District Court Denies Bankruptcy Discharge for BLIPS Shelter Investor (4/4/13)

I previously reported on a Bankruptcy Judge's Order applying 11 USC 523(a)(1)(C), here, denying a KPMG BLIPS tax shelter investor a discharge in bankruptcy for the taxes, penalties and interest arising from that misguided adventure.  BLIPS Tax Shelter Investor Denied Bankruptcy Discharge for Fraudulent Return and Evasion (Federal Tax Crimes Blog 1/10/12), here.  The district court has now sustained the Bankruptcy Judge's order.  Vaughn v. United States, 2013 U.S. Dist. LEXIS 45516 (D CO 2013), here.

Key excerpts from the district court's Opinion and Order Affirming Bankruptcy Decision are (most footnotes omitted):

Mr. Vaughn asserts error in the Bankruptcy Court's determinations under 11 U.S.C. §523(a)(1)(C) that he: (i) made a fraudulent tax return and (ii) willfully attempted to evade or defeat taxes owed for years 1999 and 2000. The IRS asserts error in the Bankruptcy Court's denial of its Motion for Summary Judgment in which it sought a determination that the taxes owed for 1999 and 2000 were non-dischargeable pursuant to 11 U.S.C. § 523(a)(1)(A). The Court begins with Mr. Vaughn's challenges. 

Under 11 U.S.C. § 523(a)(1)(C), tax debts can be excluded from discharge on two alternative grounds: (i) making a fraudulent return or, (ii) willfully attempting to evade or defeat a tax. The Bankruptcy Court determined that Mr. Vaughn's tax debt was excepted from discharge on both grounds. Mr. Vaughn challenges both determinations, but in order for this Court to reverse the finding of non-dischargeableability of the tax debt, Mr. Vaughn must show that both determinations are erroneous. Because the Court finds no error with regard to the Bankruptcy Court's determination that Mr. Vaughn willfully attempted to evade his 1999 and 2000 tax obligations, it is unnecessary to address the interesting issues raised by Mr. Vaughn with regard to the Bankruptcy Court's finding that he filed a fraudulent tax return. For the same reason it is not necessary to explore the issues raised by the IRS in its cross-appeal.

Turning to the question of whether Mr. Vaughn willfully attempted to evade his tax obligations, Mr. Vaughn identifies two alleged errors by the Bankruptcy Court: one of law and one of fact. To understand these arguments, it is important to recognize the context of the Bankruptcy Court's finding. 

The statutory language of § 523(a)(1)(C) is broad, extending to any willful attempted to evade or defeat a tax. Here, the Bankruptcy Court was concerned with allegations that Mr. Vaughn concealed or transferred assets in order to prevent them from being used to pay his 1999 and 2000 tax liability. The Bankruptcy Court relied on 10th Circuit authority, as well as authority from outside of this Circuit, that found a "willful attempt to evade or defeat a tax" when a debtor made large discretionary expenditures or concealed or transferred assets so as to render them unreachable by the IRS. In addition, the Bankruptcy Court made extensive factual findings relative to Mr. Vaughn's business sophistication, the time that he became aware of his potential tax liability, and the disposal or consumption of his assets. The Court stated: 

Vaughn exhibited behavior which was inconsistent with his business acumen and was implausible based on that acumen when he participated in the BLIPS investment, Further, by purchasing expensive homes, automobiles, and jewelry, following a divorce which significantly depleted his asses, he further demonstrated such inconsistent behavior. That is, knowing, as he must have, the BLIPS investment constituted an improper abusive tax shelter with no economic basis and no reasonable expectation of profit, he nonetheless continued to spend as if there would be no additional tax to pay. This is simply not logical, unless he had another motive for such spending.

The evidence before the Court not only demonstrates he spent the funds and made the transfers in face of serious financial difficulties, but also indicates his motive in doing so was to reduce assets subject to potential IRS execution. In short, by transferring funds and assets to [his fiancé] and [his stepdaughter] he attempted to take those funds and assets out of the reach of the IRS.

The Court also rejected the argument that, for willful evasion, the debtor must know of a fixed and actual tax liability, as opposed, apparently, to one that the IRS may assert when and if it discovers and audits the taxpayer.  The Court concludes

The Court appreciates that this argument derives from Mr. Vaughn's legal position that for "willful evasion" to occur, the debtor must know of a fixed or actual tax debt, and that he did not know, with certainty, the amount of his tax obligation until 2003 or 2004. In accordance with Dalton, the Bankruptcy Court engaged in a comprehensive and holistic review of the review of the evidence. Although Mr. Vaughn's liability may not have been quantified until 2003 or 2004, the Bankruptcy Court found that when Mr. Vaughn invested in the BLIPS, he knew there was some risk that the losses he would claim to offset his gains might not be recognized by the IRS. In 2001, when he purchased a home that he titled in the name of his fiancé, he also had been informed of the IRS's position in the Notice 2000-44 and knew that Mr. Koo was subject to an IRS audit regarding the BLIPS transaction. Later, after being advised by KPMG counsel to disclose his BLIPS investment to the IRS but before doing so, Mr. Vaughn transferred $1.5 million to a trust for his step-daughter. The knowledge that he was likely to have some significant tax obligation, even if the precise amount of that obligation was unknown, was sufficient for Mr. Vaughn to form a purposeful intent to conceal or dissipate his assets to evade or defeat his 1999 and 2000 tax obligations. This Court finds no clear error in these findings.

The Court did not find the mere investment in BLIPS and the reporting on the return to have been per se willful evasion.  Rather, it was Vaughn's conduct after the reporting that was designed to evade payment of the tax that was the issue.  The issue that comes to my mind is the Allen issue where the Court interpreted the unlimited statute of limitations in Section 6501(c)(1), here, to apply if the return is fraudulent regardless of the taxpayer's personal fraud in reporting the fraudulent item or items on the return.  The Government did make that argument that the fraudulent nature of the BLIPS shelter caused the liability not to be dischargeable.  Section 523(a)(1)(C) provides that there is no discharge "(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax."  (Note the disjunctive.)  Given the purposes of the denial of discharge, however, I would suspect that the result should be the same as the civil fraud penalty in Section 6663(a), here, which, applies to fraudulent returns without a specific textual requirement for the taxpayer's fraud.  The IRS does not make the Allen argument for the civil fraud penalty and, I suspect, wisely does not do so.