Cole v. United States of America (Internal Revenue Service

OCR transcription for search; preserved printed pages are authoritative

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 1of14

UNITED STATES BANKRUPTCY COURT
MIDDLE DISTRICT OF FLORIDA
TAMPA DIVISION
In re
KATHY L. COLE, Case No. 8:04-bk-10201-KRM

Debtor.

ee

KATHY L. COLE,
Plaintiff,
Vs.

Adversary No. 04-00361

UNITED STATES OF AMERICA,
INTERNAL REVENUE SERVICE,

Defendant.

ee ee ee

MEMORANDUM OPINION ON
DISCHARGEABILITY OF DEBTOR’S TAX
OBLIGATIONS FOR THE YEARS 1992 AND 1993

The Bankruptcy Code permits a debtor to discharge
income taxes in Chapter 7 for a period which is at least three
years before the bankruptcy filing, if the applicable returns
were filed at least two years before the bankruptcy case, the
returns are not fraudulent, and the debtor has not willfully
attempted, in any manner, to evade or defeat the otherwise
dischargeable taxes. 11 U.S.C. § 523(a) (1) (C).

In this case, the debtor is an accountant who

prepared tax returns for a living. Her electronic tax filing

AUTHENTICATHD
U.S. GOVERNMHNT
INFORMATIO

G

e)

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 2 of 14

service filed fraudulent tax returns for some of its clients
in 1992 and 1993. She was indicted and pleaded guilty to one
count of tax fraud.

What brings this matter before this Court is that
the debtor did not pay her own income taxes for 1992 and 1993,
and for 1996 through 1998. She now seeks to discharge ali of
these tax obligations.! For the reasons set forth below, the
Court concludes that the debtor willfully attempted to evade
or defeat the 199? and 1993 income taxes, which are therefore
excepted from the discharge.°

BACKGROUND

In 1992, the debtor and a business partner formed
Tamptax, Inc. (“Tamptax”), to prepare and file electronic tax
returns for its clients.*? The debtor also operated a separate

accounting practice.’

1 The Court has jurisdiction pursuant to 28 U.S.C. §§ 157 and

1334. This matter is a core proceeding pursuant to 28 U.8&.C.
§ 157 (b) (2) (1). This Opinion constitutes the findings of fact and
conclusions of law required to be made pursuant to Federal Rule of
Bankruptcy Procedure 7052.

® By the time of trial, the United States had conceded that the
cutstanding taxes for three years, 1996-1998, are dischargeable. Thus, the
trial focused only on the 1992 and 1993 income taxes and related statutory
additions.

3 Tamptax was a Schedule C corporation, in which the debtor
was a 50% shareholder and a director.

4 The debtor, formerly known as Kathy L. Mouling, earned 4
bachelor’s degree in accounting from the University of South Florida in
1980. Later, she took over her father’s accounting practice.

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 3 of 14

On April 9, 1998, the debtor was indicted for tax
fraud; on November 10, 1998, she pleaded guilty to one count
of making a fraudulent claim to the I.R.S. with respect to a
Tamptax client’s 1993 return. She served three years’

probation, three months’ home detention, and paid a $2,000

fine.

The debtor filed her tax returns for 1992 and 1993
after they were due. These returns were inaccurate and
underreported her income. As a result, on June 1, 1999, the

debtor entered into a stipulation with the government
assessing income taxes and statutory penalties of $9,508.00
and $7,131.00, respectively, for 1992, and $16,693.00 and
$12,494.00, respectively, for 1993.°

Tax Year 1992

In 1992, the debtor derived taxable income from her
accounting practice and from Tamptax. Periodically, the
plaintiff deposited funds received from Tamptax into her
personal checking account or into a savings account in the
name of her minor child. The debtor also deposited income
from her accounting practice into both of these accounts. The
debtor also deposited other funds into these accounts which

she asserts were not taxable: child support payments, widow’s

5 The penalties were assessed under I.R.C. Section 6663. By

the petition date, these taxes plus penalties and interest had grown to a
total of $40,560.48 for 1992 and $71,066.08 for 1993.

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 4of14

pension payments, monies received from various family members
and clients, and $12,352,93 from State Farm Insurance
Company’s payments on a claim arising from burglaries of
Tamptax’s equipment.°

The debtor did not file her 1992 tax return until
August 23, 1992, eight days after the extension deadline. In
preparing the return, the debtor employed a “bank account
deposits” method by which she totaled her bank deposits and
then deducted the depesits which she maintains were not
taxable income (e.g., the child support payments, widow's
pension payments, funds held for family members, and the
insurance proceeds). The resulting sum was reported as gross
receipts on Schedule C for the debtor’s accounting practice.

The debtor did not report any wages or salary from
Tamptax on her return. She reported total income (Line 23) of
only $16,337 even though her bank deposits, net of the
asserted “non-taxable” items, totaled $55,281.’ She then
declared $2,366 of taxes due. The income reported was about
$5,000 less than the amount of funds she actually received

(and deposited) from her accounting practice and from Tamptax.

6 These insurance proceeds were payable to Tamptax on a policy

it maintained. The proceeds were paid by the insurer to compensate the
corporation for the burglaries.

; The debtor reported $55,281 of bank deposits on Schedule C
as “gross receipts” from her business -- “Kathy L. Mouling, Accountant.”
She then deducted $38,034 of “business expenses” to arrive at “net profit”
of $16,319 shown on Line 12 of her 1992 return.

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 5of14

Tax Year 1993

The debtor did not file her 1993 tax return until
April 5, 1996, nearly two years after the return was due. The
debtor argues that the late filing is excusable because the
government seized her records in the Tamptax criminal
investigation, sometime in May or June of 1994;*® but, the tax
filing deadline had already passed when the records were
taken.

The debtor used the same “bank account deposits”
method and reported no wages, salary or dividends from
Tamptax. Funds received from Tamptax were again included in
the “gross receipts” from her accounting practice on Scheduie
Cc. She included deposits of $55,044 as gross receipts in
Schedule C for “Kathy L. Mouling.” She then deducted
“pusiness expenses” of $11,357, to arrive at “net profit” of
$43,697. As a result, even though her records reveal total
bank deposits, net of the asserted non-taxable items, of about

$60,244, the debtor reported only $43,832 of total income. ?

8 The records were returned in the first half of 1995.

° The return that the debtor actually filed was not available
at trial because it had been destroyed by the I.R.S. The I.R.S. routinely
generates a computer summary, or transcript, when a return is filed. In
this case, the I.R.S. produced at trial a transcript for the debtor's 1993
taxes, showing only $18,609 of adjusted gross income. The debtor testified
that she had prepared several versions of her 1993 tax return. The one she
produced at trial shows reported income of $55,054. If, as the Government
contends, the 1993 return produced by the debtor was not the same as the
one actually filed, then the computer transcript for the 1993 return

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 6 of 14

DISCUSSION

Taxes for a period that is more than three years
before the bankruptcy filing, and which might otherwise be
dischargeable, cannot be discharged if the debtor willfully
attempted, in any manner, to evade or defeat the taxes. 11
U.S.C. § 523(a) (1) (C). “Willful evasion” requires proof of
(1) specific conduct and (2) a mental state of willfulness.
Griffith v. United States (In re Griffith), 206 F.3d 1389,
1396 (11th Cir. 2000) .*°

A debtor’s conduct is “willful” if it is done
voluntarily, consciously or knowingly, and intentionally.
Fretz v. United States, 244 F.3d 1323, 1330 (11th Cir. 2001}.
The government is required te prove that the debtor (a) had a
duty to file returns and pay taxes; (b) knew she had such a
duty; and (c) voluntarily and intentionally violated that
duty. Td, Proof of intentional omissions may be sufficient,
just as proof of affirmative acts, to support a finding of

willful evasion. Id. In Fretz, the debtor’s intentional

suggests that she may have reported as much as $20,000 less than the amount
she determined was taxable under her own bank account analysis.

10 The United States bears the burden of proof to show by a

preponderance of the evidence that the taxes are non-dischargeable under 11
U.S.C. § 523{a} (1) (C). Grogan v. Garner, 498 U.S. 279, 287-88 (1991).

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 7 of 14

failure to file tax returns and pay the taxes for ten years
was held to be sufficient to render all of the taxes non-
dischargeable.

In deciding this case, the Court is mindful of the
prevailing view that Section 523(a})(1)(C) should be applied in
such way as to best promote the purpose of granting a
discharge to the honest, but unfortunate debtor. See In re
Birkenstock, 37 F.3d 947, 951 (7th Cir. 1996}. Thus, the late
filing of returns due to “mistake, inadvertence or an honest
misunderstanding” would not, without more, constitute evasion
of the tax. In re Fretz, 244 F.3d at 1330. Understating
income, by itself, does not establish willful evasion.
Burgess v. United States {In re Burgess), 199 B.R. 201, 207
(N.D, Ala. 1996). A debter’s failure to pay taxes, without
some other indication of willfulness, is not sufficient to
except the taxes from the discharge. In re Haas, 48 F.3d 1153
(lith Cir. 1995).

“Willfulness” may be found where there exist certain
fact patterns, known as “badges of fraud,” or other
circumstantial evidence indicating that the debtor intended to
evace tax obligations. See In re Birkenstock, 87 F.3d at 951;
In re Zuhone, 88 F.3d 469, 473 (7th Cir. 1996); Berzon v.
United States (in re Berzon), 145 B.R. 247, 250 (N.D. Ill.

1997).

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 8 of 14

Examples of conduct found to be sufficient for a
finding of willful tax evasion include: transfers of assets
to family members for insufficient consideration for the
purpose of limiting the ability of the I.R.S. to collect, In
re Griffith, supra; acts preventing I.R.5. agents from
lawfully entering the taxpayer’s premises, In re Gillis, 251
B.R. 920 (Bankr. S.D. Ga. 2000); the combination of unexcused
late-filed returns and significant understatement of income,
In re Berzon, supra. The understatement of income fer mere
than one tax year, implausible or inconsistent explanations of
behavior, inadequate records, or transfer of assets to a
family member may support the necessary inference of
willfulness., See In re Greene, 207 B.R. 21, 24-25 (M.D. Fla.
1997).

Specific Conduct

The debtor in this case did much more than file tax
returns late. The returns for 1992 and 1993 were inaccurate
and materially understated her real taxable income. The
debtor did not report as wages, salary or dividends the monies
she received for her services at Tamptax. Instead, she lumped

the amount of bank deposits which she selected as “taxable”

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 9 of 14

into the gross receipts from her separate accounting practice,
against which she deducted the expenses of that business. |

The debtor did not even include in her reported bank
deposit totals all of the deposits that she actually made inte
her savings account in 1992. She did not include as income
her deposits of the insurance monies which were paid by the
insurer on a claim by made Tamptax under its business policy.”

Willfulness

There is no doubt that the debtor’s underreporting
of income was willful. She is an accountant who prepares tax
returns for a living. She was aware of her duty to accurately
report her income and timely file tax returns.

The debtor claims that she was justified in
preparing her tax returns from bank deposits. The use of this
indirect method, however, is suspect in light cf the debtor’s
sophisticated knowledge of accounting procedures and tax laws.
By electing not to utilize customary and verifiable
decumentation, such as W-2 or 1099 forms for the monies
received from Tamptax, the debtor could conceal a portion of

her taxable income.

4 There was no legal justification offered by the debtor for

treating the monies she received from Tamptax as gross receipts of her
accounting practice.

1¢ While such payments might not be taxable when paid to the
owner of the policy who makes the claim, there is no legal basis for
excluding such payments from income when they are distributed to a
shareholder of the claimant.

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 10 of 14

In fact, the debtor did not directly report any
monies received from Tamptax as wages or compensation even
though she had prepared corporate tax returns for Tamptax for
1992 and 1993, showing payment of officer compensation to her.
She did not report as income the payments made on Tamptax'’s
insurance claim and she did not report as income ali of her
bank deposits from Tamptax and the accounting practice.

When the debtor applied for a credit card in 1993,
she advised the bank that she had an annual salary from
Tamptax of $36,480. She even gave the bank a “dummy” W-2 form
showing that she earned “wages” from Tamptax totaling $35,684
in 1992, The debtor had never filed any Tamptax W-2 forms
with the I.R.S. and she elected not to report any such wages
from Tamptax on her 1992 or 1993 returns.

The Court is compelled te conclude from this
particular conduct -- the preparation and use of wage-
verifying documents to get a credit card, while omitting such
wages from her tax returns -- that the debtor acted
deliberately and intentionally to understate her income.
Locking at the totality of the circumstances, there is no
doubt that the plaintiff evaded her tax obligations for 1992

and 1993.

10

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 11 of 14

Allocation of Payment to I.R.S. During Chapter 7 Case

The debtor filed a motion in the Chapter 7 case
seeking approval of a sale of fully-encumbered real property
that the trustee likely would have abandoned. The proceeds
were paid to lien holders, including the I.R.S. which received
$44,304.32. The check to the I.R.S. did not designate how the
payment was to be applied. The debtor now seeks a ruling that
this payment must be applied to reduce the 1992 and 1993 tax
obligations.

In cases where there is no designation as to how a
taxpayer’s payment is to be applied, or if the tax payments
are made “involuntarily,” the I.R.S. may allocate payment “in
a manner serving the best interests of the I-R.5.” In re
Tecson, 291 B.R. 199, 200 (M.D. Fla. 2003).

An undesignated payment is one as to which the
taxpayer has given no direction as to how the funds are to be
applied. Id. A tax payment is “involuntary” if it is
“received by . . . the United States as a result of distraint
or levy or from a legal proceeding in which the Government is

seeking to collect its delinquent taxes or file a claim

therefor.” Td. at 201 (citing Amos v. Comm’r, 47 T.C. 65, 69
(1966)). When a payment is involuntary the Government is free
to allocate the payment as it chcoses. In re A & B Heating &

Air Conditioning, 823 F.2d 462, 463 (llth Cir. 1987).

11

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 12 of 14

Examples of payments deemed to be “involuntary”
include: Harker v. United States, 357 F.3d 846 (8th Cir.
2004) (payment from the sale of property secured by a federal
tax lien during a Chapter 7 bankruptcy); United States v.
Pepperman, 976 F.2d 123, 127 (3rd Cir. 1992) (payment to the
I.R.S. from a Chapter 7 estate is “involuntary”); In re
Villanueva, 291i B.R. 193, 200 (Bankr. M.D. Fla. 2003)
(restitution payments, stemming from a tax fraud conviction,
were “involuntary”); and In re R.L. Inge Development Corp., 78
B.R. 793 (E.D. Va. 1987) (payments by a Chapter 7 debtor
pursuant to a bankruptcy court order directing that certain
property be soid and proceeds applied to claims of
lienhclders).

The I.R.S. filed a secured claim in this case in the
amount of $168,516.26. The $44,304 payment was made pursuant
to a court order in a judicial proceeding in which the
Government had filed a claim to collect the taxes that were
due. No written designation accompanied the payment and none
appears on the payment check. Therefore, the payment of
$44,304 to the United States was involuntary and the I.R.S. is
free to allocate the payment as it deems appropriate. The
I.R.S. will not be required to apply the $44,304 payment to

the non-dischargeble 1992 and 1993 tax cbligations.

12

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 13 of 14

CONCLUSION

The Government has proven that the debtor willfully
evaded her tax obligations for 1992 and 1993. The debtor
filed her tax returns late, maintained inconsistent records,
and materially underreported her income for two consecutive
years. The totality of the circumstantial evidence compels
the finding that such conduct was intentional and willful.
Therefore, the debtor’s 1992 and 1993 tax obligations are
excepted from discharge by 11 U.S.C. § 523 (a) (1) (Cc). Further,
these tax obligations are not required to be reduced by the
$44,304 payment to the Government from the asset sale in the
Chapter 7 case. The Court will enter a separate judgment
consistent with this opinion.

——

DONE and ORDERED at Tampa, Florida, this S_ day of
August, 2005.

Keb Me

K. RODNEY MAY
United States Banktuptcy Judge

13

Case 8:04-ap-00361-KRM Doc 25 Filed 08/05/05 Page 14 of 14

Copies Furnished To:
Kathy L. Cole, Debtor, P.O. Box 1728 Tampa, FL 33601

Buddy D. Ford, Esquire, Attorney for Debtor, 115 N. MacDill
Avenue, Tampa, Florida 33609

Mary Apostolakos Hervey, Esquire, Trial Attorney, Tax

Division, U. S. Department of Justice, Post Office Box 14198,
Ben Franklin Station, Washington, D.C. 20044

14