Taxpayer Denied Bankruptcy Discharge For BLIPS Related Tax Liability (8/30/14)

11 U.S.C. Section 523(a)(1)(C), here, provides in relevant part that a taxpayer may not be discharged in bankruptcy for a tax debt if one of two circumstance exist:  (i) "with respect to which the debtor made a fraudulent return" or (ii) the debtor "willfully attempted in any manner to evade or defeat such tax."

In In re Vaughn, ___ F.3d ___, 2014 U.S. App. LEXIS 16417 (10th Cir. 2014), here, the Court denied Vaughn a discharge for his tax debt arising from the bullshit tax shelter (the BLIPS variety).  In so doing, the court affirmed the bankruptcy court and the district court below.

It appears that, in denying the discharge, the courts relied principally upon the second basis for denial of discharge -- "willfully attempted in any manner to evade or defeat such tax."  The 10th Circuit found that Vaughn participated in a shaky shelter and then voluntarily depleted his assets during the long period of time before the Government finally assessed the tax liability.  (Readers will recall that substantial periods of time can elapse from  the time an  unreported tax liability arises and when it finally is assessed.)  The taxpayer claimed that his conduct was negligent at best, but not willful as required by the text of the statute, because it was before the IRS assessed the tax.  The 10th Circuit rejected the argument, holding as it had previously held that assessment of the tax is not required for the denial of discharge to apply.

Although the 10th Circuit apparently did not rely upon the first basis -- the taxpayer made a fraudulent return -- it appears from the history of BLIPS that the return was fraudulent because the BLIPS shelter was fraudulent.  I have noted that in another context -- Section 6501(c)(1), here, which has an unlimited statute of limitations "In the case of a false or fraudulent return with the intent to evade tax."  See for the most recent discussion, BASR Briefs On Issue of Unlimited Statute of Limitations for NonTaxpayer Fraud (Federal Tax Crimes Blog 8/27/14), here.  There is no textual requirement in Section 6501(c)(1) that the taxpayer make the fraudulent return; the text only requires that the return be fraudulent.  Taxpayers, of course, argue that, despite the lack of a textual requirement that the taxpayer be complicit on the fraud on the return, the text properly interpreted has an implicit requirement that the taxpayer have known the return was fraudulent and thus made a fraudulent return.  The few courts that have addressed the issue are split, with, as of now, the weight of authority that the taxpayer's fraud is not required.

In any event, the bankruptcy provision does seem textually to require the taxpayer's fraud.  Promoter or preparer fraud without the taxpayer's fraud is not sufficient to deny discharge.  So, that is not an issue.  And, as noted, the 10th Circuit seemed to have relied upon the taxpayer's fraud.  Nevertheless, the 10th Circuit did seem to at least advert to the issue of some culpability on Vaughn's part in filing the return claiming the fraudulent benefits of BLIPS (emphasis supplied):

Second, Appellant argues his "reliance on the advice of KPMG, his longtime tax advisor, that the BLIPS transaction was an aggressive but ultimately legitimate tax position might have been at worst unreasonable under the circumstances, making [Appellant] negligent," but not willful. (Appellant's Opening Br. at 23.) Appellant contends that because he innocently, even if unreasonably, relied on KPMG's advice, he cannot be found to have acted willfully. We find this argument unpersuasive under all of the circumstances in this case, particularly in light of the bankruptcy court's finding that Appellant's assertion of innocent reliance was "simply not credible." In re Vaughn, 463 B.R. at 548.

I think Vaughn's argument was in the context of claiming that his subsequent conduct dissipating his assets was not knowingly evasive of tax because he was continuing to rely upon the advice of KPMG during that period.  Nevertheless, it seems to me that the court discounted his reliance on KPMG at any time, including the time he filed his return, which would possibly raise an inference that he had made a fraudulent return.  But the court does not make that explicit.

Vaughn did make the argument that a prior 10th Circuit case, Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), approving a negligence penalty in a BLIPS transaction for the tax involved supported that Vaughn was at best negligent in his actions here.  I suppose the taxpayer's argument could have included that, if a taxpayer's investment in and reporting of BLIPS itself was fraudulent, the 10th Circuit would have so held in Blum but only held that the investment and reporting was negligent.  And, the notion is that Vaughn should be able to ride on the coattails of that holding, both for the return filing and the subsequent conduct dissipating his assets.  The Court rejected the argument as follows

Third, Appellant suggests our recent opinion in Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), must control our review of this case. The facts in Blum are similar to those in Appellant's case. The plaintiff in Blum was a self-made business man who participated in a different tax shelter marketed by KPMG. The IRS sent the Blum plaintiff a notice disallowing the losses he claimed in connection with the tax shelter and imposing "two accuracy-related penalties for underpayment of taxes," id. at 1306, including a penalty for "negligent underpayment" under I.R.C. § 6662(b). The tax court upheld this decision. On appeal, we affirmed the imposition of the negligent underpayment penalty, despite the Blum plaintiff's assertion that he merely relied on KPMG's representations regarding the validity of the tax shelter. In the case before us, Appellant argues our decision affirming a negligent underpayment penalty in Blum "confirms[ that Appellant's] decision to rely on KPMG's tax advice is not blameless, but . . . does not rise to the level of intentional or knowing conduct either." (Appellant's Reply Br. at 17.) Appellant's suggestion that Blum controls our decision in this case is unpersuasive. Our decision to uphold a negligent underpayment penalty in Blum does not prove that Appellant's conduct in this case failed to rise above the level of negligence. The fact that the conduct in Blum was sufficient to support a finding of negligence does not require us to find the bankruptcy court's finding of willful evasion in this case to be clearly erroneous.

Merely because Blum may have been negligent, of course, does not mean that Vaughn was only negligent.  Indeed, the holding in Blum was that he was at least negligent.  Neither the 10th Circuit nor the Tax Court in the case held that Blum did not fraudulently sign his return.  If the IRS had asserted the fraud penalty, that issue would have been presented and decided, but it was not.  (Indeed, as I have noted before, the Government has been far too timid in letting taxpayers in these bullshit tax shelters off the fraud hook, but that is another subject).

Finally, the Court had this to say about Vaughn's argument that the language of the court below bespoke only negligence:

Finally, Appellant argues the bankruptcy court's order "couched all of its criticism of [Appellant's] conduct with terms generally used to describe negligent conduct." (Appellant's Reply Br. at 9.) Appellant particularly mentions the bankruptcy court's use of the terms "reasonably" and "known or should have known" as terms that he claims generally convey negligence rather than willfulness. While the bankruptcy court did use those terms in its opinion, it did not do so in a way suggesting Appellant's actions were merely negligent. Rather, in the context of the bankruptcy court's opinion as a whole, such language was simply used to express the bankruptcy court's conclusions that Appellant "must have been aware," In re Vaughn, 463 B.R. at 544, of the circumstances demonstrating the invalidity of his BLIPS losses, and that Appellant chose to claim those losses on his tax returns and to deplete his remaining assets, "knowing, as he must have, the BLIPS investment constituted an improper abusive tax shelter," id. at 547. Therefore, the language identified by Appellant as suggesting a negligence-based finding, when read in context, actually buttresses the bankruptcy court's finding that Appellant willfully attempted to evade his tax obligations.