Column: Some tax debts are not discharged by bankruptcy
Submitted by editor on Tue, 10/14/2014 - 9:37am
In 2003 William M. Hawkins, III filed Chapter 11 (reorganization) Bankruptcy Petition that (as usual) was later converted to a Chapter 7 (full discharge) Bankruptcy. The District Court affirmed the Bankruptcy Court holding that as to Mr. Hawkins the tax debts were not discharged by the bankruptcy, but the tax debts of Mrs. Lisa Hawkins (his second wife) were discharged. He appealed the ruling.
The Ninth Circuit court said the key question was did he “willfully” attempt to evade (paying) taxes. Since the structure of the statute as a whole, including legislative history, other precedent cases and analogous statutes required a narrow interpretation of “willful” the case was remanded (sent back) to the District Court to reanalyze whether the discharge exception (tax debts not discharged) applies using the specific intent standard.
Mr. Hawkins had an MBA degree from Stanford. He was one of the earliest employees of Apple Computer and co-founded Electronic Arts, Inc. (EA) which became the world’s largest supplier of computer entertainment software. In 1996 he had a net worth of about $100 million. In 1996 he divorced his first wife and married Lisa. He sold stock in EA to start a wholly owned subsidiary 3DO. The sales resulted in large capital gains of about $66 million. His accountants, KPMG advised him to shelter the gains in investments that would generate large paper losses that could offset the capital gains.
In 2001 IRS challenged the validity of the tax shelters and audited Hawkins’s 1997 through 2000 tax returns. 3DO deteriorated and filed a voluntary petition in bankruptcy under Chapter 11 (reorganization) in 2003. It was later converted to Chapter 7.
In 2003 Mr. Hawkins filed a motion to reduce the child support payments he had to make to his first wife. He acknowledged he owed IRS $25 million, had limited income and was insolvent. The family court granted his request in part, but made him put his assets in trust.
IRS assessed him with $21 million of tax, interest and penalties debts in 2005. California Tax Board assessed him about $15 million for the same tax years. He made an offer in compromise to IRS of $8 million, which was rejected. (IRS felt he could pay more than that). In 2006 he sold his home for $6.5 million and paid that to IRS. California seized $6 million from his various financial accounts. In Sept. 2006 the Hawkinses filed a Chapter 11 bankruptcy petition. IRS said he still owed them $19 million and California said he still owed them about $10 million.
The Chapter 11 plan paid IRS $3.4 million and discharged the other tax debts, but said IRS and California could sue to determine if he still had to pay his tax debts. IRS and California said the rich lifestyle constituted a willful attempt to evade taxes. The bankruptcy court estimated the personal expenses were greater than the income by up to $2.35 million during Jan. 2004 through Sept. 2006. His tax debts were not discharged, but Lisa’s were discharged (she did not have to pay them).
The Ninth Circuit Court sent the case back to the District Court to see if the specific intent standard applied and if the tax debts were discharged or not.
— John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.
