Can a Bankruptcy Court discharge unmanageable tax debt? The answer, like many things in the legal world, is maybe. The Bankruptcy Court will consider many things when determining whether or not to forgive tax debt. In a recent case, the court showed how the lifestyle choices of the applicant could play a role in its decision.

First, some background

In the case at issue, a medical professional filed for bankruptcy. Upon review of her filings, the Bankruptcy Court determined a portion of tax debt could potentially qualify for relief. However, the Internal Revenue Service (IRS) claimed the tax bill should stand because the doctor intentionally evaded her tax obligations.

If the agency could establish this claim, they could argue the taxes were not dischargeable.

Next, the IRS builds their claim

To make their case, the agency argued that the physician chose to continue a “comfortable, even affluent lifestyle” instead of paying her taxes. The IRS provided evidence to support this claim that included lavish trips, leasing high-end automobiles, and spending over $325,000 in private schooling for their children. The agency also claimed the doctor’s choice to sell and lease back their family home was an attempt to keep the asset from the IRS.

Finally, a holding and a note of caution

The Bankruptcy Court applied a two-part test to determine if the tax debt should stand. The first step involved a review of the doctor’s conduct. The court decided the doctor engaged in affirmative acts to avoid her tax bill because she made a substantial income and spent large sums of money while failing to pay her taxes. The second part of the test required the court to consider the doctor’s state of mind. The court determined the doctor was aware of her obligation to pay the IRS but had chosen not to.

Ultimately, the bankruptcy court held in favor of the IRS.

It is important to note that the two-part test was used by the Sixth Circuit, where the doctor resided. It is not used by every court. As a result, anyone in a similar situation is wise to seek legal counsel to ensure they understand the law that applies in their situation. The attorneys at Goldburd McCone are familiar with these matters and can provide counsel.