Some Very Nasty Bankruptcy Law

 

      In the past ten years, individuals across the country have bankrupted millions of dollars in back taxes.  Of course the situation is very distressing to the IRS because, contrary to popular belief, the Bankruptcy Code does allow the bankrupting of taxes providing that special rules are met.  Obviously some judges are interested in making it more difficult for debtors to discharge taxes and they have begun to interpret statutes to say things that they do not say.  In the case of Mickens v. United States, 1997 WL 729062 (N.D.Ohio), the court created a situation in which the debtor cannot file a return for purposes of the two year rule if the government files a return first.  This terrible state of affairs will effectively bar many individuals who have not filed returns from a Chapter 7 Bankruptcy.  This interpretation of the law is a new and novel interpretation that extends the meaning of the statute. 

 

      The court found that the debtor's failure to file a return before the IRS properly assessed the tax liability rendered his tax liability non-dischargeable for failure to file a return.  The court took the position that the return filed by the debtor did no constitute a return.  In order to constitute a "tax return" for purposes of dischargeabiity under 11 U.S.C. Section 523(a)(1)(B)(i), a document must: (1) purport to be a return;(2) be sworn to as such under the penalties of perjury; (3) contain sufficient data to allow calculation of the tax; and (4) appear on its face to constitute an honest and genuine endeavor to satisfy the law. See Germantown Trust Co. v. Comm'r, 309 U.S. 304, 60 S. Ct. 566, 84 L.Ed. 770 (1940); Zellerbach Paper Co. v. Helvering, 293 U.S. 172, 55 S.Ct. 127, 79 L.Ed 264 (1934); In rehindenlang, 205 B.R. 874 (Bankr.S.D.Ohio 1997). The parties agreed that the returns purport to be returns, are sworn to as such and contain sufficient data to allow calculation of the tax.  The dispute is whether the form appear to constitute an honest attempt to satisfy the law.

 

      The court's ruling in this case is really horrible foray individual who does not file a return pre assessment. 

 

      "The Court agrees with the Government.  Section 523 (a) (1) (B) (1) was meant to encourage honest and self-generated reporting taxpayers, not to immunize non-reporting debtors who, one caught, seek to discharge their discovered tax obligations along with other debts in bankruptcy."  In re Haywood, 62 B.T. 482, 486 (Bankr.N.D.Ill. 1986).  Courts in determining whether a given document constitutes a tax return typically place great weight on the taxpayer's cooperation in the auditing process, consent to immediate assessment, and assistance in the preparation of the assessment.  See. Matter of Berard, 181 B.R. 653, 657 (Bankr.M.D.Fla. 1995).  No such cooperation appears in the record of this case; indeed, the record indicates instead that the debtor is a non-reporting debtor who, now that he has been caught seeks,  to discharge his discovered tax obligations along with other debts in bankruptcy.   

Common Law Trusts

 

      Various individuals around country are selling "common law trusts," or "pure trusts."  They are making the claims that these trusts are exempt from payment of income taxes and that they don't have to file tax returns.  They are selling the trusts for tens of thousands of dollars to small businessmen.  They take the position that since the funds are paid to this special type of trust that no tax is owed. 

 

      Unfortunately, they are incorrect.  There is no statutory or case law that stands for the proposition that a common law or pure trust has some sort of special exemption under the tax laws and furthermore, they have a problem with the assignment of income.  The courts take the position that income is taxable to the person who earns it.  United States v. Bayse, 410 U.S. 441; Commissioner v. Culbertson, 337 U.S. 733.  That means that if an individual sets up a trust to take the income for him, the courts may rule that it is still his income because the power to dispose of income is considered equivalent to its ownership.  See Helvering v. Horst, 311 U.S. 112.  Justice Holmes in Lucas v. Earl, 281 U.S. at 114-115 stated:

 

"There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillful devised to prevent the salary when paid from vesting even for a second in the man who earned.  That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew." 

 

      Many of the individuals who have purchased these magic pure trust documents will find that the courts rule against them by taking the position that the shifting of the tax liability to a paper entity runs afoul of the well-settled principal that "income must be taxed to him who earns it."  Commissioner v. Culbertson, 337 U.S. at 739.  In the case of Vanuk v. Commissioner, 621 F.2d 1318 (8th Cir. 1980), a physician engaged in the practice of radiology, created at trust to which he conveyed "the exclusive use of my lifetime services and all the currently earned remuneration accruing therefrom.  Id. at 1319.  The Eighth Circuit concluded that the taxpayer and not the trust, was taxable on the income accruing from radiological services, reasoned as follows (id. at 1320.)

 

      "Where the taxpayer simply assigns his lifetime services and income earned from the performance of those services, and the taxpayer rather than the trust has the ultimate direction and control over the earning of the compensation, the conveyance is ineffective to shift the tax burden from the taxpayer to the trust."

 

      The court concluded that that ultimate direction and control over the earning of compensation rested with the taxpayer.  The trust had no right to supervise the taxpayer's employment or to determine his compensation. Other cases that have agreed with this position are:  Hanson v Commissioner, 696 F2d 1232; Schulz v. Commissioner, 686 F2d 490: Wesenberg v. Commissioner, 69 T.C. 1005 (1978).  If the taxpayer has control over the money in the trust he has been required to include the money in his gross income.  See Commissioner v. Glenshaw Glass Co. 348 U.S. 486 and Chu v. Commissioner, 72 T.C.M. (CCH) 1519 (1996).

 

      The moral of the story is that you must be very careful about the purchase of common law trusts as a magic way to avoid taxes.  The government under current case law has avenues of attack and the tax court is not going to take the position that a common law or pure trust does not have to pay taxes on income. 

 

 

      The three year period is tolled during any period in which an extension to file was in effect. (11 U.S.C. 507(a)(8)(A)(i), In re Gidley, 138 B.R. 298 (M.D.Fla. 1992), or during the time any other bankruptcy case was pending or the period of time that a taxpayer assistance order is in effect.  Courts have also held that the three-year period is tolled during the time the debtor was in bankruptcy, plus an additional six months.  See Matter of Ross, 130 B.R. 312 (Neb. 1991); In re Worthen, 137 B.R. 1016 (DC Ore. 1992); In re West, 137 B.R. 1012 (D.Or. 1992); In re Wise, 127 B.R. 20 (E.D.Ark. 1991). 

 

      The two year rule has also been hold to be tolled during the time a bankruptcy is pending See Matter of Stoll, 132 B.R. 782 (N.D.Ga. 1990.

 

      The 240-day period for assessment is tolled during any time that the debtor has a case pending in tax court plus it is tolled during any period the individual is in bankruptcy court plus six months.  It is also tolled by an offer in compromise.  The OC tolls the running of the 240-day assessment period plus 30 days.  See 11 U.S.C. Section 597 (a)(8)(A)(ii).  The 240 day period is also tolled by any time that the debtor was in a bankruptcy within the 240 day period plus 60 days for the assessment period or six months for the collection period.  See In re Brickley, 70 B.R. 113 (9th Cir. 1986); In re Moina, 99 B.R. 792 (Ohio, 1988)