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IRS Guidance

        

 

Couple Must Exhaust Administrative Remedies First When Pursuing IRS for Violating Discharge Order (Parker Tax Publishing: November 03, 2013)

A bankruptcy court did not err in ordering a couple to first exhaust their administrative remedies under Code Sec. 7433(d) instead of using the bankruptcy court as a remedy for suing the IRS for violating an order discharging their taxes in bankruptcy. In re McDonald, 2013 PTC 298 (D. Nev. 9/27/13).

On April 4, 2007, Richard and Paula McDonald filed a voluntary petition for relief under chapter 13 of the Bankruptcy Code. The IRS timely filed a proof of claim for its taxes, which had a priority tax amount of $11,200 for tax years 2003-05 and a secured portion in the amount of $1,105 with 7 percent interest. The McDonalds' plan was confirmed several months later and provided the IRS the priority amount of $12,700 for those tax years. Their plan paid the IRS its exact amount, through the bankruptcy trustee. The McDonalds received their discharge on September 23, 2011. Following their discharge, the IRS contacted the McDonalds at least three times to attempt to collect the tax debt from tax year 2005. The IRS subsequently withheld the McDonalds' 2011 tax refund of $998 and applied it towards the 2005 tax year. On June 27, 2012, the McDonalds served a motion on the IRS to reopen the chapter 13 case, hold the IRS in contempt, and for sanctions for violation of the discharge injunction.

On August 31, 2012, the a bankruptcy court (1) ordered the McDonalds' chapter 13 case reopened; (2) ordered the IRS to have no further contact with the McDonalds, including no collection letters, no legal process and no administrative action, with regard to their 2005 federal income tax; (3) ordered the IRS is to refund back to the McDonalds the $998 tax refund that was levied by the IRS within 45 days of the bankruptcy court hearing; (4) ordered the McDonalds to exhaust their administrative remedies before the court determined any further damages or attorneys' fees in the case; and (5) held that, for the purposes of the beginning of the six-month time period for administrative action under Code Sec. 7433, the date of service of the McDonalds' motion, i.e. June 27, 2012, started this time period.

Code Sec. 7433 provides for civil damages for certain unauthorized collection actions of the IRS. Under Code Sec. 7433(b), upon a finding of liability on the part of the IRS, the amount awarded is equal to the lesser of $1 million ($100,000, in the case of negligence) or the sum of (1) actual, direct economic damages sustained as a proximate result of the reckless or intentional or negligent actions of the officer or employee, and (2) the costs of the action.

Code Sec. 7433(d) provides limitations on the damages in any action brought under Code Sec. 7433(a) or Code Sec. 7433(e) that can be claimed for unauthorized collection. First, a judgment for damages is not awarded unless the court determines that the taxpayer has exhausted the administrative remedies available to the taxpayer within the IRS. Second, the amount of damages awarded must be reduced by the amount of such damages that could have reasonably been mitigated by the taxpayer.

Code Sec. 7433(e) provides, in part, that if the IRS willfully violates any provision of Bankruptcy Code Section 524 (relating to a discharge of taxes), the taxpayer may petition the bankruptcy court to recover damages against the United States and that this is the exclusive remedy for recovering such damages.

Reg. Sec. 301.7433-2 sets forth the administrative processes for seeking redress for violations of Bankruptcy Code Section 524 (relating to the discharge of a tax debt) and generally provides that no action relating to such violation can be maintained in any bankruptcy court before the earlier of (1) the date a decision is rendered on a claim filed in accordance with Reg. Sec. 1.7433-2(e); or (2) the date that is six months after the date an administrative claim is filed.

The McDonalds appealed to a district court, arguing that the bankruptcy court erred in ordering them to first exhaust their administrative remedies under Code Sec. 7433(d) instead of using the plain language of Code Sec. 7433(e), which states the bankruptcy court is the exclusive remedy for debtors when the IRS violates a bankruptcy discharge.

The IRS argued that the bankruptcy court erred in finding that, for purposes of an administrative action under Code Sec. 7433, the date of service of the McDonalds' motion, i.e., June 27, 2012, began the six-month period because the McDonald's motion did not contain the necessary information for the IRS to adequately consider their claim. The McDonalds claimed that their motion satisfied all the requirements of Reg. Sec. 301.7433-2(e)(1).

The district court upheld the bankruptcy court's holding that the McDonalds must first exhaust their administrative remedies. The court said that while the plain language of Code Sec. 7433 makes a petition under Code Sec. 7433(e) a debtor's exclusive remedy for recovering damages, Code Sec. 7433(b) places limitations on the damages that may be awarded by the bankruptcy court and explicitly states that it applies to petitions filed under Code Sec. 7433 (e).

OBSERVATION: A number of courts, including the Second and Seventh Circuits, have so applied the statute, determining that, before a judgment for damages can be awarded to a debtor under Code Sec. 7433(b) for violation of the discharge injunction or automatic stay, Code Sec. 7433(d) requires the debtor first to exhaust the administrative remedies available to the debtor within the IRS. However, at least one bankruptcy court, in In re Jha, 2011 PTC 129 (Bankr. N.D. Cal. 2011), has held that the debtors need not exhaust administrative remedies before seeking relief in bankruptcy court. In concluding that the administrative remedy requirement was not applicable to a petition brought under Code Sec. 7433(e)(1), the Jha court noted that Code Sec. 7433(e)(2) states that such a petition is the exclusive remedy for recovering damages for violations of the discharge injunction or the automatic stay. The court further reasoned that, because there is no express requirement in Code Sec. 7433(e)(1) that administrative remedies must first be exhausted, a petition filed in bankruptcy court under Code Sec. 7433(e)(1) is not subject to such a requirement. Thus, the court essentially concluded that the words exclusive remedy in Code Sec. 7433(e)(2) should be read to exclude any such exhaustion requirement with respect to a petition under Code Sec. 7433(e)(1).

For a discussion of taxpayer claims for damages from unauthorized IRS collections, see Parker Tax ¶260,550. Parker Tax Publishing Staff Writers

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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