Can a wife discharge in a chapter 7 bankruptcy a divorce order requiring her to pay half her husband’s tax liability to the IRS?

Can a wife discharge in a chapter 7 bankruptcy a divorce order requiring her to pay half her husband’s tax liability to the IRS?

Not in the New Hampshire case of In the Matter of Robin Mason and Martin Mason, No: 2012-096 (2012), where the Supreme Court of New Hampshire reversed the trial court’s decision and ruled that the debt was automatically nondischargeable in the wife’s subsequent chapter 7 bankruptcy case.

In Mason, the husband and wife were divorced in 2007.  In the final divorce decree, the wife was ordered to pay one-half of the husband’s federal income tax liability for the 2006 tax year.  In 2010, the wife filed chapter 7 bankruptcy, listing the husband as an unsecured nonpriority creditor for a debt arising out of a divorce settlement and as a co-debtor on a federal tax lien.  She also included the Internal Revenue Service (“IRS”). as a creditor for a joint federal tax lien claim for the 2006 income tax liability.  The wife received a chapter 7 discharge in her bankruptcy case.

The husband and wife both petitioned the IRS for “innocent spouse” relief from their 2006 tax liability.  “Innocent spouse relief” relieves an innocent spouse who filed a joint income tax return from liability for his or her spouse’s failure to include income on the joint tax return.  The IRS granted the wife’s petition and denied the husband’s.

The husband then initiated a show cause against the wife in state court for violating the court’s order requiring her to pay one-half of his 2006 tax liability.  The state court judge found that the wife’s innocent spouse relief from the IRS had converted her obligation to the IRS into one to her ex-husband and that the wife had discharged her obligation to the ex-husband in her chapter 7 bankruptcy case.  The court denied the husband’s motion for contempt and his request for attorney’s fees.  The husband appealed the trial court’s ruling to the state’s highest appellate court.

The state supreme court first recognized the concurrent jurisdiction of state courts and the bankruptcy courts to address the dischargeability of  debts, in accordance with the original, but not exclusive, grant of bankruptcy jurisdiction to the federal district courts in 28 U.S.C. § 1334(b).  The court then ruled that the trial court judge had erred as a matter of law by holding that the wife’s debt to the husband had been discharged in bankruptcy, citing the exceptions to the discharge of debts for domestic support obligations (“DSO”) and non-DSO debts related to divorce in 11 U.S.C. § 523(a)(5) and (15).  The court further held that non-DSO family law debts under 11 U.S.C. § 523(a)(15) are automatically nondischargeable now, and do not require the filing of an adversary proceeding and determination of dischargeability in the bankruptcy court, as was required with a balancing act test prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) in 2005.  The court found that the wife’s obligation to pay the tax debt arising out of the divorce case was a debt under 11 U.S.C. § 523(a)(15).

The wife’s argument that the debt did not fit within the ambit of 11 U.S.C. 523(a)(15) because it was owed to a third party and not directly to her former spouse was rejected by the court, citing Howard v. Howard, 336 S.W.3d 433 (Ky. 2011), where the Kentucky Supreme Court held that argument was precluded by the broad definitions of “claim” – “…right to payment…or right to equitable remedy for breach of performance”, 11 U.S.C. §101(5), and  “debt” – “…liability on a claim”, 11 U.S.C. §101(12), in the Bankruptcy Code.

The court further held that the doctrine of res judicata barred the wife’s argument that the amount of the federal tax liability as determined by the trial court was incorrect because it included penalties on an early retirement account withdrawal that was not technically income.  The wife had not objected to the inclusion of such a penalty or appealed the trial court ruling and therefor could not raise the judicially settled matter five years later in this appeal of the show cause ruling.  Reversing the lower court’s decision that the debt had been discharged, the appellate court remanded the case to the trial court for a consideration of an award of attorney’s fees to the husband.

It is important to note that this kind of family law debt might have been discharged in a chapter 13 case, which excepts from discharge only Domestic Support Obligation family law debts.

You should discuss with your Virginia bankruptcy and divorce attorney or Richmond Divorce Lawyer James H. Wilson, Jr., whether a particular debt arising out of a divorce case might be discharged in bankruptcy.

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