Dionne Warwick’s Latest Attempts to Discharge Over $10 Million in Taxes

Have you heard the news? In September, the bankrupt soul singer Dionne Warwick filed a lawsuit against the United States and State of California to discharge federal and state taxes dating back to 1991. Warwick had previously been granted a Chapter 7 discharge by a New Jersey bankruptcy court in July, and now seeks a determination by the bankruptcy court that her tax debt was included in that discharge. The Internal Revenue Service filed a claim in Warwick’s bankruptcy totaling almost $7 million and the State of California filed claims at over $3 million.

Warwick’s attorneys assert that all of her federal and state tax debts were included in the July discharge order. They stated that all of the taxes claimed owed by the IRS and State of California were assessed more than 240 days prior to the date she filed for bankruptcy relief, and all taxes owed were “due” more than three years prior to the petition date. Read the following carefully:

Personal tax debts are generally dischargeable in bankruptcy if the following conditions are satisfied:

• The taxes are income taxes.
• There is no evidence of fraud or willful evasion.
• The debt was originally due at least three years before the bankruptcy filing.
• A tax return for the debt was filed at least two years before bankruptcy.
• The tax debt was assessed by the IRS at least 240 days before the bankruptcy was filed (and the IRS did not suspended collection activity because of an offer in compromise or a previous bankruptcy filing).

To reduce litigation, Warwick’s camp and the State of California filed a consent order to tie the state tax claims to the fate of the federal taxes. If the federal tax debts are determined as discharged, the state taxes will be discharged as well. On the other hand, if the federal taxes are excepted from the bankruptcy discharge, the state taxes will survive also.

In October, the United States filed an answer and counter-claim against Warwick. The United States alleges that Warwick engaged in a pattern of conduct to wilfully evade or defeat the collection of her tax debt. As I’ve mentioned in the past, willfully evading collection of debts is risky business and tends to turn out worse for the debtor than things generally would have turned out to be. See Section 523(a)(1)(C) of the Bankruptcy Code states:

11 USC § 523 – Exceptions to discharge

1. (a) A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt—
   1. (1) for a tax or a customs duty—
      1. (C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax

The United States alleges that “for many years Warwick willfully attempted to evade and defeat the collection of her 1991 through 2007 federal income tax liabilities, through acts of omission and commission, at times when she was financially able to pay the liabilities, had a duty under law to report and pay the liabilities, and voluntarily and intentionally violated that duty.” The counter-claim also contends that Warwick “habitually made grossly inadequate payments with regard to her income tax liabilities while earning significant income.”

The United States’ counter-claim states that Warwick used her majority-controlled companies, Star Girl Productions, Inc. and KMBA Productions, Inc., to pay her personal expenses including a housekeeper, rents, dentist, accountant, pharmacy, utilities, car insurance, and health insurance.

During those years, some of Warwick’s tax debts were paid from company checking accounts. The United States points out that Warwick does not have a personal checking account and is using these companies as “alter egos” to “prevent the collection of her tax liabilities.”

Furthermore, Warwick submitted offers in compromise to the IRS to pay her tax liabilities six times, in 2000, 2004, 2006, 2009, 2011, and 2012. Filing an offer in compromise will stop the IRS collection process, just as Warwick’s Chapter 11 bankruptcy filing did in 1993 (which was dismissed in 1998). However, the three year rule and the 240 day assessment rule are suspended or “tolled” when the government is prevented from collecting a tax debt because of a bankruptcy or offer in compromise.

For each bankruptcy case and offer of compromise, the tax authority gains an additional 90 days to collect once the limitation is lifted. So far the United States is not claiming that any of Warwick’s tax debt is within the time frame of either the three year or the 240 day rule (and therefore not eligible for discharge), although calculating time may become an issue in the case as it develops.

When will we see the bankruptcy hearing?

Warwick’s adversary case is set for trial in August of 2014. The government has the burden of demonstrating by a preponderance of the evidence that Warwick willfully attempted to evade her tax liability. See Grogan v. Garner, 498 U.S. 279 (1991). The IRS’s Internal Revenue Manual (IRM) itself states that “What constitutes a willful attempt to evade or defeat taxes under 11 USC § 523(a)(1)(C) is not always clear.”

Most courts find that the taxing authority must prove that the debtor

1. 1) had a duty to pay taxes;
2. 2) knew she had a duty, and
3. 3) voluntarily and intentionally violated that duty. See Stamper v. United States (In re Gardner), 360 F.3d 551 (6th Cir.2004).

Simply failing to pay the taxes is not enough by itself to render a tax debt non-dischargeable, because section 523(a)(1)(C) requires “affirmative acts to avoid payment or collection of taxes.” See United States v. Jacobs (In re Jacobs), 490 F.3d 913 (11th Cir. 2007) see also Stamper, 360 F.3d at 557 (non-dischargeability under 523(a)(1)(C) requires a “voluntary, conscious, and intentional evasion”).

What’s the take home?

Planning to avoid or evade paying your taxes through filing bankruptcy. The IRS will do their utmost to ensure and investigate whether you’re trying to fraud the system and if you are, they usually discover your plan. Stay tuned for the Warwick’s bankruptcy trial in 2014, it should be interesting.