Tim’s Tax News on the Tenth – June 2022

It is improper for the IRS to continue to send demand letters seeking to collect liabilities that have been discharged in a bankruptcy. Failure to respect a discharge order can result in the IRS having to pay damages claims, including court costs, legal fees, and damages relating to the unlawful collection attempts. That is what happened in McAuliffe v. United States.

The McAuliffes were husband and wife co-debtors in a Chapter 13 bankruptcy they filed in 2016, where the IRS asserted a claim for $13,624.58 relating to tax years 2010 and 2011 (of which $7,230.78 was secured). Before filing for bankruptcy, the McAuliffes had entered into an installment agreement with the IRS. However, and as per the Chapter 13 bankruptcy, the installment agreement was terminated and the McAuliffes instead paid their debts through a bankruptcy repayment plan and received a discharge on September 24, 2019, with the IRS receiving a 22% distribution on the $6,393.80 unsecured portion of their claim.

However, despite their discharge, the IRS continued to send the McAuliffes demand letters seeking to collect the liabilities from the discharged 2010 and 2011 tax years. After receiving two demand letters, the McAuliffes sent a letter to the IRS advising them of the discharge. The IRS did not respond to that letter. Instead, some months later, it sent the McAuliffes a third collection letter.

Eventually, about 6 months later, the IRS finally acknowledged receipt of the McAuliffes’s letter advising them of the discharge, but then stated it would need another sixty days to review the liability. However, and despite that letter, the IRS actually abated the assessment. Complicating matters, in addition to the 2010 and 2011 liabilities that were covered by the discharge, the McAuliffes also owed on their 2018 tax year. And since the IRS, albeit mistakenly, believed the McAuliffes still owed for the discharged years, there was a delay in setting up an installment agreement for the 2018 liability. That in turn resulted in the IRS sending a soft notice of intent to levy, and threatening to seize state tax refunds.

The continued IRS demand letters and notice of intent to levy caused the McAuliffes to reopen the bankruptcy case and to eventually seek damages under Section 7433(e). To find a violation under this section, a debtor must show by clear and convincing evidence that the IRS “had knowledge [actual or constructive] of the discharge and willfully violated it by continuing with the activity complained of.”

The IRS attempted to avoid damages by coming up with numerous defenses and justifications, including deflecting blame to the McAuliffes. First, the IRS argued that the court needed to find that a specific IRS employee had willfully violated the discharge order (rather than the IRS as a whole) in order for the IRS to be liable. In arguing that there was no willful violation against the McAuliffes, the IRS cited to cases where courts concluded that clerical errors alone were insufficient to justify finding damages. Second, the IRS argued that the McAuliffes should have contacted the IRS bankruptcy specialist (instead of the IRS office that had issued the collection letters) about their discharge. Third, the IRS argued that the McAuliffes should not have viewed the automatic collection notices as collection actions, especially since the automatic nature of the notices removes them from any one IRS employee, and thus should insulate the agency from sanctions designed to punish the agency for employee misconduct. Finally, the IRS argued COVID-19 had a significant impact on all levels of the federal government, including the IRS.

In the end, the court rejected all of the excuses the IRS came up with to explain its actions. In a nutshell, the court opined that the IRS’s attempts to characterize its actions as “inadvertent” were unpersuasive because the IRS had failed for nearly twelve months to enter the discharge in its systems, despite the McAuliffes calling and mailing multiple notices to correct the issue. Similarly, the court viewed the IRS’s attempt to deflect blame to the McAuliffes for failing to contact an IRS bankruptcy specialist (rather that the IRS office that had issued the collection letters) as defying common sense. The court also opined that since the IRS demand letters stated that a monthly payment was due immediately and further threatened default if no payment was made, and did not include a disclaimer that they were not an attempt to collect, the letters served no purpose other than to collect discharged personal liabilities. Because the IRS is a federal agency within the executive branch and serves an extremely important mission, if employees and automated systems are disconnected from the interactions of other offices, the resulting shortcomings should not be attributed to the McAuliffes, but to the IRS. Finally, as to the COVID excuse, while the court was sympathetic, it nevertheless noted that there had been ample time following the discharge and before the pandemic hit for the IRS to have gotten the taxpayers’ account fixed. In the end, it was the combination of repeated notices that lasted almost a year after discharge, despite the McAuliffes’s attempt to halt the collection action, that led the court to conclude that the IRS acted willfully.

If you would like more details, please do not hesitate to call our office. Our office has been successful in helping taxpayers with IRS and IDOR collection problems for over 29 years. If you have a tax or debt problem, please contact me at 847-705-9698 or thughes@lavellelaw.com and find out how we can help you.

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