Don’t Trust the IRS’ Advice, it May be Wrong!

What recourse do taxpayers have if they wrongly rely upon the IRS’ bankruptcy advice?  None according to In re Brown, 533 B.R. 344 (Bankr. M.D. FL 2015).  There, taxpayers followed the IRS’ inaccurate bankruptcy advice that resulted in unwanted tax collections, including levies against the taxpayers’ bank accounts and tax refund offsets after the taxpayers’ bankruptcy case concluded.  The Brown court rejected the taxpayers’ theories of laches and estoppel to stop the IRS  because these equitable doctrines could not thwart the clear mandate of the U.S. Bankruptcy Code.  11 U.S.C. §101 et seq. The opinion did not state whether the taxpayers were represented by counsel at the time the IRS gave the advice or, if represented, why the taxpayers did not rely on contrary advice given by the taxpayers’ attorney.

Originally, the Brown taxpayers sought bankruptcy protection for relief from the IRS’ collection efforts initiated prior to the bankruptcy filing.  The taxpayers’ confirmed repayment plan, as amended, provided for the repayment of 100% of the IRS’ non-dischargeable priority tax claims and only a small percentage of the IRS’ non-priority unsecured claims relating to tax penalties (hereinafter, “Penalty Claims”).

Later, the taxpayers experienced problems making the plan payments.  The IRS recommended a strategy urging the taxpayer to file for a “hardship discharge” pursuant to 11 U.S.C. §1328(b) and then resolve the remaining priority debt issue outside of bankruptcy through an offer in compromise.  According to the IRS, this strategy would have allegedly discharged the Penalty Claim.  The taxpayers took the IRS’ advice and concluded the bankruptcy early by obtaining a hardship discharge.

The post-bankruptcy events did not go as planned.  The taxpayers’ offer in compromise was rejected by the IRS and the IRS sought to collect both the priority claim PLUS the Penalty Claim.  After the bank levied the taxpayers’ bank accounts and offset their tax refund, the taxpayers filed action in the bankruptcy court alleging the IRS violated the bankruptcy discharge injunction.

The Brown court had to determine if a hardship discharge under 11 U.S.C. §1328(b) eliminated the IRS’ Penalty Claim since the IRS encouraged the taxpayers to pursue a hardship discharge, and at no time indicated the IRS intended to collect on its Penalty Claim after the hardship discharge.

First, the Brown court understood that the hardship discharge of 11 U.S.C. §1328(b) is more limited in scope than the general discharge of 11 U.S.C. §1328(a).  Of particular importance was the discharge exception relating to tax penalties pursuant to 11 U.S.C. §523(a)(7). Unlike the general discharge of §1328(a) which eliminates tax penalties, the hardship discharge of §1328(b) does not discharge tax penalties relating to government claims for income taxes due within the three years prior to the bankruptcy filing.

Second, the Brown court found that the IRS’ inaccurate advice rendered prior to the entry of the hardship discharge did not affect the dischargeability of the IRS’ Penalty Claim.  The Penalty Claims remained non-discharged.  Therefore, the IRS was not violating the discharge injunction when it levied on the taxpayers’ bank accounts because the IRS’ debts were not discharged when the taxpayers received the §1328(b) hardship discharge.

Practice Pointer: Do not take the IRS’ advice on bankruptcy issues of law. Contact a qualified bankruptcy attorney with extensive experience in income tax dischargeability.  Taxpayers should follow the advice of experienced counsel and not the advice/strategy of the IRS.  Honest taxpayers who follow the IRS’ inaccurate advice could find themselves in deep trouble.  The old adage is true:  You get what you pay for; so don’t take free advice!

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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