Bankruptcy Court Doesn't Buy IRS's Excuses for Attempting to Collect Discharged Debts

(Parker Tax Publishing June 2022)

A bankruptcy court held that a couple was entitled to recover damages under Code Sec. 7433(e) for the IRS's unauthorized collection action because the IRS violated a discharge order when it made multiple attempts to collect tax debts previously discharged in the couple's bankruptcy. The court rejected the IRS's argument that its violation was inadvertent because the notices were sent by automated delivery systems which were affected by the COVID-19 pandemic after finding that the notices were sent despite the couple's repeated attempts to contact the IRS and resolve the issue. In re McAuliffe, 2022 PTC 150 (Bankr. N.D. W.V. 2022).

Background

Suzanne McAuliffe and her husband, Brian McAuliffe, were co-debtors in a Chapter 13 case they filed in 2016. Suzanne and Brian are both licensed attorneys, and although Suzanne does not routinely practice bankruptcy, Brian is a frequent litigant in the bankruptcy court and is well-versed in the intricacies of the Bankruptcy Code. Accordingly, Brian represented himself and Suzanne in their bankruptcy case.

The IRS asserted a claim for $13,624 relating to tax years 2010 and 2011. Before declaring bankruptcy, the McAuliffes paid the IRS under a 2012 installment agreement, but the McAuliffes terminated the agreement in the bankruptcy and instead paid the debts through their repayment plan. The McAuliffes received a discharge in September 2019. During the case, however, the McAuliffes accrued a new liability for the 2018 tax year.

Several months after the discharge and prior to the effects of the COVID-19 pandemic reaching the United States, the IRS sent the McAuliffes two demand letters seeking to collect the liabilities from the 2010 and 2011 tax years. On the couple's behalf, Brian sent a letter to the IRS's Cincinnati Service Center in March 2020 contesting the collection and advising the IRS of the discharge. After receiving a third demand letter from the IRS, the McAuliffes filed a motion to reopen the bankruptcy case. The IRS did not acknowledge Brian's March 2020 letter until September 29, at which point it communicated it would need 60 days to review the liability. Contrary to this communication, the IRS had already abated the 2010 and 2011 taxes the previous day. The IRS attributed the seven-month delay and miscommunications to a combination of the COVID-19 pandemic and Brian's mailing of communications to the wrong IRS office. Further, the IRS blamed the effects of COVID-19 for the "delay before the IRS applied the discharge order to the federal tax accounts" of Suzanne, which presumably led to the automated notices.

The bankruptcy court reopened the McAuliffes' case and the McAuliffes filed an adversary proceeding. While the IRS granted no relief through administrative remedies, it sent another letter to the McAuliffes stating an intent to terminate their installment agreement and stating that $1,150 was due immediately to avoid default. In addition, the notice stated that the IRS "may levy (seize) your state income tax refund or other property or rights to property and apply the proceeds to the total amount of your unpaid liability." Around the same time, the McAuliffes received separate communications from the IRS accepting the installment plan regarding the 2018 debts, nearly 20 months after Brian's initial request.

Brian continued to represent Suzanne, despite filing a motion to remove himself as a plaintiff in the action on the eve of the trial. The couple did not establish a fee agreement or contract for the legal services and Suzanne did not make any payments to her husband for the representation. Nevertheless, the McAuliffes sought to recover legal fees for pursuing the action. They also claimed that they intended to sell their Martinsburg residence and while it was initially listed for $295,000, they took the first offer they received as a result of the notice of intent to levy. The accepted offer was $280,000, representing a sale of the home for $15,000 less than its listing price. The McAuliffes asserted that a fear of the IRS's possible levy resulted in the hastened sale. Lastly, the McAuliffes sought costs associated with filing the action and accrued interest and penalties relating to the 2018 tax liability.

Under 11 U.S.C. Section 524(a)(2), a discharge order operates as an injunction against the commencement or continuation of an action to collect a debt which was previously discharged in bankruptcy. Code Sec. 7433(e) provides that "if, in connection with any collection of Federal tax with respect to a taxpayer, any officer or employee" of the IRS "willfully violates" any provision of 11 U.S.C. Section 524, the taxpayer may petition the bankruptcy court to recover damages.

The IRS admitted that the letters it sent related to the debts discharged in the bankruptcy but argued that there was not a willful and intentional violation by the IRS and its employees. Instead, it contended that the attempts were inadvertent and thus damages could not be awarded under Code Sec. 7433(e). The IRS argued that Code Sec. 7433(e) requires proof that a specific IRS officer or employee willfully violated the discharge order, rather than the entity as a whole. According to the IRS, none of its employees violated the discharge order because the notices were sent automatically and thus unattached to any employee. The IRS also sought to blame any administrative mishaps and delays on the McAuliffes' communications to the Cincinnati office, rather than a Richmond "bankruptcy specialist" involved in the bankruptcy claim.

Analysis

The bankruptcy court held that the IRS violated the discharge order and the McAuliffes were therefore entitled to recover damages. The court was not persuaded by the IRS's characterization of its actions as inadvertent, given that it failed for nearly 12 months to enter the discharge into its systems despite the McAuliffes' multiple attempts to correct the issue. In the court's view, the IRS was attempting to hide behind the same thing for which it sought to punish the McAuliffes - the multitude of national offices involved in communications. The court noted that during the bankruptcy, the McAuliffes received communications from, or were given the address to, at least five different IRS offices across the country. Yet at the same time, the IRS sought to blame any administrative mishaps and delays on the McAuliffes' communications to the Cincinnati office - the office from which the McAuliffes received a collection notice. The court said that it contravened common sense to require a taxpayer who received a notice from Cincinnati to direct a response to a Richmond office involved in the bankruptcy claim filed four years earlier rather than responding directly to the office from which he or she received the communications.

The court also was not persuaded that the notices were unconnected to any IRS employee. The court reasoned that if employees and automated systems in the Cincinnati office are disconnected from the interactions of other offices, the resulting shortcomings should not be attributed to the McAuliffes, but rather to agency responsible. The court said that while COVID-19 had a significant impact on all levels of the federal government, that did not excuse repeated attempts to collect from the McAuliffes, who were doing everything possible to correct any miscommunications. According to the court, one notice could be "inadvertent," but action should have been taken after Brian contacted the IRS multiple times regarding a discharge of which it should have already been aware.

Having found that the McAuliffes were entitled to recover damages, the court determined that the amount of their recovery was limited to a refund of the filing fees associated with their complaint plus the interest and penalties which accrued from the initial March 2020 notice letter until the IRS's eventual acceptance of their settlement offer. The court rejected the McAuliffes' claim for damages resulting from the sale of their home at a reduced price as being too speculative. The court further found that the McAuliffes could not recover legal fees because no attorney's fees were actually paid and no fee agreement was entered between Brian and Suzanne.

For a discussion of the discharge of taxes in a bankruptcy, see Parker Tax ¶16,160. For a discussion of claims for damages from unauthorized collection, see Parker Tax ¶260,550. For a discussion of recovering litigation or administrative costs, see Parker Tax ¶263,540.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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