Birkenstock, Matter of

• Decision Date: 03 July 1996
• Docket Number: No. 95-1043,95-1043
• Citation: 87 F.3d 947
• Parties: -5229, Bankr. L. Rep. P 77,064 In the Matter of Joseph J. BIRKENSTOCK and Generose M. Birkenstock, Debtors-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 947

87 F.3d 947

78 A.F.T.R.2d 96-5229, Bankr. L. Rep. P 77,064

In the Matter of Joseph J. BIRKENSTOCK and Generose M. Birkenstock, Debtors-Appellants.

No. 95-1043.

United States Court of Appeals Seventh Circuit.

Argued Nov. 3, 1995.

Decided July 3, 1996.

Thomas P. Schneider, Office of the United States Attorney, Milwaukee, WI, Gary R. Allen, Gary D. Gray (argued), Curtis C. Pett, Department of Justice, Tax Division, Appellate Section, Washington, DC, for Appellee.

Joseph W. Weigel (argued), Eisenberg, Weigel, Carlson, Blau, Reitz & Clemens, Milwaukee, WI, for Debtors-Appellants.

Before CUMMINGS, CUDAHY, and KANNE, Circuit Judges.

KANNE, Circuit Judge.

The Birkenstocks have a history of problems with the Internal Revenue Service--everything from the IRS's disagreement with their challenges to the legitimacy of the monetary system and their creation of a family trust to shelter tax liabilities to Mr. Birkenstock's conviction for four consecutive years of failing to file income tax returns. Due to this pattern of recalcitrant conduct, the Birkenstocks' tax debts have risen to the point where a large percentage of their retirement benefits and social security payments has been levied upon by the government. In an effort to thwart the IRS once and for all, the Birkenstocks filed for chapter 7 bankruptcy, seeking a discharge of all debts, including their federal income tax obligations. The bankruptcy court, however, found their federal tax debts to be nondischargeable pursuant to § 523(a)(1)(C), and the district court agreed on appeal. We now determine that the bankruptcy court's decision with respect to Joseph Birkenstock was correct, but because we find that the bankruptcy court clearly erred in determining that Generose Birkenstock acted "willfully," we reverse the district court's affirmance of her tax debt nondischargeability.

I. H ISTORY

Joseph and Generose Birkenstock have filed joint federal income tax returns since their marriage in 1943. In 1950, Mr. Birkenstock and others organized the Formrite Tube Company, and Mr. Birkenstock served there as an engineer and as the company's president until 1988.

On their 1974 joint federal income tax return, the Birkenstocks indicated their receipt of $35,184.82 in United States currency, which they referred to as "pseudo-dollars." Using a formula that supposedly accounted for the dollar's true gold value, the Birkenstocks reduced this figure to a reported taxable income of $9,316.42--apparently overlooking the fact that their tax liability would be paid in "pseudo-dollars" and therefore that "pseudo-dollars" were the appropriate measure of taxable income. The Internal Revenue Service determined that the Birkenstocks' calculation of their taxable income for 1974 was improper, and it issued a statutory notice of deficiency, which was upheld by the United States Tax Court on May 21, 1979. We affirmed the Tax Court's decision on March 16, 1981, holding that "[o]ur research confirms the Commissioner's contention that this case is but one 'in a seemingly endless series of tax cases challenging the federal monetary system.' " Birkenstock v. Commissioner of Internal Revenue, 646 F.2d 1185, 1186 (7th Cir.1981) (quoting Commissioner's Brief, at 3).

On November 26, 1975, during the pendency of litigation concerning their 1974 return, the Birkenstocks created, and then conveyed all their property to, the Joseph Birkenstock Equity Trust. The Birkenstocks initially retained a 37% beneficial interest in the trust, but this was subsequently transferred to their children effective February 15, 1981, and the Birkenstocks received no other money or property in exchange for transferring their property to the family trust. Among the property conveyed to the trust were the Birkenstocks' home (subject to a mortgage), their lifetime incomes, and Mr. Birkenstock's approximately five hundred shares of stock in the Formrite Tube Company. After the conveyance, however, the Birkenstocks continued to live in their home rent free, and Mr. Birkenstock remained on the Formrite payroll and continued to receive his salary and other payments directly from Formrite. In the years that followed, the trust purchased various securities and real estate properties, but Mr. Birkenstock personally guaranteed loans taken out by the trust and used his personal monies to pay for repairs, utilities, and other expenses relating to trust properties.

On their 1975 joint federal income tax return, the Birkenstocks deducted the costs of setting up the family trust. Additionally, on their joint returns for the years 1975 through 1979, the Birkenstocks attempted to assign their personal income to the family trust for federal income tax purposes. The IRS issued statutory notices of deficiency for these years, and in 1983 the Birkenstocks petitioned the Tax Court for a hearing. The Tax Court determined: (1) that the income the Birkenstocks had attempted to assign to the trust was taxable to them in their individual capacities; (2) that the costs of creating the family trust were nondeductible personal expenditures; and (3) that the Birkenstocks' deficiencies for the years 1975 through 1979 were the result of negligence or an intentional disregard of the law. Thus, the Tax Court upheld the assessed deficiencies and imposed an additional 5 percent penalty against the Birkenstocks for negligence.

From 1980 through 1983, during the dispute concerning their joint tax returns for 1975 through 1979, the Birkenstocks failed to file any returns at all. Accordingly, in 1986, a jury found Mr. Birkenstock guilty of willful failure to file income tax returns for the years 1980 through 1983, in violation of 26 U.S.C. § 7203. We subsequently affirmed his conviction in United States v. Birkenstock, 823 F.2d 1026 (7th Cir.1987). Mr. Birkenstock was sentenced to serve six months in a work-release program followed by three years of probation, as well as to pay a $30,000 fine and the costs of prosecution. In addition, Mr. Birkenstock was ordered to file returns for 1980 through 1983, which he did, claiming no taxable income. The government subsequently filed a petition seeking revocation of Mr. Birkenstock's probation on the ground that he had failed to make any payments toward his fine. Following a hearing on January 25, 1990, the district court revoked Mr. Birkenstock's probation, finding that although he had the ability to pay at least some portion of the fine, he had declined to do so.

During 1987, Mr. Birkenstock received $137,925 from Formrite, including approximately $44,000 from the cashing out of his retirement fund with the company. The IRS levied against much of this amount for taxes, fines, and court costs, and Mr. Birkenstock actually received $19,000 from Formrite for the year. He did not use any of this money to pay tax arrearages, but instead used it to pay mortgage payments on some of the real estate properties held by the trust.

In August of 1987, Mr. Birkenstock began receiving monthly social security payments. The payments were for $1,300, but after IRS levies Mr. Birkenstock received only $325 per month. According to IRS documents, the Birkenstocks actually overpaid their taxes during the years 1986 through 1988 (due to excessive withholding), and these credits were applied to satisfy the Birkenstocks' tax liabilities for 1975 and 1976, and part of their liability for 1977. At no time did the Birkenstocks ever make a voluntary payment toward their liability for back taxes, interest, or penalties.

On November 27, 1990, the Birkenstocks filed for bankruptcy liquidation under chapter 7 of the Bankruptcy Code, 11 U.S.C. § 701 et seq. The government filed a timely proof of claim for income tax liabilities due for the years 1977 through 1979 and for the years 1980 through 1983 (further review of the returns Mr. Birkenstock had been ordered to submit revealed deficiencies). On March 1, 1991, the government commenced an adversary proceeding against the Birkenstocks, requesting that their discharge be denied pursuant to 11 U.S.C. § 727(a)(4). In the alternative, the government asserted that the Birkenstocks' joint federal income tax liability from 1977 through 1979, as well as Mr. Birkenstock's individual federal income tax liability from 1980 through 1983, should be ruled nondischargeable pursuant to 11 U.S.C. § 523(a)(1)(C), which excepts tax debts from discharge where the debtor has willfully attempted to evade or defeat them.

The bankruptcy court determined that the Birkenstocks had not run afoul of § 727(a)(4) and thus were entitled to a discharge, but it ruled their federal income tax obligations to be nondischargeable, finding that the Birkenstocks' entire history of conduct dating back to 1974 demonstrated "a continuing and unrelenting effort by the debtors to evade or defeat federal income taxes within the meaning of § 523(a)(1)(C)." The bankruptcy court held that the Birkenstocks' joint tax liabilities for 1977 through 1979 were nondischargeable to Mrs. Birkenstock as well as her husband because "[s]he signed the joint returns. She had to have knowledge of their failure to file returns and their failure to pay taxes." The district court affirmed the decision of the bankruptcy court, finding that the Birkenstocks' actions "clearly go beyond mere oversights by an innocent party, and exhibit a voluntary, conscious, and intentional failure to fulfill federal income tax obligations."

II. A NALYSIS

Generally, in a chapter 7 discharge, all liabilities of the debtor arising prior to the filing of the bankruptcy petition are discharged. 11 U.S.C. § 727(b). Congress, however, intended that the fresh start provided by the bankruptcy discharge would apply only to the "honest but unfortunate debtor." Grogan v. Garner, 498 U.S. 279, 286-87, 111 S.Ct. 654, 659, 112 L.Ed.2d 755 (1991). As a result, Congress provided in 11 U.S.C. § 523 for certain exceptions to the rule of discharge. In this case, the...