This, from Ars Technica, is pretty extraordinary:
bq. In the early 2000s, William “Trip” Hawkins—founder of video game publisher Electronic Arts—was living the good life. … Hawkins had a peculiar way of keeping his cash flow up; he wasn’t paying all the taxes connected to the proceeds of some of his stock sales. Instead, he participated in a tax sheltering setup designed to produce on-paper “monetary losses” to offset the gains. The scheme was all done through accounting firm KPMG, which used convoluted Swiss and Cayman Islands deals that eventually raised the eyebrows of Internal Revenue Service (IRS) tax auditors. The IRS and the California Franchise Tax Board eventually cried foul. In 2002, the IRS notified Hawkins’ lawyers that the tax shelters, accounting for about $60 million in claimed losses, wouldn’t be allowed for the tax years 1997 to 2000. This meant that Hawkins would be on the hook for millions in back taxes on all those EA stock profits. Still, Hawkins continued living a jet setter’s life until around the time he filed for bankruptcy protection in 2006. For instance, a government legal filing said that Hawkins’ private jet had cost $11.8 million in 2000 and had an “operating” cost of $1 million annually.
bq. Hawkins did eventually pay more than $10 million toward his tax debt, but $26 million still remained. Because of Hawkins’ continued high spending, a federal bankruptcy court refused to give him the usual bankruptcy benefit of wiping his tax burden. … But Hawkins appealed this ruling—and he doesn’t have to pay those taxes, at least not for now. A recent decision by a three-judge panel for the 9th US Circuit Court of Appeals in San Francisco sided 2-1 with Hawkins despite objections from a dissenting appellate judge who said that Hawkins didn’t deserve a break because he was engaged in “profligate spending.” The appeals court concluded that it didn’t matter whether Hawkins bought a private jet or lived the high life, so long as he wasn’t willfully scheming to evade his tax burden. The majority opinion concluded that the law was on Hawkins’ side and that “bankruptcy law must apply equally to rich and poor alike.”
The key quote from the majority’s ruling is below:
bq. [A] mere showing of spending in excess of income is not sufficient to establish the required intent to evade tax; the government must establish that the debtor took the action with the specific intent of evading taxes. Indeed, if simply living beyond one’s means, or paying bills to other creditors prior to bankruptcy, were sufficient to establish a willful attempt to evade taxes, there would be few personal bankruptcies in which taxes would be dischargeable. Such a rule could create a large ripple effect throughout the bankruptcy system. As to discharge of debts, bankruptcy law must apply equally to the rich and poor alike, fulfilling the Constitution’s requirement that Congress establish “uniform laws on the subject of bankruptcies throughout the United States.”
On the one hand, there might in principle be a sort of logic to this. US bankruptcy law has been revised to the great benefit of creditors in recent years. Stripping away another set of protection for debtors could be problematic, given that most debtors in need of protection are not Trip Hawkins. You could read the first part of the argument as referring to this possibility. On the other hand, the second part of the judges’ decision seems to be guided by exactly the opposite fear. They seem, very literally to be arguing that the laws which protect poor people from adverse judgments that they are spending above their income, should also give _carte blanche_ to a rich dude with creative accountants and a massive tax judgment hanging over his head to keep his jet, his Giants season tickets etc without any adverse implications being drawn about his willingness to settle his tax affairs. And they made this judgment despite (as a dissenting judgment points out) the fact that Hawkins’ tax attorney “testified that Hawkins’ intent was not to pay the tax debt, but to discharge it in bankruptcy.” I don’t imagine that the judges realize that they are unconsciously recapitulating Anatole France, with the satiric effect surgically removed. But the incentive effects on rich people in temporary financial difficulties will be interesting, if the judgment stands.
[Title stolen from David Moles, with a small modification]
{ 32 comments }
mpowell 10.02.14 at 4:30 pm
The story doesn’t indicate the current disposition of Hawkins’ assets. The lavish living referred to in the article is all pre-bankruptcy. If he is now broke, it’s hard to disagree with the appellate court’s finding. If he has substantial remaining assets, that sounds like a problem with the bankruptcy law quite independent of the nature of his lifestyle after being hit with a post-due tax bill. By all means, carve away protections for the once wealthy to hide assets in bankruptcy proceedings. But do you really want to argue that the wealthy should see debtor’s prisons?
Area Man 10.02.14 at 5:23 pm
The very phraseology is absurd. There is no such thing as a rich person who declares bankruptcy. There are only poor people who refuse to accept that they are no longer rich.
If I didn’t know better, I’d think the court was applying a class system that goes even beyond wealth.
TM 10.02.14 at 6:02 pm
mpowell: the alternative wouldn’t be debtor’s prison. The alternative would be the same treatment that thousands of unlucky former middle-class bankruptees face – having to keep paying off some of their debts.
Remember that for example you can’t discharge a student loan debt in bankruptcy, but a multi-million tax debt incurred through dubious if not illegal off-shore tax evasion shenanigans is just fine. “Rich and poor alike”, indeed.
cassander 10.02.14 at 6:45 pm
@Area Man
I’m not so sure about that. In a lot of states, there are large asset classes protected from bankruptcy, like primary residences. Someone with a large protected asset (like a multimillion dollar home) filing for bankruptcy is definitely a lot less rich than he thought he was a few years earlier, but he isn’t exactly poor.
Barry 10.02.14 at 7:28 pm
Area Man 10.02.14 at 5:23 pm
“The very phraseology is absurd. There is no such thing as a rich person who declares bankruptcy. There are only poor people who refuse to accept that they are no longer rich.”
Actually, there are. You can tell because afterwards, they still have lots of nice stuff, and are not working as a WalMart greeter.
Sandwichman 10.02.14 at 8:34 pm
Don’t envy the rich. Think of all the jobs Hawkins was creating by spending money and not paying taxes.
mpowell 10.02.14 at 9:29 pm
TM – there is such a thing as going to jail for dodging taxes. Whether a person’s conduct is worthy of such punishment does not hinge on the purchasing of private jets. The post title implied this guy retained his jet through bankruptcy. That was pretty clearly not the case.
On the other hand, student loans absolutely should be dischargeable in bankruptcy. I don’t think bringing the hammer down on this guy is going to address that issue however.
Henry 10.02.14 at 10:10 pm
No. It doesn’t in the slightest. What is it about the phrase “while waiting to declare” that you don’t understand?
Brett Bellmore 10.02.14 at 10:13 pm
I tend to think it’s a very good principle that the law, in it’s majesty, treats the rich and the poor alike.
‘Cause it’s not the poor who will get the better treatment if that principle is abandoned.
que_es 10.02.14 at 10:21 pm
Though the majority opinion in the case cites valid statutory interpretations as precedent for its ruling, the effect of that ruling is to expose the irony of the system. If Mr. Hawkins wished to maintain his ability to discharge his tax debt in bankruptcy then he’d better not be caught “declining to file tax returns, shifting assets to another person or a false bank account, shielding assets, and switching all financial dealings to cash.”
What these activities have in common is that they are an attempt to hide the fact of his income from tax authorities. On the other hand, he was free to declare in open court, through his attorney, that his “intent was not to pay the tax debt, but to discharge it in bankruptcy. . . .”
So if he hid income, then the tax was nondischargeable. However, so long as he was open about his income, he could escape all responsibility for paying tax on it. He was well-advised by his highly-paid lawyers.
It seems to me that the government should make a fuss over the fact of the tax shelters themselves as evidence that he actually attempted to evade tax by hiding income. After all, that’s why those devices were ultimately determined to be shams and why KPMG was fined almost half a billion dollars for peddling them.
Unfortunately, I would disagree with the OP that this situation is extraordinary. These things play out this way all the time. For oligarchs.
William Berry 10.02.14 at 10:51 pm
The fault lies not in our laws but in our inequality.
Well, if there is fault in our laws it is the fault of the inequality, so whatever.
Area Man 10.03.14 at 12:47 am
Well, you aren’t supposed to have nice stuff after a bankruptcy. Minus basic personal items, it’s supposed to be sold off and the proceeds given to your creditors (yes, some states do let you keep your primary residence, which is frankly a scam). Declaring bankruptcy, by definition, means you don’t have the income to service your debts or the assets to cover them. That makes you poorer than most WalMart greeters. Poorer even than most junkies living on the street. That “rich” people with a negative net worth refuse to accept that they are in actuality poor, and that society appears eager to uphold their class expectations, is the whole problem here.
Factory 10.03.14 at 12:52 am
#9: ‘Cause it’s not the poor who will get the better treatment if that principle is abandoned.
Pretty sure the poor will be living in mortal fear that their private jets might be in danger from their cayman island tax avoiding banking scheme.
john c. halasz 10.03.14 at 1:01 am
@2:
Oh, dear. Donald Trump.
For the rest, there is a basic common law doctrine in bankruptcy law; it’s called “fraudulent conveyance”. IANAL but I think this case abuts upon it. OTOH there was a case of a private equity firm that bought one of its portfolio companies out of bankruptcy with one arm, after having put it into bankruptcy with another arm. Fancy lawyering that! Dickens wouldn’t have had a clue.
Dr. Hilarius 10.03.14 at 3:21 am
Area Man: Florida’s state constitution provides for an unlimited Homestead exemption to debt collection (with a few limitations, such as not exceeding 160 acres if outside a municipality). This protection extends into federal bankruptcy. So, if you’re thinking about filing for bankruptcy, buy the multi-million dollar Florida home, discharge your debts and keep the home. This is exactly what O.J. Simpson did.
There are other exemptions in bankruptcy such as ERISA-qualified retirement funds. You can walk out of bankruptcy with a lot of wealth if you plan it right. I don’t do bankruptcy law but have seen quite a few people manage to emerge with assets far beyond anything I’ll ever hope to have.
John Quiggin 10.03.14 at 6:35 am
An interesting polsci finding is that states with more debtor-friendly bankruptcy laws have eg Texas have less progressive tax systems
Martin Bento 10.03.14 at 9:27 am
I’m not sure what “waiting to declare bankruptcy” would mean in a legal sense. Declaring bankruptcy is a thing. Intending to declare it? Would such an intention have to be explicit? Of definite? Here I guess the open declaration of the lawyers makes things unusually clear cut, but I don’t expect you often get in court declarations of intent not to pay taxes, so the situation may be unusual and therefore not handled well by existing law. But in general, for rich people or for poor, is intent to declare bankruptcy a state with legal implications? If you get a loan with a thought to declaring bankruptcy in the future, is that illegal? Or is it caveat lendor?
Barry 10.03.14 at 12:14 pm
John Quiggin
“An interesting polsci finding is that states with more debtor-friendly bankruptcy laws have eg Texas have less progressive tax systems”
As the title of this post hints at.
Barry 10.03.14 at 12:17 pm
Seconding Factory @19: the poor don’t have either protections, or the means to take advantage of them.
Trader Joe 10.03.14 at 1:17 pm
Bankruptcy means that stated assets are less than stated liabilities. In more complex estates its very often declared when either the value of the liabilities – in this case the tax assessment – or the value of the assets are in question. Declaring bankruptcy is different than having that declaration certified by a judge. The purpose of declaration is to force a negotiation (as is clearly the case here). It has little to do with what the actual assets might or might not turn out to be.
The first tactic of the tax man (in this case, or a major creditor otherwise) would be to question the reported assets and assert that there are more than enough for all creditors to be made whole. The first tactic of the debtor is to conceal or otherwise reduce assets in a way that still renders them recoverable at a later date by transfering them to protected classes (i.e. real estate, 401k etc.). Establishing trusts and partnerships is another popular approach. (It doesn’t seem to be the case here, but this sort of action hapens pretty much 100% of the time in divorce cases as well where wealthy parties are involved.)
While the language of the judgement is somewhere between interesting and laughable, the actions the preceeded it are pretty much business as usual – although maybe for a bit higher sums than the norm.
mpowell 10.03.14 at 2:49 pm
No. It doesn’t in the slightest. What is it about the phrase “while waiting to declare†that you don’t understand?
This is just fantastic. I read your post and thought, wow, this guy was filing for bankruptcy while flying a jet around, or at least perhaps prepping the filing. Then I read the article and, no, he sold the jet several years prior to filing (and it had been purchased before he learned of his tax obligations). There is no clear meaning for what it means to be waiting to file, so you can always claim that your intended meaning matched perfectly what actually happened. All I can say is that what actually happened did not very closely match my first interpretation of the summary you gave.
MapMaker 10.03.14 at 3:00 pm
We have cases similar to this at my school. What is the right answer?
Henry, if a tuition paying parent at my school signs a contract (a debt) to pay X in tuition, what are their obligations if their employers goes bankrupt? Should they immediately pull their child out of our school, turn their car in, sell their house? No, generally they don’t cut their spending, they hope they get another job, the stock market goes up or whatever. Luckily, most of the time it works out. For those times it doesn’t, well bankruptcy is a form of compassion I guess…
Henry 10.03.14 at 3:29 pm
Mpowell – according to the legal documents he sold the jet in October 2003, and his attorney officially told the IRS he was planning to discharge his tax liability via bankruptcy in January 2004. It had been clear since 2001 that his tax avoidance scheme was going to be disallowed, presenting him with a massive tax liability that he clearly had no intention of paying. I don’t know where you are getting the “several years” from, but wherever it is, it’s completely mistaken.
Mapmaker – if someone was trying to figure stuff out for real, there’s a good case to be made. That’s why I note that “Stripping away another set of protection for debtors could be problematic” in the OP. But when someone who is extremely rich is planning to go into bankruptcy (has also, although the article doesn’t note this, salted 750k into a foundation to support his kids) and is effectively spending down his money on living the high life in the interim, there’s an obvious incentive problem.
L2P 10.03.14 at 4:23 pm
” But when someone who is extremely rich is planning to go into bankruptcy (has also, although the article doesn’t note this, salted 750k into a foundation to support his kids) and is effectively spending down his money on living the high life in the interim, there’s an obvious incentive problem.”
Setting up a trust is an entirely different thing than just “spending down his money on living the high life.” When a rich debtor files for bankruptcy, he has by definition been “spending down his money on living the high life.” You rarely will be able to blow through $50 Million living FRUGALLY, for the love of gawd.
I think you’re confusing some sort of an obligation to organize one’s life to maximize repayments to creditors with intentionally defrauding creditors. No one has any obligation to ensure that their creditors get paid as much as possible from their assets. You are free to blow your money at the craps table rather than letting your credit card companies get all the money you have available. Unless there’s an identifiable asset that your creditors can seize and you’re trying to hide from them, nothing wrong happened here.
On the other hand, setting up a trust for your children’s education when you are insolvent is almost certainly a fraudulent transaction that can be set aside by your creditors. There is an asset you are trying to hide from creditors and they can get it. But this is an asset-by-asset determination.
Also, the courts are well aware of the “incentive problems” debtors face. There’s a variety of remedies creditors have, up to and including involuntary bankruptcies, to keep debtors from dissipating assets. In particular, the IRS has no grounds to complain as they could have made a jeopardy assessment and seized this guys assets as soon as they saw any evidence he was dissipating assets.
And finally, all the court is saying here is that the government did not show, merely by a debtor saying (essentially) “I’m going to continue doing all the things I’ve done rather than start saving money to repay creditors,” that the debtor intentionally defrauded creditors. And frankly the facts here show literally nothing. The vast majority of the “high living” this article talks about started before the debtor had any inkling he owed any debts; that makes it incredibly hard to show that the debtor started doing things
Layman 10.03.14 at 4:49 pm
“I think you’re confusing some sort of an obligation to organize one’s life to maximize repayments to creditors with intentionally defrauding creditors. No one has any obligation to ensure that their creditors get paid as much as possible from their assets. You are free to blow your money at the craps table rather than letting your credit card companies get all the money you have available. Unless there’s an identifiable asset that your creditors can seize and you’re trying to hide from them, nothing wrong happened here.”
But I believe the court has the option of refusing to set aside some debts which are not settled. The bankruptcy filer could be left with outstanding debts and the responsibility to settle them in the future. When should the court opt to do this? One reason is evidence that the filer squandered assets rather than try to meet his/her obligations, banking on the willingness of the court to relieve those obligations. In fact, I’d say that was the most compelling reason, especially when the filer admits to this strategy. If such an outcome isn’t permissible under current law, then current law – or the judicial interpretation thereof – is biased in favor of those with large debts and copious assets to squander. Which is the point of the OP, after all.
someguy88 10.03.14 at 5:24 pm
He put way 750K for his kids. [It seems like this was based on Family Court instructions. Good for his kids] Maybe his arrangement with his parents is a wink wink deal. Maybe his wife still has a bit of the money. Whatever.
He seems to have sold how quite a few assets and applied the proceeds to his tax debt. Excess spending by bankruptcy claimants is the chronic behavior that results in bankruptcy not fraud. A lawyer’s statement that he intended to have the tax liabilities written off isn’t proof of fraud, it is a hopeful legal claim.
The mere existence of over spending, coupled with legal claims regarding what portions of an individual’s they expect to be written, off seems like a pretty low bar for proof of fraud.
Let’s not eat the rich. It might give us indigestion.
que_es 10.03.14 at 5:25 pm
Let’s put this in some perspective. This guy might be a sophisticated businessman with piles of resources but all we’re talking about here is letting him avoid a few million or so in tax debts. It’s not like they’re letting him get away with discharging student loan debt for gawdsakes.
Barry 10.03.14 at 6:45 pm
ME: “Actually, there are. You can tell because afterwards, they still have lots of nice stuff, and are not working as a WalMart greeter.”
Area Man: “Well, you aren’t supposed to have nice stuff after a bankruptcy. ”
Perhaps you should think about your comment to which I was replying.
Richard York 10.04.14 at 12:39 am
Unless things have changed, bankruptcy does not relieve anyone from their tax burden. Unfortunately, I speak from personal experience.
Richard York 10.04.14 at 12:41 am
I should have said personal, Chapter 7 bankruptcy.
mpowell 10.05.14 at 4:36 am
The article specifically states that he filed for bankruptcy in 2006. Three years after selling the jet. But I’m the one who is completely mistaken.
Seth Gordon 10.05.14 at 4:54 pm
How often do non-rich people get into bankruptcy while owing taxes, in a way that makes it worth arguing about whether or not they intended to evade taxes? Most of the taxes that poor and middle-class people owe are either paid up front (sales, FICA) or overpaid up front (income).
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