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Taxpayers Must Exhaust Administrative Remedies before Recovering Costs for Bankruptcy Violations

(Parker Tax Publishing May 2018)

A bankruptcy court held that two former debtors who sought damages and attorney fees from the IRS for violating their bankruptcy discharge injunctions by attempting to collect discharged taxes were first required to exhaust administrative remedies before seeking recourse from the bankruptcy court. The bankruptcy court found that, although the debtors may have been entitled to seek attorney fees and costs, they had not exhausted the administrative remedies provided in the applicable IRS regulations. In re Thal, 2018 PTC 128 (Bankr. S.D. Fla. 2018).

Background

Lucy Thal filed for Chapter 13 bankruptcy in February 2009. The IRS filed a proof of claim that listed a priority claim for approximately $7,100 and an unsecured general claim for around $60,500. The IRS did not object to Thal's Chapter 13 plan, in which she proposed to pay the full amount of the priority claim, and the bankruptcy court confirmed her plan in October 2009. Thal received her discharge in September 2016 and her case was closed.

In February 2017, the IRS sent four notices of intent to levy to Thal for tax years 2002-2005 for charges of approximately $37,100. Thal received a notice of the IRS's intent to seize up to 15 percent of her social security benefits for taxes due for years 2002-2005; the IRS said the unpaid taxes totaled over $17,200. Thal filed a motion for contempt against the IRS for violation of the discharge injunction by attempting to collect the discharged debts. Thal asked the bankruptcy court to order the IRS to pay punitive damages as well as attorney's fees and costs.

The IRS responded that it was not advised that a notice of intent to seize was sent to Thal, and that it was not notified until September 2017 that the U.S. Attorney's Office had taken $227 from Thal. The IRS claimed that it immediately placed a stop on all future collection actions and refunded the $227. For these reasons, the IRS argued that it would be inappropriate for the court to issue a sanction. The IRS also argued that Thal's request for attorney's fees and costs should be denied because Thal failed to exhaust her administrative remedies as required by Code Sec. 7433.

Robert Lee Slattery had a similar experience with the IRS. He filed a Chapter 13 petition in April 2011 and scheduled the IRS as a creditor. The IRS filed a proof of claim listing an unsecured priority claim for $37,700 and a general unsecured claim for $6,900 for tax years 2006 and 2008-2010. Slattery filed a plan in August 2011 proposing to pay the full amount of the IRS's priority claim. The IRS did not object and the court confirmed the plan in October 2011. Slattery completed his plan payments in August 2016 and received his discharge in October 2016.

In December 2016, Slattery received two notices of intent to levy for tax years 2008 and 2009 for over $1,400. Slattery's counsel advised that the debt owed was paid in full and that no further contact should be made with Slattery. In August 2017, Slattery received another letter from the IRS stating that $785 from his 2016 tax refund was applied to an amount owed for tax years, 2006, 2008 and 2009, and that $700 was still due and owing for 2008. Slattery filed a motion to reopen his bankruptcy case and to have the IRS held in contempt for violating the discharge injunction. Slattery asked that the funds the IRS withheld be returned and for the IRS to pay his attorney fees and costs. The IRS responded by arguing that the taxes at issue were excepted from discharge, and therefore its actions to collect any balance did not violate the discharge injunction. The IRS also argued that Slattery's request for attorney fees and costs should be denied because Slattery failed to exhaust his administrative remedies under Code Sec. 7433.

Analysis

Under Code Sec. 7430, a taxpayer must exhaust administrative remedies before suing the government to recover litigation costs in connection with the collection of any tax. Code Sec. 7433 gives a taxpayer the right to bring a civil action for damages against the U.S. when the IRS recklessly, intentionally or negligently disregards any provision of the Code. Under Code Sec. 7433(e), if the IRS violates a bankruptcy discharge injunction, the taxpayer may petition the bankruptcy court for damages. However, before doing so, Code Sec. 7433(d)(1) requires the taxpayer to first exhaust all available IRS administrative remedies provided for in the regulations.

Thal and Slattery argued that exhaustion of administrative remedies was not required under In re Jove Engineering, 92 F.3d 1539 (11th Cir. 1996) and In re Jha, 2011 PTC 129 (Bankr. N.D. Cal. 2011). In Jove, the Eleventh Circuit held that a corporate debtor could seek damages against the IRS based on the agency's intentional violation of the automatic stay. The Eleventh Circuit held that the district court had discretion to award attorney fees, but such awards had to be consistent with Code Sec. 7430. In Jha, a California bankruptcy court held that a debtor need not exhaust administrative remedies before seeking relief in a bankruptcy court; the court found that there was no mention in Code Sec. 7433(e) of the need for exhaustion.

The bankruptcy court first found that the IRS violated both Thal's and Slattery's discharge injunctions by attempting to collect discharged taxes. Turning to damages, the court found that they could be entitled to recover attorney fees and costs, but were first required under Code Sec. 7433 to exhaust the administrative remedies provided by the applicable IRS regulations.

The bankruptcy court found that Code Sec. 7433(d)(1) clearly applied to a claim for violation of a discharge injunction. The court found the holding in Jove to be unclear and noted that the Eleventh Circuit never discussed exhaustion of administrative remedies. The court explained that if Code Sec. 7433(e) had never been enacted, Jove would support the debtors' position. However, in the court's view, Code Sec. 7433(e) made clear that the exhaustion requirement applies to any claim for damages for violation of a discharge injunction. The court also court noted that Code Sec. 7433(e) was enacted two years after the Jove decision, but it found nothing in the legislative history to suggest it was enacted in response to Jove.

The court also found that the Jha holding ignored the plain meaning of Code Sec. 7433(e) by disregarding the clear cross references in the statute. As the bankruptcy court explained, Code Sec. 7433(b), which provides for damages and costs, clearly applies to petitions brought under Code Sec. 7433(e). The exhaustion requirement in Code Sec. 7433(d)(1) explicitly applies to damages awards under Code Sec. 7433(b). Therefore, the court concluded that the exhaustion requirement applies to actions for damages under Code Sec. 7433(b).

The court found that Thal's claim for punitive damages was barred under 11 U.S.C. Sec. 106(a)(3), which permits a money recovery for violation of a discharge injunction but does not allow any award of punitive damages. Slattery's claim for a return of the money the IRS improperly took was granted because the court found that nothing in Code Sec. 7433 prevented it from ordering the funds to be returned.

For a discussion of recovering litigation or administrative costs, see Parker Tax ¶263,540. For a discussion of taxpayer claims for damages for unauthorized collection, see Parker Tax ¶260,550.

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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