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Sovereign Immunity Bars Claims for Emotional Damages from IRS Misconduct

(Parker Tax Publishing November 2016)

A district court rejected a bankruptcy court's award of $4,000 to a couple going through bankruptcy who proved that the IRS had taken actions that were in violation of the automatic bankruptcy stay. In reversing the bankruptcy court, the district court held that the couple's claims were barred by sovereign immunity. Hunsaker v. U.S., 2016 PTC 421 (D. Or. 2016).

Jonathan Hunsaker is a retired Oregon State Police trooper. His wife, Cheryl, works in the business office of a local hospital. The couple filed a bankruptcy petition under Chapter 13 of the Bankruptcy Code on November 5, 2012. The case was difficult from the outset because property acquired by the couple as their homestead was discovered to be subject to disputed claims by secured creditors and the local government.

A plan of reorganization was finally confirmed on September 3, 2014, and an automatic stay under Bankruptcy Code Section 362(a) became effective when the bankruptcy petition was filed. Under the automatic stay provisions, a bankruptcy petition for relief operates as a stay, applicable to all entities, of "the commencement or continuation, including the issuance or employment of process, of a judicial, administrative or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case." Under Bankruptcy Code Section 362(k), an individual injured by a willful violation of the stay can recover actual damages, including costs and attorneys' fees, as well as punitive damages in appropriate circumstances. Actual damages under Bankruptcy Code Section 362(k) includes damages for emotional distress.

Since their bankruptcy case began, the Hunsakers made all required plan payments. The IRS was scheduled as a creditor at the time the case began and received notice of the bankruptcy filing. A certificate of notice was filed on November 8, 2012, and the IRS filed a proof of claim, in the amount of $9,301, five days later.

During the course of the case, while the automatic stay was in effect, the IRS delivered directly to the Hunsakers four notices, each of which demanded payment and advised of imminent enforcement action if payment was not made promptly. In the notices, the IRS announced its intent to levy on the Hunsakers' social security benefits, state tax refund, and other property.

Each time the Hunsakers brought the notice to the attention of their attorney, their attorney assured them that the collection efforts were unlawful, and twice wrote to the IRS advising that the Hunsakers were in bankruptcy, and asking that the IRS to cease all collection activity. Although their attorney assured them that the automatic stay prevented the actions threatened by the notices, the effect of the attorney's assurances began to wear thin as the notices continued to come.

Both of the Hunsakers were adversely affected by the notices and they filed suit in bankruptcy court seeking compensation for the emotional distress they endured as a result of the IRS's violations of the automatic stay. Mrs. Hunsaker testified to the onset of migraine headaches within hours of receipt of each of the notices. Each spouse noted signs of tension and anxiety in the other, which in turn added to his or her own stress. The couple told the court that they were especially concerned with the threat to levy on Mr. Hunsaker's social security income, because loss of a substantial portion of their income would render their plan of reorganization unfeasible.

The IRS conceded that its actions constituted violations of the automatic stay provisions but argued that it was immune from claims for damages for emotional distress as a result of having sovereign immunity. However, Bankruptcy Code Section 106(a) waives sovereign immunity for some claims under Bankruptcy Code Section 362(k). Bankruptcy Code Sec. 362(k) allows individual debtors injured by a creditor's willful violation of the automatic stay to recover "actual damages." In In re Dawson, 390 F.3d 1139 (9th Cir. 2004), the Ninth Circuit for the first time established that emotional distress damages are compensable under Bankruptcy Code Section 362(k) and established the criteria for ascertaining when such damages are allowable. In resolving the question of whether Congress intended "actual damages" to include claims for emotional distress, the court concluded that allowing emotional distress damages best fulfilled the legislative intent to protect debtors from excessive psychological and emotional harm.

The bankruptcy court held that the Hunsakers demonstrated by clear and convincing evidence that (1) the IRS actions were a violation of the automatic stay; (2) the circumstances surrounding the violations would obviously cause a reasonable person to suffer significant - that is, non-trivial or insubstantial - emotional harm; and (3) the Hunsakers in fact sustained significant emotional damages as a result of the automatic stay violations. As a result of its findings, the court awarded the Hunsakers $4,000 in damages. The IRS appealed to a district court.

The district court reversed the bankruptcy court and held that sovereign immunity barred the Hunsakers' claims against the IRS. Sovereign immunity, the court said, can only be waived by unequivocal, clear statutory language. The court noted that whether the IRS had waived sovereign immunity for emotional distress damages under Bankruptcy Code Section 362(k) was an issue of first impression in the Ninth Circuit. According to the court, Bankruptcy Code Section 362(k) contains, at best, an ambiguous waiver for emotional distress damages and stated that ambiguities must be resolved in favor of immunity.

The district court also noted that In re Dawson did not address sovereign immunity because the dispute there involved only private parties. That emotional distress damages are available against private parties does not automatically authorize them against the federal government, the court said, because when it comes to an award of money damages, sovereign immunity places the federal government on an entirely different footing than private parties.

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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