Category Archives: Penalty

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.

Follow Robert Schaller on social media Join Robert V. Schaller on Facebook Join Robert V. Schaller on Linkedin

Does a Bankruptcy Filing Stop the IRS from Levying Assets? 

Yes, filing bankruptcy immediately stops the IRS from levying assets or even threatening to levy assets while the bankruptcy case is pending.  Section 362 of the Bankruptcy Code provides that a bankruptcy filing immediately protects a taxpayer by an automatic injunction called the “automatic stay” from any act by a taxing authority to collect, assess, or recover a claim against the taxpayer that arose before the bankruptcy case was filed. 11 U.S.C. §362(a)(6). The conduct prohibited ranges from that of an informal nature, such as by telephone contact or by dunning letters, to more formal judicial and administrative proceedings.

In the IRS context, the automatic stay prohibits the IRS from sending a Notice of Intent to Levy and a Notice of Levy. However, the Bankruptcy Code does not prohibit all communications by the IRS.  Despite the fundamental importance of the automatic stay, Congress provided taxing authorities an exception to the automatic stay provision for “(A) an audit by a governmental unit to determine tax liability; (B) the issuance to the debtor by a governmental unit of a notice of tax deficiency; (C) a demand for tax returns; or (D) the making of an assessment for any tax and issuance of a notice and demand for payment of such an assessment. See 11 U.S.C. §362(b)(9).

The §362(b)(9) exception has its own limitations and is narrowly construed.  The IRS may be permitted to make an assessment and a demand for payment. However, the IRS cannot couple that demand for payment with a Notice of Levy or other collection effort, or a Notice of Intent of Levy or other threat of a collection effort, including IRS pamphlets entitled “Understanding the [IRS] Collection Process (IRS Publication 954).

The limits of a §362(b)(9) exception was addressed recently in the non-IRS case In re Gonzalez, 532 B.R. 1 (D. PR 2015). The Gonzalez court had to determine if the Treasury Department of Puerto Rico violated the automatic stay by sending a debtor a “Final Notice” regarding the taxpayer’s prepetition income tax debt. That notice also included an assertion that the law empowers the taxing authority to use collection steps like wage garnishments and asset levies. The Gonzalez court rejected the taxing authority’s argument that such communications are excepted from the automatic stay by §362(b)(9).  Instead, the Gonzalez court ruled that the threat of collection efforts is outside the creditor protection of §362(b)(9) and is an automatic stay violation of 11 U.S.C. §362(a)(6).  The tax authority’s actions were enjoined and the violation subjected the taxing authority to sanctions, costs, and attorney’s fees.

PRACTICE POINTERS: A tax professional should recommend a taxpayer seek the advice of a bankruptcy attorney whenever the IRS or other taxing authorities are threatening collections action like levies and garnishments.  The automatic stay protections afforded by the Bankruptcy Code give taxpayers breathing room to orderly address the tax collection issues jointly with the tax professional and bankruptcy attorney.  The automatic stay stops the IRS from collecting, including levies and garnishments.

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

Follow Robert Schaller on social media Join Robert V. Schaller on Facebook

Is the IRS “failure to file” penalty discharged in bankruptcy?

A taxpayer can discharge an IRS “failure to file” penalty assessed per 26 U.S.C. §6651(a)(1) for failure to file a tax return.  A taxpayer has two choices.

Option 1: A taxpayer with income can choose to file a Chapter 13 bankruptcy case and establish a repayment plan addressing all creditors, including the IRS.  The IRS “failure to file” penalty would be treated as an unsecured claim and paid on the same level as credit card debt, medical debt, and personal loans.  The IRS and other unsecured creditors could receive as little as 10 cents for every dollar owed and less in some jurisdictions.  At the completion of the repayment plan, any unpaid unsecured debt would be discharged and the IRS penalty obligation eliminated per 11 U.S.C. §1328(a).

Option 2:  A taxpayer without income or with insufficient income to fund a Chapter 13 bankruptcy case, instead, could file a Chapter 7 bankruptcy case.  No repayment is required in a Chapter 7 case and the IRS could be entitled to distribution from property of the bankruptcy estate on a prorate basis with all other unsecured creditors.  However, there is typically no property to distribute in a normal Chapter 7 case.

At the conclusion of a Chapter 7 case the taxpayer would receive a general discharge of debts pursuant to 11 U.S.C. §727(a).  This general discharge does not necessarily cover the IRS’ “failure to file” penalty because 11 U.S.C. §523(a)(7) creates an exception for penalties payable to a governmental unit. So a deeper analysis is required.

The exception to the bankruptcy discharge applies “to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit.   11 U.S.C. §523(a)(7).  The IRS is clearly a governmental unit.  But this exception to discharge is limited when it relates to a “tax penalty.”

Section 523(a)(7)(B) provides that the exception to discharge does not apply and the IRS tax penalty is discharged if it was “imposed with respect to a transaction or event” that occurred more than three years before the bankruptcy petition.  Therefore, a taxpayer may not be discharged of an income tax penalty imposed less than three years before the bankruptcy petition is filed.  But, a taxpayer would be discharged of an income tax penalty imposed more than three years before the bankruptcy petition is filed.

So the question becomes: “when is an income tax penalty “imposed with respect to” a failure to file penalty imposed by the IRS pursuant to 26 U.S.C. §6651(a)(1)?”  That issue was addressed in  In re Wilson, 527 B.R. 635 (Bankr. N.D.CA 2015).  In Wilson, a taxpayer was granted a filing extension for his 2008 tax return from April of 2009 to October of 2009.  That taxpayer did not file the return until 2011.  The taxpayer filed for bankruptcy in July of 2012, which was more than three years after the April 2009 filing deadline and less than three years after the October 2009 filing deadline.

The taxpayer argued that the penalties should be discharged because they were imposed with respect to his 2008 tax liability, due April of 2009, and therefore were more than three years old when he filed his bankruptcy.  The IRS argued that the penalties should not be discharged because they were imposed in October of 2009, when the taxpayer missed his extended filing deadline, and were therefore less than three years old when the bankruptcy petition was filed.

The Wilson court agreed with the taxpayer and found that §523(a)(7)(B) is to be applied according to its plain meaning, so that a penalty imposed on unpaid taxes accruing more than three years before the filing of the bankruptcy petition is dischargeable.  Interestingly, the court stated that “penalties imposed on account of failure to file a return are computed by reference to the tax obligation itself,” and not by reference to the filing date. Id. at 638.

Practice Pointer:  A tax professional should have counseled the taxpayer to postpone the bankruptcy case filing date from July of 2012 to a few months later and after October 16, 2012 to ensure the case was filed more than three years after the due date.  The tax professional would have saved the cost of litigation had the taxpayer strategically timed the bankruptcy filing date.

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