Individual with Unpaid Taxes Denied Discharge in Joseph Case
Charles J. Stevens was a construction hired hand who decided, for reasons unknown, to disregard or neglect to submit and pay his federal income taxes. On September 1, 2023, Stevens initiated a petition in the U.S. Bankruptcy Court for the Eastern District of Kentucky, requesting Chapter 7 relief. In subsequent filings, Stevens would assert that he possessed only $21,095 in assets relative to his substantial debts exceeding $10 million.
Intrigued by the substantial disparity between Stevens' assets and liabilities, the U.S. Trustee initiated an inquiry into Stevens' financial affairs and business activities. The files Stevens provided were meager, primarily made up of eight pages of documents and four receipts obtained from a subcontractor with whom he had worked. Stevens would later claim that the subcontractor possessed numerous business records but failed to provide them.
The U.S. Trustee subsequently initiated a legal challenge against Stevens, aiming to deny him a discharge due to his refusal to fully disclose his financial records. Discovery proceedings were initiated in this proceeding, during which Stevens did provide some additional documents to the U.S. Trustee, including images of 139 bank checks he had received, totaling approximately $1.4 million. It also emerged that Stevens conducted his business solely in cash, without maintaining a general ledger or any financial records.
Given Stevens' failure to maintain financial records for his construction business, how could he declare and pay his taxes? The answer is straightforward: he did not. In fact, Stevens had not submitted any income tax returns since 2007, citing that "his records are not up to par" and that he "kept putting it off." Consequently, Stevens could not explain the fate of the income he had earned.
As a result, the U.S. Trustee sought a summary judgment to deny Stevens' discharge, which led to the following opinion in Randolph v. Stevens (In re Stevens), Bk.E.D.Ky. Case No. 23-51021, Doc. 34 (Oct. 31, 2024).
The Court first recognized that Bankruptcy Code § 727(a)(3) requires the denial of a debtor's discharge if the debtor has neglected to maintain records of their financial condition or business activities. While § 727(a)(3) does not explicitly mention tax returns, numerous court rulings have determined that tax returns constitute the records that a debtor must keep. The Court then commented:
"Debtor's refusal to file personal tax returns for sixteen years (2008 to 2023) is appalling. This is particularly notable given Debtor ran a construction business as a sole proprietorship and received substantial income from that endeavor. At the trial, the UST reported that no case could be located that involved such a prolonged, consistent failure to file tax returns. The Court was similarly unable to locate such a case through independent investigation. Debtor's admission of his failure to submit federal tax returns for sixteen years provides a solid foundation for concluding that the UST has met its burden under § 727(a)(3), thereby shifting the burden to Debtor to justify the inadequacy of his records."
However, Stevens' failure to maintain and submit tax records was not the only issue at hand. Section 727(a)(3) fundamentally mandates that a debtor must provide sufficient information for creditors and other parties involved in the bankruptcy to evaluate the debtor's financial condition and transaction history. Stevens' records fell far short of meeting this requirement:
"Since at least January 1, 2019, Debtor has not maintained a bank account and, hence, provided no bank records to the UST. Debtor did business exclusively in cash during this period, resorting to check-cashing businesses to cash large checks, which in turn led to a scarcity of financial records. While Debtor provided the UST with images of checks he received during a twenty-month period in 2022 and 2023, totaling $1,421,337, Debtor only offered documentary evidence to the UST to explain $65,426 in expenditures (excluding those to his spouse) during this period. Debtor failed to provide records to substantiate what happened to the over $1.3 million in revenue he earned during the twenty months preceding the filing of his bankruptcy petition."
Stevens submitted an affidavit to attempt to explain his financial situation, but this was insufficient. Affidavits, which often have a self-serving nature, are not an acceptable substitute for ordinary business records. The affidavit stated that after filing for bankruptcy, he had sought the assistance of a tax preparer to file his back tax returns, but no tax preparer would work with him under the circumstances. Stevens also expressed frustration that one of his subcontractors had failed to provide necessary records to him. However, none of this provided a valid justification for Stevens' failure to maintain proper business records or file his tax returns, and, thus, the Court concluded:
"Debtor managed a construction business for an extended period and, as such, should have some familiarity with business operations. Debtor chose to operate a business generating significant income and requiring frequent expenditures without a bank account. Debtor failed to maintain the records of his sole proprietorship in a manner sufficient to establish his financial condition in substantial detail and accuracy. Debtor also failed to file tax returns for an extended duration. Debtor did not offer sufficient evidence to create a material dispute of fact warranting a trial, as no reasonable fact-finder could find in Debtor's favor on the justification issue based on the evidence presented in the Motion."
In this scenario, the court ruled in favor of the U.S. Trustee's request for a summary judgment, denying Joseph's request for bankruptcy discharge. This decision was made due to Joseph's history of not filing his tax returns, often referred to as a 'non-filer'. This predicament usually makes it challenging for individuals to be granted a discharge in bankruptcy proceedings. It's worth noting that even those who consistently file their taxes on time might face challenges if they cant maintain proper business records. A curious twist here is that someone struggling with maintaining business records could potentially end up in bankruptcy more frequently than someone who is able to manage their records effectively.
This case can provide valuable insight for financial advisors when working with clients facing financial hardships.
Despite his claims that the subcontractor had numerous business records, Stevens failed to provide them during the bankruptcy proceedings, further complicating his case. As a result of his prolonged history as a 'non-filer' and his failure to maintain tax returns or financial records, Stevens was unable to explain the source of his income and was ultimately denied a discharge in the bankruptcy proceedings.
