Bruner, Matter of

• Decision Date: 21 June 1995
• Docket Number: No. 94-40586,94-40586
• Parties: -5024, 64 USLW 2031, 95-2 USTC P 50,356, Bankr. L. Rep. P 76,543 In the Matter of James Russell BRUNER and Judith Ann Jones Bruner, Debtors. James Russell BRUNER and Judith Ann Jones Bruner, Appellants, v. UNITED STATES of America, Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 195

55 F.3d 195

76 A.F.T.R.2d 95-5024, 64 USLW 2031,

95-2 USTC P 50,356,

Bankr. L. Rep. P 76,543

In the Matter of James Russell BRUNER and Judith Ann Jones

Bruner, Debtors.

James Russell BRUNER and Judith Ann Jones Bruner, Appellants, v. UNITED STATES of America, Appellee.

No. 94-40586.

United States Court of Appeals, Fifth Circuit.

June 21, 1995.

Ralph S. Bowie, Jr., Daye, Bowie & Beresko, Shreveport, LA, for appellant.

Gary D. Gray, Gary R. Allen, Chief Appellate Section, Tax Div., Billie Crowe, Janet A. Bradley, Washington, DC, for appellee.

Appeal from United States District Court for the Western District of Louisiana.

Before JONES, DUHE and STEWART, Circuit Judges.

STEWART, Circuit Judge:

This bankruptcy case involves the single issue of whether the debtors' tax liabilities should be excepted from discharge due to

their pattern of failing to file returns, failing to pay taxes, and attempting to hide income and assets. Because we conclude that the debtors' conduct constituted a willful attempt to evade or defeat their tax liabilities, we affirm both the bankruptcy court and the district court's determination that the tax debts should not be dischargeable in bankruptcy.

FACTS

Debtors James and Judith Bruner resided in Louisiana, a community property state, at all times relevant herein. James Bruner is a surgeon. For the 1980 tax year, Dr. and Mrs. Bruner filed a joint federal income tax return evidencing professional income of $243,457, a farm loss of $21,239, and a charitable deduction of $10,000 to "Three-L Ministries." The Bruners paid $30,766 in federal income taxes for 1980.

Perhaps the sting of paying federal income taxes proved more than the Bruners could bear: they did not file a tax return again for the next eight years, nor did they pay any taxes. The Bruners' failure to check in with the government every April 15th did not go unnoticed by the Internal Revenue Service. After the Bruners failed to file returns in 1981, 1982, and 1983, the Service began an investigation. The investigation revealed that the Bruners had made substantial cash expenditures during the period in question, and that substantial funds were deposited into both the Bruners' bank accounts and those of "Three-L Ministries." These transactions would indicate, inter alia, substantial income being earned by the Bruners, and yet the Bruners had not reported any income to the government for these years, nor had they paid any taxes.

In 1988, Dr. Bruner was indicted under 26 U.S.C. Sec. 7203 on three counts of willfully failing to file federal income tax returns for 1981, 1982, and 1983. He pled guilty to one count of willfully failing to file his 1981 tax return. The district court ordered, inter alia, that Dr. Bruner pay a $10,000 fine, pay back taxes, penalties, and interest for the 1981 tax year, and file back income tax returns for 1981, 1982, 1983, 1984, 1985, 1986, 1987, and 1988.

The Service tried to reconstruct the Bruners' income and prepared substitute returns for them for the 1981 through 1983 tax years, reflecting income in excess of $100,000 for each of those years. The Bruners executed a Form 870 whereby they accepted the income tax liability determinations stated on the substitute returns prepared by the IRS. The Bruners filed their own returns for the years 1984 through 1988. Based on the returns filed, the Service issued tax assessments against the Bruners totalling over $290,000 for tax years 1981 through 1988. For tax years 1981 through 1983, tax assessments were made against Dr. and Mrs. Bruner separately, while the assessments were made against them jointly for 1984 through 1988. ¹ In addition to the tax assessment, hefty penalties and interest were also levied against the Bruners. Between 1989 and 1993, they made substantial payments on their tax debts; however, because of the overwhelming amount due, vast sums still remained unpaid.

James and Judith Bruner filed a Chapter 7 bankruptcy petition on April 21, 1993. Two days later, they filed an adversary proceeding against the United States seeking a determination of the dischargeability of their federal income tax liabilities for 1981, 1983, 1986, 1987, and 1988. ² The Bruners also filed a motion for summary judgment, contending that no statutory exception to discharge would be applicable so as to preserve the tax liabilities in question. The IRS filed a proof of claim in the bankruptcy action The bankruptcy court conducted a trial on the dischargeability issue. The court held, inter alia, that the Bruners' tax liabilities for 1981, 1983, 1986, 1987, and 1988 were excepted from discharge pursuant to 11 U.S.C. Sec. 523(a)(1)(C) because the Bruners had willfully attempted to evade or defeat their taxes for those years. ³ The district court affirmed the bankruptcy court's determination. The Bruners have appealed to this court.

asserting an outstanding tax liability of over $365,000.

Standard of Review

We review questions of statutory interpretation de novo. Penn v. Howe-Baker Engineers, Inc., 898 F.2d 1096, 1101 (5th Cir.1990). Thus, we review de novo the district court's interpretation of the Bankruptcy Code. See Matter of Texas Research, Inc., 862 F.2d 1161, 1163 (5th Cir.1989). We review the bankruptcy court's factual determinations, in which the district court concurred, under the "clearly erroneous" standard. See Matter of Webb, 954 F.2d 1102, 1103-1104 (5th Cir.1992).

DISCUSSION

When a Chapter 7 debtor obtains bankruptcy relief, the general rule is that all debts arising prior to the filing of the bankruptcy petition will be discharged. See 11 U.S.C. Sec. 727(b). However, Congress has excepted certain liabilities from discharge. For example, Sec. 523 of the Bankruptcy Code enumerates several situations in which tax liabilities are not dischargeable in bankruptcy. The pertinent statutory provision relevant to this dispute is 11 U.S.C. Sec. 523(a)(1)(C). It provides:

(a) A discharge under section 727 ... of this title does not discharge an individual debtor from any debt--

(1) for a tax or a customs duty--

(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.

11 U.S.C. Sec. 523(a)(1)(C) (emphasis added).

The sole issue in this case is whether the district court correctly affirmed the bankruptcy court's conclusion that the Bruners "willfully attempted" to evade or defeat their taxes, such that their tax liabilities are excepted from discharge. The parties agree that the government bore the burden of proof on this issue. In concluding that the Bruners' tax liabilities for 1983, 1986, 1987, and 1988 were excepted from discharge under Sec. 523(a)(1)(C), the bankruptcy judge employed a three-prong test to determine whether the debtors had "willfully attempted in any manner to evade or defeat" their tax liabilities. The court concluded that the proper test is whether, in the case of a debtor who is financially able to pay his taxes but chooses not to do so, (1) the debtor had a duty under the law, (2) the debtor knew he had that duty, and (3) the debtor voluntarily and intentionally violated that duty. ⁴

After considering the evidence and arguments presented by both parties, the bankruptcy judge held that, under the three-part test, the Bruners' tax liabilities for the years in question were not dischargeable in bankruptcy. He found that the Bruners had earned substantial income during the years in question, as evidenced by their deposits and cash expenditures, and therefore had the financial ability to pay their taxes. ⁵ He also As to the third prong of the test, the bankruptcy judge carefully considered the relevant cases which have construed the willfulness aspect of Sec. 523(a)(1)(C) (discussed below) and concluded that the Bruners did indeed "willfully attempt [ ] to evade or defeat" their tax liabilities. In particular, the bankruptcy court noted that, not only did the Bruners fail to pay their taxes, they also engaged in a pattern of failing to report their income and file returns. Thus, their conduct indicated they were willfully attempting to evade or defeat the assessment of taxes against them. Moreover, the bankruptcy court also concluded that the Bruners had conceded that Three-L Ministries was a shell entity for hiding income and assets, because they agreed to accept the returns filed for them by the Service for 1981 through 1983, in which income passing through Three-L was imputed to them. The bankruptcy judge also referred to the numerous cash transactions in which the Bruners had engaged, implicitly indicating that these cash transactions constituted attempts to hide income and assets.

noted that the evidence established that the Bruners both knew they had a duty to file tax returns and to pay taxes, as evidenced by their filing a joint return in 1980, as well as by their subsequent compliance with the district court's order that they file tax returns for later years. ⁶

The district court reviewed the bankruptcy court's interpretation of Sec. 523(a)(1)(C) de novo, and reviewed its findings of fact for clear error. The district court affirmed the bankruptcy court in all respects and concurred in the bankruptcy court's factual finding. The district court noted the application of the three-prong test and rejected the Bruners' contention that proof of an affirmative act is required in order to find that a debtor "willfully attempted" to evade or defeat a tax. The court noted in its Memorandum Ruling that the purpose of Sec. 523(a)(1)(C) is to prevent the use of the Bankruptcy Code as part of a dishonest scheme to avoid liability, while at the same time providing relief to the honest debtor. Because the Bruners failed to file tax returns and pay their income tax liability when financially able to do so, the district court concluded that the Bruners did not qualify as the sort of "honest debtor" the Code was designed to protect.

On appeal, the...