Hawkins v. Franchise Tax Bd. of Cal.
| Decision Date | 15 September 2014 |
| Docket Number | No. 11–16276.,11–16276. |
| Citation | 769 F.3d 662 |
| Parties | William M. HAWKINS, III, aka Trip Hawkins, Appellant, v. The FRANCHISE TAX BOARD OF CALIFORNIA; United States of America, Internal Revenue Service, Appellees. |
| Court | U.S. Court of Appeals — Ninth Circuit |
OPINION TEXT STARTS HERE
Heinz Binder (argued) and Wendy Watrous Smith, Binder & Malter, LLP, Santa Clara, CA, for Appellant.
Kathryn Keneally, Assistant Attorney General, Kathleen E. Lyon, Bruce R. Ellisen, William Carl Hankla, and Rachel I. Wollitzer (argued), Attorneys, Tax Division, United States Department of Justice, Washington, D.C., for Appellee United States.
Lucy Wang, California Department of Justice, San Francisco, CA, for Appellee State of California.
A. Lavar Taylor, Attorney and Adjunct Professor of Law, Chapman University School of Law, Santa Ana, CA, for Amicus Curiae A. Lavar Taylor.
Appeal from the United States District Court for the Northern District of California, Jeffrey S. White, District Judge, Presiding. D.C. No. 3:10–cv–02026–JSW.
Before: ANDREW J. KLEINFELD, SIDNEY R. THOMAS, and JOHNNIE B. RAWLINSON, Circuit Judges.
Opinion by Judge THOMAS; Dissent by Judge RAWLINSON.
In this case, we consider what mental state is required in order to find that a bankruptcy debtor's federal tax liabilities should be excepted from discharge under 11 U.S.C. § 523(a)(1)(c) because he “willfully attempted in any manner to evade or defeat such tax.” Consistent with similar provisions in the Internal Revenue Code, 26 U.S.C. § 7201, we conclude that specific intent is required for the discharge exception to apply and remand to the district for re-evaluation under that standard.
F. Scott Fitzgerald observed early in his career that the very rich “are different from you and me,” 1 to which Ernest Hemingway later rejoined, “Yes, they have more money.” 2 As with many bankruptcy cases involving the wealthy, our saga reads like a Fitzgerald novel, telling the story of acquisition and loss of the American dream, and the consequences that follow.
William M. “Trip” Hawkins designed and received an undergraduate degree in Strategy and Applied Game Theory from Harvard University, and an M.B.A. from Stanford University. After college, he became one of the earliest employees at Apple Computer, where he ultimately became Director of Marketing. He left Apple to co-found Electronic Arts, Inc. (“EA”), which became the world's largest supplier of computer entertainment software. Hawkins owned 20% of EA and served as its Chief Executive Officer. By 1996, his net worth had risen to $100 million. That year, he divorced his first wife, Diana, and married his second wife, Lisa. Tripp and Lisa purchased a $3.5 million home, where she cared for their two children and Tripp's two children from his first marriage. The IRS asserts they enjoyed the trappings of wealth, such as a private jet, expensive private schooling for the children, an ocean-side condominium in La Jolla, and a large private staff.
In 1990, EA created a wholly owned subsidiary, 3DO, for the purpose of developing and marketing video games and game consoles. Hawkins left EA to run 3DO, which went public in 1993. Beginning in 1994, Hawkins sold large amounts of his EA stock to invest in 3DO. The capital gains from the sales were large: approximately $24 million in 1996, $3.8 million in 1997, and $39 million in 1998. His accountants, KPMG, advised him to shelter the gains in a Foreign Leveraged Investment Portfolio (“FLIP”) and an Offshore Portfolio Investment Strategy (“OPIS”). Both strategies were designed to generate large paper losses to shield the EA capital gain from taxation.
To execute the FLIP transaction, Trip purchased shares of the Union Bank of Switzerland (“UBS”) for $1.5 million and an option to acquire shares of Harbourtowne, Inc., a Cayman Islands corporation. Harbourtowne then contracted with UBS to purchase shares of UBS for $30 million, with UBS receiving an option to repurchase the shares before the sale closed. UBS exercised the option, and the UBS shares were never transferred to Harbourtowne. Hawkins then received a letter from KPMG stating that he could add to the tax basis of his UBS shares the $30 million that Harbourtowne had contracted to pay for its UBS shares. The opinion letter stated that UBS's repurchase of its shares would likely be considered a distribution to Harbourtowne (which was nontaxable because Harbourtowne was a foreign corporation), and that Harbourtowne's basis in its UBS shares should be treated as a transferred to Hawkins's basis in his UBS shares.
OPIS worked in a similar way. Hawkins purchased shares of UBS for $1.99 million and an option to acquire an interest in Hogue, Investors LP, a Cayman Islands limited partnership. Hogue contracted to purchase shares of UBS treasury stock, with UBS retaining a call option to repurchase the shares before transfer. UBS exercised the option. KPMG issued an opinion letter to Hawkins stating that he could add the Hogue shares to his basis in the UBS stock.
Over the next several years, Hawkins then sold various quantities of the UBS stock and claimed losses of approximately $6 million on his 1996 federal tax return, $23.4 million on his 1997 return, $20.5 million on his 1998 return, $3.5 million on his 1999 return, and $8.2 million on his 2000 return.
In 2001, the IRS challenged the validity of the tax shelters and commenced an audit of Hawkins's 1997 return, which later expanded to include the 1998–2000 tax years. In 2002, the IRS sent Hawkins's attorney a letter stating that the losses from the FLIP and OPIS transactions would be disallowed. The subsequent audit report indicated that Hawkins owed additional taxes and penalties of $16 million for tax years 1997–2000.
During this period, the financial fortunes of 3DO deteriorated to the point where it needed a large capital infusion. Hawkins loaned 3DO approximately $12 million, but it was to no avail. 3DO filed a voluntary petition in bankruptcy under Chapter 11 seeking reorganization in 2003. It was later converted to a Chapter 7 liquidation, from which Hawkins never received a significant distribution.
Faced with these losses, Hawkins filed a motion in family court in 2003 to reduce the child support payments he was required to make to his first wife. He acknowledged that he owed $25 million to the IRS, had limited income, and was insolvent. The family court granted his request in part, but required him to place his assets in trust. During the family court proceedings, Hawkins's attorney testified that Hawkins intended to discharge the tax debt in bankruptcy proceedings.
In 2005, the IRS made an aggregate assessment of taxes, penalties, and interest for tax years 1997–2000 that totaled $21 million. The California Franchise Tax Board (“FTB”) assessed $15.3 million in additional taxes, penalties, and interest for the same tax years. Hawkins made an offer in compromise to the IRS of $8 million, which was rejected.
The bankruptcy court found that Hawkins and his wife did very little to alter their lavish lifestyle after it became apparent in 2003 that they were insolvent and that their personal living expenses exceeded their earned income.
In July 2006, Hawkins sold his primary residence and paid the entire $6.5 million net proceeds to the IRS. A month later, the FTB seized $6 million from various financial accounts. In September of that year, the Hawkinses filed a Chapter 11 bankruptcy petition, which the bankruptcy court found was for the primary purpose of dealing with their tax obligations. Shortly after filing, Hawkins sold the La Jolla condominium for $3.5 million and paid the proceeds to the IRS. Even after these payments and the seizure by the FTB, the IRS filed a proof of claim for $19 million and the FTB filed a claim for $10.4 million.
Hawkins proposed a liquidating plan of reorganization, which was confirmed by the bankruptcy court. The IRS received a distribution of $3.4 million from the estate. The confirmed plan discharged the Hawkinses from any debts that arose before the date of plan confirmation, but provided that the Hawkinses, IRS, or FTB could bring suit to determine whether the tax debts should be excepted from discharge. The Hawkinses filed this declaratory action against the IRS and FTB seeking a determination that the unpaid taxes were covered by the discharge. The IRS and FTB counterclaimed, alleging that the tax debts were excepted from discharge pursuant to 11 U.S.C. § 523(a)(1)(c), which excepts from discharge any debt “with respect to which the debtor ... willfully attempted in any manner to evade or defeat such tax.” The primary, but not exclusive, theory of the IRS and FTB was that the Hawkinses' maintenance of a rich lifestyle after their living expenses exceeded their income constituted a willful attempt to evade taxes. The bankruptcy court rejected most of the other government theories, but found that the Hawkinses' personal living expenses from January 2004 to September 2006 were “truly exceptional.” The court estimated that the couples' personal expenses exceeded their earned income by $516,000 to $2.35 million during that period. Given these facts, the bankruptcy court concluded that, as to Trip Hawkins, the tax debts were excepted from discharge. However, as to Lisa Hawkins, the court held that the tax debts were discharged. The district court affirmed. This timely appeal followed.
Generally, a debtor is permitted to discharge all debts that arose before the filing of his bankruptcy petition. 11 U.S.C. § 727(b). However, the Bankruptcy Code provides for certain exceptions to that general rule. 11 U.S.C. § 523. Relevant to our case, the Code provides that a debtor may not discharge any tax debts “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. § 523(a)(1)(C) (emphasis added). As the district court...
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