the losses claimed from their
transactions in UBS stock. 2 	The audit was later expanded to include
Debtors’ 1998, 1999, and 2000 tax returns. 	Debtors immediately
retained Hochman, Salkin, Rettig, Toscher & Perez, P.C. (Hochman), a
law firm specializing in tax litigation, to represent them in the
audit. 	Hochman responded to several IRS requests for information
regarding the FLIP and OPIS transactions.
In July 2002, the IRS Revenue Agent performing the audit of
Debtors’ returns sent Debtors’ counsel a letter stating that the
losses from the FLIP and OPIS transactions should be disallowed.
[T]he Service has concluded that it has a strong case
regarding this issue. 	It is the position of the IRS that
the claimed benefits from this transaction are not
allowable. 	The question of application of additions to
tax, sometimes called penalties, is also being actively
considered.
In October 2002, the IRS issued Announcement 2002-97, in which
it described the terms upon which it would settle cases involving
basis-shifting tax shelters, such as FLIP and OPIS. 	The
Announcement stated that settling taxpayers would be required to
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concede 80 percent of the claimed losses, would be permitted to
claim 20 percent of the claimed losses, and in appropriate cases
would be relieved of certain penalties.
On November 27, 2002, Debtors’ counsel wrote to the IRS,
stating Debtors’ intention to participate in this settlement
program. 	On December 23, 2002, Debtors received a response from the
IRS, stating that Debtors were not eligible for the settlement
program, because one of the tax years in which Debtors claimed FLIP
losses was no longer open to audit. 	In October 2003, Debtors’
counsel asked that their request for participation in the settlement
program be forwarded to the Appeals Division of the IRS.
C. 	Debtors’ Investment Losses
At the same time Debtors’ tax woes were mounting, their
investments began to go bad. 	By late 2002, 3DO, the company in
which Debtors had invested almost all of the proceeds from the sale
of their EA shares, was experiencing severe financial difficulty.
In December 2002, Trip acknowledged that the company needed a large
infusion of capital and that he was the only source from which the
company could raise that capital. 	Between October 2002 and January
2003, Trip loaned 3DO approximately $12 million. 	In May 2003, 3DO
filed a chapter 11 petition. 	In September 2003, Trip told his ex-
wife that his 3DO shares were worthless. 	In November 2003, the 3DO
bankruptcy was converted from a chapter 11 reorganization to a
chapter 7 liquidation. 	Debtors never received any significant
distribution from that liquidation.
D. 	IRS Audit Report
In July 2003, IRS Revenue Agent John Barrett issued his audit
report, which disallowed the vast majority of the losses that
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28 3 The additional amount due by year was: $3,804,850 for 1997;
$9,743,786 for 1998; $262,964 for 1999; and $2,214,673 for 2000.
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Debtors had claimed from the sale of their UBS shares. 	The report
stated that Debtors should not be allowed to add to the tax basis of
their UBS shares any amounts that Harbourtowne or Hogue contracted
to pay for their UBS shares. 	The claimed basis transfer was
inappropriate, the report concluded, because Debtors were never at
risk regarding the shares that Harbourtowne and Hogue contracted to
purchase, because the transaction lacked economic substance and
business purpose apart from tax savings, and because a principal
purpose of the transaction was the evasion of federal income tax.
As a result of the disallowance of the FLIP and OPIS losses, the
audit report indicated that Debtors owed additional taxes and
penalties in the amount of $16 million for the years 1997-2000. 3
E. 	The Family Court Proceeding
On July 23, 2003, faced with the IRS audit report and
investment losses, Trip Hawkins filed a motion in the family court
to reduce the child support payments he was required to make to his
first wife. 	He argued that he was entitled to such relief on the
basis of reduced income, investment losses, and large tax debts. 	In
the papers submitted in support of this motion, Trip acknowledged
that he owed $25 million to the IRS and the FTB and that he was
insolvent as a result. 	These representations are discussed in more
detail below.
The family court granted this motion in part, but at the same
time required Trip to place additional assets in a trust that had
been previously established for the support of the children. 	The
court also imposed a judicial lien on all the assets of that trust,
to ensure that those assets could not be seized by taxing
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authorities. 	The genesis and terms of this transfer, which the
Government relies upon to show Debtors’ attempt to evade collection
of tax, is also described in more detail below.
F. 	Assessment of Additional Taxes
On December 30, 2004, Debtors consented to the assessment of
the additional taxes and penalties shown on the IRS Audit Report.
In March 2005, the IRS made an aggregate assessment of taxes,
penalties, and interest for tax years 1997-2000 totaling $21
million.
On July 22, 2005, the FTB issued a Notice of Proposed
Assessment, asserting that Debtors owed additional California state
income taxes, penalties, and interest in the amount of $15.3 million
for years 1997-2000. 	These taxes were assessed shortly thereafter.
G. 	Lawsuit Filed Against KPMG
In July 2005, Trip filed suit against KPMG in the San Mateo
County Superior Court, alleging claims for fraud and professional
negligence arising out of KPMG’s recommendation that Debtors invest
in the FLIP and OPIS shelters. 	Trip later dismissed this action to
participate in a federal class action suit brought against KPMG in
the United States District Court in New Jersey.
Debtors never contemplated that their claims against KPMG would
enable them to pay in full the tax liabilities arising out of the
FLIP and OPIS shelters. 	At a family court hearing in January 2004,
Trip’s bankruptcy counsel testified that the damages from such a
suit would be limited to the amount of any tax penalties imposed on
Debtors, because Debtors would have had to pay the principal amount
of the tax due even if they had not been induced to invest in the
shelters. 	In the Disclosure Statement accompanying their chapter 11
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4 The aircraft was held by an entity wholly owned by Debtors.
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plan, Debtors estimated that proceeds of the claims against KPMG
“may be as much as $3 million.” 	Although the parties did not
introduce evidence as to the exact amount received in settlement of
Debtors’ claims against KPMG, it appears that the recovery was not
materially in excess of the amount Debtors estimated in the
Disclosure Statement.
H. 	Offer in Compromise
In October 2005, Debtors submitted an Offer in Compromise to
the IRS in which Debtors offered to pay the IRS $8 million over a
two-year period. 	Such an amount would have been equal to
approximately 38 percent of the amount that had been assessed by the
IRS earlier that year. 	In March 2006, an IRS official advised
Debtors’ counsel that she could not recommend acceptance of Debtors’
Offer in Compromise. 	Debtors withdrew the Offer on March 23, 2006.
I. 	Debtors’ Lifestyle
From the time of their 1996 marriage onward, Debtors maintained
a lifestyle that was commensurate with the great wealth they enjoyed
at the time they were first married. 	In 1996, Debtors purchased a
home in Atherton, California for $3.5 million. 	In 2000, Debtors
purchased an $11.8 million private jet that they used for family
vacations as well as for business trips. 4 	In 2002, Debtors
purchased an ocean-view condominium in La Jolla, California for $2.6
million. 	From the date of their marriage to the date of their
bankruptcy petition, Debtors employed various gardeners and
household attendants.
Debtors altered this lifestyle very little after it became
apparent in late 2003 that they were insolvent. 	Although they
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5 The family contained only two drivers. 	None of Debtors’
children were old enough to drive.
6 In addition to specific living expense items totaling
$652,000, Debtors listed “other” living expenses totaling $487,000
annually.
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sold the private jet in 2003, they continued to maintain both the
Atherton house and the La Jolla condominium until July 2006. 	In
October 2004, Debtors purchased a fourth vehicle costing $70,000. 5
Debtors’ personal living expenses exceeded their earned income
long after Trip had acknowledged that Debtors were insolvent. 	In
the Collection Information Statement accompanying their October 2005
Offer in Compromise, Debtors disclosed annual after-tax earned
income of $150,000 and annual living expenses of more than $1.0
million. 6 	In the schedules filed in their bankruptcy case in
September 2006, Debtors disclosed annual after-tax earned income of
$272,000 and annual living expenses of $277,000. 	The components of
Debtors’ living expenses are discussed in more detail below.
J. 	Debtors’ Bankruptcy Case
On September 8, 2006, Debtors filed a chapter 11 petition,
primarily for the purpose of dealing with their tax obligations.
Those tax obligations had been paid in part shortly before and after
the bankruptcy petition. 	In July 2006, Debtors had sold their
Atherton home, and the entire $6.5 million net proceeds had been
paid to the IRS in partial satisfaction of its lien. 	In August
2006, the FTB had seized $6 million from Debtors’ various financial
accounts. 	Shortly after the petition date, Debtors sold the La
Jolla condominium and paid the entire $3.5 million net proceeds to
the IRS. 	Even with these payments, however, Debtors owed huge
liabilities to both the IRS and FTB. 	The IRS filed a proof of claim
in the bankruptcy case asserting that Debtors owed federal taxes in
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28 7 The new-value contribution and purchase of personal property
were made through a loan obtained from Trip Hawkins’ father.
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the amount of $19 million after taking account of the recent $9.6
million payment. 	The FTB filed a proof of claim asserting that
Debtors owed state income taxes in the amount of $10.4 million after
taking account of the FTB’s recent seizure of $6 million.
Debtors proposed a plan of reorganization that provided for
payment of part of the amount owed the IRS and FTB through: (1) a
new-value contribution of $500,000; (2) Debtors’ purchase of art and
furnishings from the bankruptcy estate for $270,000; 7 (3) proceeds
from the class action suit against KPMG; and (4) liquidation of the
other assets of the estate. 	The plan was confirmed on July 13,
2007.
The IRS acknowledges that it received payment of approximately
$3.4 million through the bankruptcy case, and contends that it holds
an unpaid claim of approximately $12 million afterwards. 	The FTB,
whose lien rights against Debtors’ assets were junior to those of
the IRS, received much less in the chapter 11 case. 	It is not
necessary to determine the exact amount due to either the IRS or the
FTB, as the parties have sought only a determination as to whether
the unpaid taxes, whatever their amount, should be excepted from
discharge.
The discharge provisions of the confirmed plan state “The
Hawkinses will be discharged from any debts that arose before the
date of confirmation of the Plan to the extent provided by 11 U.S.C.
Section 1141(d),” and that the Debtors, IRS, or FTB may bring suit
to determine whether the unpaid tax debts were excepted from the
discharge Debtors received.
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28 8 All statutory references are to the United States Bankruptcy
Code, Title 11 of the United States Code.
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K. 	The Present Action
On December 14, 2007, Debtors filed a declaratory relief action
against the IRS and the FTB alleging that a dispute existed as to
whether the tax liabilities not paid through the chapter 11 case
(the Unpaid Taxes) were discharged, and seeking a determination that
the Unpaid Taxes were in fact covered by the discharge entered by
this court in October 2007. 	The IRS and the FTB filed answers
acknowledging the existence of the dispute, but asking this court to
determine that the Unpaid Taxes were excepted from discharge
pursuant to section 523(a)(1)(C) of the Bankruptcy Code. 8
DISCUSSION
I.
Fraudulent Returns
The Government first contends that the Unpaid Taxes should be
excepted from discharge on the basis that Debtors filed fraudulent
returns for the years in which those liabilities arise. 	§ 523(a)(1)
(C). 	The Government contends that the 1997-2000 returns were
fraudulent, because Debtors knew that they could not properly claim
losses from the FLIP and OPIS shelters to offset gains from the sale
of their EA shares.
It is a difficult question whether Trip Hawkins acted with
intent to defraud in filing the returns in question. 	An objective,
well-trained tax professional would have known that the claimed loss
deductions lacked substance and would not be upheld if challenged.
Trip Hawkins clearly has the financial acumen to understand why the
FLIP and OPIS losses should not be allowed, and once the IRS
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challenged the deductions, Debtors never contended that the
deductions were valid, and immediately tried to opt into a
settlement program that would have allowed them only a small portion
of the losses they claimed in their returns. 	At the same time,
however, the FLIP and OPIS shelters were extremely complicated, and
at the time Trip signed the returns in question, he held opinion
letters from tax professionals stating that it was more likely than
not that the claimed deductions would be upheld. 	These opinion
letters were themselves so long and complex that they helped to
disguise the lack of substance in the FLIP and OPIS transactions.
The court need not, and does not, decide whether Trip Hawkins
acted with intent to defraud regarding 1997-2000 returns. 	As
explained below, the Unpaid Taxes should be excepted from discharge
on the basis that Trip caused Debtors to make unreasonable
discretionary expenditures for an extended period of time after he
became aware of tax obligations that he knew he could not pay.
There is no evidence that Lisa Hawkins signed the 1997-2000
returns with fraudulent intent. 	To establish such intent, the
Government would have to show that she knew that Debtors could not
properly claim losses from the FLIP and OPIS transactions. 	The
Government introduced no evidence that Lisa had any understanding of
those very complex transactions.
II.
Willful Attempt to Evade Tax
A. 	Introduction
The Government next contends that the Unpaid Taxes should be
excepted from discharge, because Debtors willfully attempted to
evade the collection of those taxes. 	Section 523(a)(1)(C) excepts
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from discharge any debt “with respect to which the debtor . . .
willfully attempted in any manner to evade or defeat such tax.”
The Government contends that Debtors attempted to avoid
collection of these taxes by maintaining an extravagant lifestyle
while not paying a known tax liability, by making fraudulent
transfers of assets, by failing to disclose assets on their
bankruptcy schedules, by making an inadequate offer in compromise to
the IRS, and by concealing their plan to file bankruptcy.
For the reasons stated below, the court finds that the Unpaid
Taxes should be excepted from discharge with respect to Trip
Hawkins, because he willfully avoided the collection of tax by
making unreasonable and unnecessary discretionary expenditures at a
time when he knew he owed taxes and knew he would be unable to pay
those taxes. 	The court determines that the Unpaid Taxes should not
be excepted from discharge with respect to Lisa Hawkins, because the
Government failed to show that she understood the Debtors’ financial
condition or significantly influenced their spending.
B. 	Legal Standard
The elements that the Government must establish to show a
willful attempt to evade or avoid tax are summarized well in
U.S. v. Jacobs:
Section 523(a)(1)(C) “contains a conduct requirement (that
the debtor ‘attempted in any manner to evade or defeat [a]
tax’), and a mental state requirement (that the attempt
was done ‘willfully’).” 	“The government satisfies the
conduct requirement when it proves the debtor engaged in
affirmative acts to avoid payment or collection of the
taxes”, either through commission or culpable omission.
The mental state requirement - willfulness - is satisfied
where the government shows that the debtor’s attempt to
avoid tax liability was “done voluntarily, consciously or
knowingly, and intentionally.” 	That standard is met where
“(1) the debtor had a duty under the law, (2) the debtor
knew he had that duty, and (3) the debtor voluntarily and
intentionally violated that duty.”
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9 See, e.g., U.S. v. Fretz (In re Fretz), 244 F.3d 1323, 1329-
30 (11th Cir. 2001); U.S. v. Fegeley (In re Fegeley), 118 F.3d 979,
984 (3rd Cir. 1997).
10 See, e.g., Jacobs, 490 F.3d at 926-27; Wright v. IRS (In re
Wright), 191 B.R. 291, 293-95 (S.D.N.Y. 1995); U.S. v. Swenson (In
re Swenson), 381 B.R. 272, 299-300 (Bankr. E.D. Cal. 2008); Hamm v.
U.S. (In re Hamm), 356 B.R. 263, 285 (Bankr. S.D. Fla. 2006).
11 See, e.g., Jacobs, 490 F.3d at 925-27; Dalton v. IRS, 77
F.3d 1297, 1302-04 (10th Cir. 1996).
12 Discussed in detail in text below.
-15-	Memorandum Decision
U.S. v. Jacobs, (In re Jacobs), 490 F.3d 913, 921 (11th Cir. 2007)
(citations omitted).
The necessary “affirmative act,” or “culpable omission” may
consist of failure to file returns, 9 concealment of income, 10
fraudulent transfer or concealment of assets, 11 or unnecessary
expenditures. 12
The requirement that the taxpayer act voluntarily, consciously,
and intentionally “prevents the application of the exception [from
discharge] to debtors who make inadvertent mistakes,” but does not
require the government to establish fraudulent intent. 	Jacobs, 490
F.3d at 924.
Numerous decisions have held that unnecessary expenditures
combined with nonpayment of a known tax can be the basis for
excepting that tax from discharge.
[T]he caselaw applying section 523(a)(1)(C) has
consistently held section 523(a)(1)(C)’s requirements to
be satisfied in situations where the debtor-even without
fraud or evil motive-has prioritized his or her spending
by choosing to satisfy other obligations and/or pay for
other things (at least for non-essentials) before the
payment of taxes, and taxes knowingly are not paid.
Lynch v. U.S. (In re Lynch), 299 B.R. 62, 64 (Bankr. S.D.N.Y. 2003);
accord Jacobs 490 F.3d at 925-27; Stamper v. U.S. (In re Gardner),
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-16-	Memorandum Decision
360 F.3d 551, 560-61 (6th Cir. 2004); Wright, 191 B.R. at 293; Hamm,
356 B.R. at 285-86.
Courts have used the following language to explain the logic
and limits of the doctrine under which a tax debt may be rendered
nondischargeable because the debtor pays other creditors or
purchases luxuries instead of paying taxes.
This Court starts with the recognition that as numerous
cases have recognized, “nonpayment of tax alone is not
sufficient to bar discharge of a tax liability.” . . .
[I]n nearly every bankruptcy case in which taxes are due,
some income came in that was spent somewhere, in some way.
Reconciling that with the principle that nonpayment alone
does not constitute evasion requires the recognition that
at least part of one’s income can be spent on living
without running afoul of the deemed evasion that results
from electing to spend one’s money on purchases or
obligations other than taxes, so long as it fairly can be
regarded as non-discretionary.
Lynch, 299 B.R. at 84 (footnotes omitted)(emphasis added).
[I]t is not necessary to prove that the debtor was
inspired by “bad purpose or evil motive” in failing to pay
his taxes. 	It is enough if the debtor “had the
wherewithal to file his return and pay his obligation,”
but “voluntarily, consciously, and intentionally” decided
to pay other creditors instead.
Wright, 191 B.R. at 293 (citations omitted).
[B]oth Debtors admit to having knowledge of their tax
liabilities since at least 1995. 	In the face of that
knowledge, they continued to spend money on various
luxuries rather than on their mounting federal income tax
liabilities. 	This spending demonstrated a decision made
by the Debtors to favor self-indulgence over their tax
debts. 	That decision was voluntarily and knowingly made
by the Debtors.
Hamm, 356 B.R. at 285-86.
C. 	Culpability of Trip Hawkins
The Government has met the required burden with respect to Trip
Hawkins by establishing that for more than two and one-half years
before filing for bankruptcy protection, he caused Debtors to make
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13 Debtors’ schedules listed no unpaid general unsecured
claims.
14 Hawkins attempted to opt into a settlement program
established by the IRS under which the taxpayer would concede 80
percent of the claimed loss deduction and the government would
recognize the remaining 20 percent of the claimed loss. 	The
calculation of federal and state tax liability at $25 million was
calculated on the assumption that Hawkins would be permitted to
claim 20 percent of the loss under the settlement program.
-17-	Memorandum Decision
unnecessary expenditures in excess of Debtors’ earned income, while
he acknowledged that Debtors had a tax liability of $25 million,
while he relied upon that tax liability in seeking a reduction of
child support payments, while he knew Debtors were insolvent, while
Debtors paid other creditors, 13 and while Debtors planned to file
bankruptcy to discharge their tax obligations.
1. 	Knowledge of tax liability.
By January 2004, Trip Hawkins had acknowledged in writing
several times that Debtors owed federal and state income taxes in
the amount of $25 million. 	In November of 2002, with the advice of
expert tax counsel, he sought to accept an IRS settlement offer that
would fix Debtors’ federal and state tax liability at $25 million. 14
In July 2003, he sought a reduction in child support payments to his
ex-wife on the basis of that liability. 	In September 2003, in an e-
mail to the ex-wife, he estimated his tax liability at $25 million.
In January 2004, he filed a brief in support of a motion to reduce
child support that stated in relevant part: “[Hawkins’] debts
include . . . a $25,000,000.00 bill for Federal and State of
California income taxes. 	The tax bill has been issued after an
offer from the Internal Revenue Service was accepted by Mr.
Hawkins.”
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-18-	Memorandum Decision
In January 2004, Trip Hawkins’ tax counsel filed a declaration
in support of the motion to reduce child support that stated in
relevant part:
The total amount that we anticipate that the
Taxpayers will owe the IRS as of today’s date is equal to
$4,375,949.00; $11,295,412.00; $305,152.00; and
$2,500,771.00 for the years 1997 through 2000,
respectively. 	Thus, we estimate the Taxpayers’ liability
to the IRS to exceed $18,000,000.00.
In addition, the FTB continues to seek their share of
the liability. 	For FTB purposes, the Taxpayers are not
eligible for the federal settlement initiative. 	Based
upon this information, it is estimated that the Taxpayers
may owe the FTB an amount equal to approximately forty
percent (40%) of the IRS liability. 	Thus, it appears that
exposure to the FTB liability will exceed $7,000,000.
It is likely that Trip Hawkins understood that he owed millions
in taxes well before January 2004. 	In closing argument, his counsel
acknowledged that Trip understood by November 2002 that Debtors
would be liable for the taxes claimed by the IRS and FTB. 	It is
worthy of note that at no time since the IRS challenged the FLIP and
OPIS shelters in July 2001 has Hawkins asserted that the losses
Debtors claimed through those shelters were allowable under law.
2. 	Knowledge of Insolvency.
By January 2004, Trip Hawkins also knew his liabilities
exceeded his assets, and that any dissipation of his assets would
reduce his ability to pay his tax liabilities. 	In the January 2004
brief in support of his motion to reduce child support, Hawkins
openly acknowledged that he was insolvent: “At this time, [Hawkins’]
assets are about $20,867,000.00 . . . and his debts include a
$4,000,000.00 house loan and a $25,000,000.00 bill for Federal and
State of California income taxes.”
The testimony of Hawkins and his bankruptcy attorney at the
January 2004 family court hearing indicates that Hawkins planned not
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15 As noted above, Debtors’ tax counsel assumed that a
liability to the IRS of $18 million would result in an additional
liability to the FTB of $7 million.
16 The bankruptcy attorney explained that the taxes could not
be discharged unless the petition was filed at least three years
after the latest return was filed and at least 240 days after the
taxes had been assessed. 	See §§ 507(a)(8) and 523(a)(1)(A).
17 The attorney may have been concerned that the bankruptcy
court might refuse to confirm Debtors’ chapter 11 plan on the basis
that its primary purpose was the avoidance of tax. 	See § 1129(d).
-19-	Memorandum Decision
to pay the tax debt in full. 	Hawkins testified that he had accepted
the IRS settlement offer, which would result in a liability of $18
million to the IRS. 15 	Immediately after this testimony, Hawkins’
bankruptcy attorney testified that Hawkins’ intent was not to pay
the tax debt, but to discharge it in bankruptcy. 	“What we’re
looking for is the ability to discharge the tax, in other words, to
eliminate the tax liability at some point in the future so that Mr.
Hawkins can be freed from that tax.” 	Hawkins’ bankruptcy attorney
then testified at length about the timing of the planned bankruptcy
filing. 16 	Following the hearing, Hawkins’ bankruptcy attorney asked
that the order issued by the family court not include any reference
to the planned bankruptcy petition, to minimize the likelihood that
the bankruptcy petition would be found to be filed in bad faith. 17
3. 	Discretionary Expenditures.
Before examining Hawkins’ expenditures, it is appropriate to
examine Hawkins’ earned income. 	For the purpose of this decision,
this court assumes that it should take some account of a debtor’s
earned income in determining what expenditures are culpable under
section 523(a)(1)(C) as unduly lavish. 	It may not be appropriate to
require a CEO earning hundreds of thousands of dollars per year to
live in an apartment suitable for a clerical employee, even if that
CEO is insolvent. 	The effort and skill required to earn such sums
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18 The court should not afford similar weight to unearned
income in evaluating the culpability of expenditures by a taxpayer
who knows he is insolvent. 	Such a taxpayer is not “working for his
creditors,” as the unearned income would be available to those
creditors in any event. 	Although at one time the value of Debtors’
stock holdings were inextricably intertwined with Trip Hawkins’
active occupation, the evidence suggests that by 2004, his unearned
income consisted primarily of dividends from UBS stock, which were
not dependent in any way upon Trip Hawkins’ current personal
efforts.
19 A taxpayer who suffers a sudden decline in income may, of
course, need some time to adjust his or her expenditures.
-20-	Memorandum Decision
require a nuanced approach in determining what living expenses are
necessary. 18 	Even the most nuanced approach, however, does not
excuse living expenses greatly in excess of earned income over an
extended period of time. 19
Debtors provided two snapshots of their income and expenses
between January 2004 and September 2006. 	In October 2005, Debtors
submitted a Collection Information Statement, signed under penalty
of perjury, in support of their Office in Compromise. 	In September
2006, Debtors filed schedules in their chapter 11 case, also signed
under penalty of perjury. 	The October 2005 Collection Information
Statement indicated monthly after-tax earned income of $12,500.
Bankruptcy Schedule I indicated monthly after-tax earned income of
$22,180. 	All of this income was earned by Trip; Lisa was not
employed outside the home at any time during this period.
Against this backdrop, the Debtors’ personal living expenses
from January 2004 to September 2006 are truly exceptional. 	After
Trip represented to the family court that he was liable for $25
million in federal and state taxes and that he was insolvent as a
result, Debtors spent between $16,750 and $78,000 more than their
after-tax earned income each month.
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20 Wages of $16,668 less income and FICA taxes of $4,200.
-21-	Memorandum Decision
In the Collection Information Statement submitted in October
2005, Debtors stated that their personal living expenses were more
than seven times their after-tax earned income, and exceeded that
income by more than $78,000 per month.
After-tax earned income 20 	$12,468
Food, clothing, misc. 	($7,000)
Housing and utilities 	($33,600)
Transportation 	($2,700)
Health care 	($700)
Child care 	($4,500)
Life insurance 	($1,650)
Other expenses 	($40,550)
Total Expenses 	($90,700)
Income less expenses 	($78,232)
Several aspects of this Statement are worthy of note. 	The
$33,600 housing expense included expenses for a 5-bedroom, 5.5 bath
house in Atherton (later sold for $10.5 million), and a 4-bedroom,
3.5 bath condominium in La Jolla (later sold for $3.5 million). 	The
transportation expense covers four vehicles for a family with only
two drivers, and includes a $70,000 Cadillac SUV purchased ten
months after Trip Hawkins had acknowledged Debtors’ tax liability
and insolvency in the family court proceeding. 	The $40,550 for
“other expenses” is not broken down. 	If that figure is exaggerated,
the exaggeration may itself represent an effort to prevent the
collection of tax.
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21 Salary and consulting fees of $24,567 less payroll and
Social Security taxes of $2,029.
22 Monthly mortgage payment on Atherton house of $19,500, plus
minimum possible real estate taxes on Atherton house of $2,917 per
month, plus minimum monthly real estate taxes on La Jolla
condominium of $2,166 per month (monthly property tax calculated at
1/12 of 1 percent of original purchase price). 	This figure does
not include any amount for fire insurance, and undoubtedly
underestimates property taxes.
23 Includes auto insurance, loan payments on the SUV, and
operating expenses.
-22-	Memorandum Decision
The schedules filed in Debtors’ bankruptcy case indicate that
Debtors’ personal living expenses greatly exceeded their after-tax
earned income until just before they filed their bankruptcy petition
in September 2006. 	Debtors sold the Atherton house just before the
bankruptcy petition was filed. 	Debtors sold the La Jolla
condominium after the bankruptcy petition was filed. 	If one adds
the minimum amount they could have been spending for housing before
the July 2006 sale of the Atherton house, together with the income
and living expenses that Debtors reported in their bankruptcy
schedules, Debtors’ living expenses greatly exceeded their after-tax
earned income through July 2006.
After-tax earned income 21 	$22,638
Housing expense 22 	($24,583)
Utilities & maintenance 	($1,615)
Food 	($3,500)
Clothing, laundry & cleaning 	($450)
Medical 	($700)
Recreation & entertainment 	($1,100)
Life insurance 	($825)
Transportation 23 	($2,328)
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house promptly after January 2004 but were unable to do so.
-23-	Memorandum Decision
Child care 	($3,800)
Education 	($150)
Storage 	($800)
Total Expenses 	($39,851)
Income less expenses 	($17,213)
Debtors made expenditures in excess of earned income for more
than two-and-one-half years after Trip Hawkins acknowledged in
January 2004 that Debtors were insolvent and would not pay their tax
debt in full. 	Debtors did not sell the Atherton home until July
2006. 	They did not sell the La Jolla condominium until after filing
for bankruptcy protection in September 2006. 24 	They reported in
their bankruptcy schedules that on the petition date they were still
making the expenditures for the Cadillac SUV, child care, and
recreation noted above. 	Debtors’ high level of expenditure also
continued well after they consented to assessment of tax by the IRS
in the amount of $21 million in December of 2004, and well after the
assessments were recorded in March 2005. 	The Collection Information
Statement indicates that Debtors’ monthly living expenses were seven
times their earned income ten months after they consented to
assessment and seven months after the IRS formally assessed the
additional tax. 	This is not a case where the taxpayers acted
appropriately once the tax was formally assessed, perhaps suggesting
that their earlier failure to pay was based on some innocent
misconception of their duty.
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25 One spouse can be vicariously liable for bad acts of the
other spouse committed in furtherance of a business partnership
including both spouses. 	Tsurukawa v. Nikon Precision, Inc. (In re
Tsurukawa), 287 B.R. 515, 523-27 (9th Cir. BAP 2002). 	That
principle is inapplicable in this case, as there is no evidence of
a business partnership including Trip and Lisa Hawkins.
-24-	Memorandum Decision
D. 	Culpability of Lisa Hawkins
The actions, knowledge, and intent of Trip Hawkins do not by
themselves require that the Unpaid Taxes be excepted from the
discharge granted Lisa Hawkins. 	Bad acts by one spouse are not
automatically attributed to the other spouse for the purpose of
determining whether a debt should be excepted from discharge.
Allison v. Roberts, (In re Allison), 960 F.2d 481, 485-86 (5th Cir.
1992); La Trattoria, Inc. v. Lansford (In re Lansford), 882 F.2d
902, 904-05 (9th Cir. 1987); Synod of South Atlantic Presbyterian
Church v. Magpusao (In re Magpusao), 265 B.R. 492, 498-99 (Bankr.
M.D. Fla. 2001). 	Bad acts by one spouse may be considered in
determining the responsibility of the other spouse, where the other
spouse knowingly participates in the bad acts and accepts the
benefits derived from those bad acts. 25 	Lansford, 822 F.2d at 905;
Magpusao, 265 B.R. at 500-01; Rainier Title Co. v. Demarest (In re
Demarest), 176 B.R. 917, 922-23 (Bankr. W.D. Wash. 1995).
The Government has not met its burden of showing that Lisa
Hawkins willfully made unnecessary expenditures while not paying a
known tax liability. 	The evidence indicates instead that Lisa
reasonably deferred to Trip regarding all significant financial
decisions, and that it was he who is responsible for all of Debtors’
actions with respect to the tax liabilities in question. 	In so
finding, I note the following.
First, Trip and Lisa had very different levels of financial
expertise and experience, and played very different roles in the
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-25-	Memorandum Decision
family. 	Trip had a Stanford M.B.A., worked full time as the CEO of
a publicly traded company, and had at one time accumulated $100
million through his own efforts and investments. 	Lisa had only an
undergraduate degree in communications, had very limited business
experience, and during the entire period of her marriage to Trip had
been a full-time, stay-at-home mother and wife. 	These facts and
circumstances indicate that it was Trip who managed all significant
aspects of the family finances, that it was Trip who decided what
the family could afford to spend, and that Lisa deferred to Trip’s
expertise and experience on all financial matters. 	Trip and Lisa’s
testimony at trial reinforced this picture.
Second, the most damaging evidence of evasion, Trip’s
representations in his motion to reduce child support payments to
his ex-wife, do not implicate Lisa. 	It was in that motion that Trip
acknowledged his tax liability, his resulting insolvency, and his
intent to discharge rather than pay his tax liabilities. 	There is
no evidence that Lisa participated in that motion or was otherwise
aware of the representations Trip made in that motion.
Third, the Government did not examine Lisa in detail regarding
her role in decision making regarding family finances, her knowledge
of the family’s financial condition, or her knowledge of Trip’s
decision not to pay taxes while maintaining the family’s previous
standard of living. 	The Government established through its
questioning of Lisa only that she knew of the tax audit, that she
participated in some undefined way in the preparation of the
Collection Information Statement, and that it was she who purchased
the $70,000 SUV in October 2004. 	Lisa testified that she paid no
attention to financial issues not directly concerned with the
immediate operation of the household, and that even the household
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-26-	Memorandum Decision
bills were generally paid by Trip’s personal assistant. 	I find this
testimony credible.
The evidence taken as a whole indicates that it was Trip who
was in every meaningful sense responsible for Debtors’ failure to
pay tax while making unnecessary personal expenditures.
E. 	Other Alleged Acts of Evasion
In support of its contention that Debtors willfully attempted
to avoid collection of tax, the Government relies upon other alleged
acts of avoidance that are more problematic. 	I give little or no
weight to the evidence of other acts of willful avoidance discussed
below.
The Government contends that Trip Hawkins intentionally used
the family court proceedings to transfer property to the Hawkins
Family Support Trust (the Trust) for the purpose of shielding those
assets from taxing authorities. 	The record of those proceedings
does not support this claim. 	Trip brought a motion to reduce his
child support payments on the basis of his investment losses and tax
liability. 	In the course of opposing that motion, the attorney for
Trip’s ex-wife urged that Trip be required to place additional funds
in the Trust, and that the assets of the Trust be shielded from
Debtors’ tax liabilities by requiring Trip to make the Trust
irrevocable and by placing a judicial lien on Trust assets. 	Trip’s
counsel opposed this request. 	It is true that after the family
court judge granted the ex-wife’s request, Hawkins’ counsel
cooperated fully in drafting an order implementing that ruling.
This record does not show, however, that Hawkins willfully
transferred property to the Trust with the intent of frustrating the
collection of tax.
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The Government next contends that the Unpaid Taxes should be
excepted from discharge, because Debtors planned from January 2004
onward to discharge those liabilities, and because they submitted an
inadequate Offer in Compromise to delay the Government’s collection
efforts while Debtors waited for their tax liabilities to become old
enough to be subject to discharge. 	This evidence does show that
Debtors intended to discharge rather than pay the Unpaid Taxes.
That by itself, however, does not justify a finding that Debtors
willfully attempted to avoid the collection of tax. 	The Unpaid
Taxes should be excepted from Trip’s discharge, not because Debtors
made a decision to file bankruptcy long before they actually did so,
but because Trip caused them to waste assets through unnecessary
personal spending after they decided to discharge their tax
liabilities.
The Government urges the court to rely upon Debtors’ personal
use of their private jet as the centerpiece of their lavish personal
spending. 	I attach little importance to ownership of the jet,
because Debtors purchased the jet while they thought they were
solvent, and they attempted to sell it soon after they understood
they were insolvent.
I also decline to rely upon the Government’s argument that
Debtors attempted to evade tax by making high-risk loans to 3DO
shortly before that company filed for bankruptcy. 	I agree that a
pattern of high-risk investments can constitute evidence of an
attempt to evade payment of tax. 	A debtor who has $100 in assets
and owes $100 in debts acts inappropriately towards his creditors by
buying $100 in lottery tickets. 	While Debtors’ loans to 3DO were
somewhat like buying lottery tickets, in that they imposed on the
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26 Although Debtors did not specify that they held a seat
license, they did disclose in their schedules ownership of season
tickets. 	This conduct is not persuasive evidence of intent to
deceive, and is very different from that involved in the cases
cited by the Government in which there was a complete failure to
list either the seat license or tickets along with failure to
disclose many other assets. 	See In re Blow, 2007 WL 1858697
(Bankr. S.D. Tex. 2007) and In re Gordon, 2002 WL 925028 (Bankr.
M.D.N.C. 2002).
-28-	Memorandum Decision
Government most of the risk of loss while affording Debtors most of
the benefits of success, the evidence of evasion of tax via
unnecessary spending is so strong against Trip that the loans to 3DO
add little to the Government’s case, and there is no evidence that
Lisa played any role in the loans to 3DO.
Finally, I am unconvinced that Debtors intentionally failed to
disclose their San Francisco Giants seat license, 26 and I consider it
wholly irrelevant that Debtors were able to maintain a high standard
of living post-bankruptcy by purchasing furniture and artworks from
the bankruptcy estate with money borrowed from Trip Hawkins’ father.
F. 	Conclusion
The Government introduced no evidence that Lisa Hawkins signed
the 1997-2000 returns knowing that Debtors could not properly claim
losses from the FLIP and OPIS shelters. 	The Government did not
establish that Lisa attempted to evade tax through excessive
personal expenditures, because it failed to show she had any
understanding of the extent of the couple’s tax liability, that she
knew of Trip’s plan not to pay that tax liability, or that she
exercised significant influence upon the family’s expenditures.
Trip Hawkins willfully evaded payment of that tax debt within
the meaning of section 523(a)(1)(C) by causing Debtors to deplete
their assets on large unnecessary expenditures for an extended
period of time, while knowing that Debtors were insolvent, while
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knowing that Debtors had a $25 million tax debt that they could not
pay and did not intend to repay, and while paying other creditors.
It is true that the present case does not exhibit all the
badges of tax evasion present in the majority of decisions in which
courts have found a willful attempt to evade or defeat tax. 	In the
more typical case in which the court relies upon luxury
expenditures, there are other indices of evasion not present here:
failure to file returns; concealment of income; failure to pay the
amount shown on the returns; or transfer of assets without
consideration. 	Lynch, 299 B.R. at 83 n.96. 	I have considered those
decisions carefully and I conclude that no specific type or number
of badges of evasion is required. 	The statute itself does not
require the presence of any badges of evasion; their sole function
is as evidence of an intentional, culpable act or omission whereby
tax is willfully evaded. 	In the present case, there is ample
evidence of both the conduct requirement and mental-state
requirement, and there is evidence of willful failure to pay tax not
found in the more typical cases noted above: Trip’s exceptional
business sophistication; Trip’s open acknowledgment of his tax debt
and insolvency; the length of time over which Trip caused Debtors to
expend funds on unnecessary expenditures after he acknowledged the
tax debt; the amount of unnecessary expenditures; and the extent to
which unnecessary expenditures exceeded Debtors’ earned income.
Both parties agree that this court may not order that the
Unpaid Taxes be excepted from discharge in part. 	Whether those
liabilities are excepted from discharge is an all-or-nothing
question. 	This is so, because section 523(a)(1)(C) does not provide
that an unpaid tax debt is excepted from discharge only “to the
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27 Monthly personal living expenditures exceeded earned income
by $17,213 to $78,232 per month (see pages 21-23, above). 	Using
those monthly figures, Debtors’ personal living expenditures
exceeded earned income by a total of $516,390 to $2.35 million over
the 30 months between January 2004 and July 2006 (when they sold
the Atherton house). 	The $2.35 million figure uses the income and
expenses shown in the Collection Information Statement signed by
both Debtors and submitted to the IRS in support of Debtors’ Offer
in Compromise. 	In the two months between the date Debtors sold the
Atherton house and the petition date, expenditures exceed earned
income, but by a smaller amount.
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extent that” such debt results from the willful avoidance of tax.
Lynch, 298 B.R. at 87-88. 	Although the amount lost to the IRS and
FTB as a result of Debtors’ excessive discretionary spending is less
than the amount of the debt excepted from discharge, the amount lost
was far from immaterial. 	Debtors’ personal living expenses exceeded
their earned income by $516,000 to $2.35 million between January
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CONCLUSION
Trip Hawkins’ income tax liabilities to the IRS and FTB for tax
years 1997-2000 are excepted from discharge pursuant to section
523(a)(1)(C) of the Bankruptcy Code. 	Lisa Hawkins’ liabilities for
the Unpaid Taxes are not excepted from discharge.
**END OF MEMORANDUM DECISION**
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