Bankruptcy and the Anti-Injunction Act

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The recent case of Horstemeyer v. United States decided by the Bankruptcy Court for the District of South Carolina addresses the tension between the anti-injunction act (AIA) of the Internal Revenue Code and the injunctive remedies available to bankruptcy judges administering a case. The bankruptcy court determined that its powers did not override the AIA and it declined to enjoin the IRS from levying on the debtor’s retirement account.  Although the court does not specifically discuss monetary remedies available to the debtor, the IRS must use it levy powers with care where a bankruptcy exists because financial remedies for violating the automatic stay or the discharge injunction could be awarded in the right circumstances.

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The case involves a debt the IRS pins on Mr. Horstemeyer as the alter ego of a business. He filed a chapter 7 bankruptcy petition in August of 2014 and disputed the $3.3 million debt the IRS claimed that he owed.  He received a discharge four months later, the usual amount of time for obtaining a discharge in a chapter 7 case, and that is when this case really began.  In January 2015 he filed an adversary proceeding against the IRS seeking a determination that any liability he owed as an alter ego was discharged in the bankruptcy case.  The IRS responded that the liability was excepted from discharge for various reasons.  This proceeding remains unresolved.

While the discharge proceeding was pending, the IRS levied on Mr. Horstemeyer’s retirement account in an effort to collect the taxes. Levying on the retirement account while the discharge complaint was pending signals a strong belief by the IRS that it will prevail in the discharge proceeding since it exposes itself to monetary damages by collecting on a potentially dischargeable liability.  Due to the levy on the retirement account, debtor filed an adversary proceeding in October 2015 seeking a preliminary injunction until resolution of the discharge proceeding.  The bankruptcy court granted a temporary restraining order preventing payment to the IRS of the funds in the retirement account.  The IRS responded that the bankruptcy court lacked authority to bar it from collecting based on the AIA.

Section 7421(a) provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person.”   The Supreme Court in Enochs v. Williams Packing & Navigation Co., stated “the manifest purpose of 7421 is to permit the United States to assess and collect taxes alleged to be due without judicial intervention, and to require that the legal right to the disputed sums be determined in a suit for refund.”  The debtor argued that the discharge injunction of section 524 of the Bankruptcy Code permits bankruptcy courts to enjoin collection despite the broad language of the AIA.

Bankruptcy courts, however, are split on the issue of their power versus the power of the AIA. The minority of bankruptcy courts concluded that the narrower language of the discharge injunction in the bankruptcy code supersedes the more general prohibition of injunctions against the IRS set out in the AIA.  The handful of courts that have ruled this way cite back to the case of Bostwick v. United States decided under the Bankruptcy Act.

The majority of bankruptcy courts addressing the issue acknowledge the power of bankruptcy courts to issue injunctions but find that this authority is insufficient to override the AIA in light of: “(1) its unequivocal language; (2) its oft-amended statutory exceptions that do not include an exception for bankruptcy courts; and (3) the failure of any bankruptcy code provisions explicitly providing for bankruptcy courts to enjoin IRS collection efforts.” Because the bankruptcy court in this case determined that the AIA applied, it must apply the judicially created exceptions to the AIA or irreparable injury and certainty of success on the merits.  Applying those tests to the facts here the bankruptcy court found that the injuries here were monetary and not irreparable.  It also found that the debtor had not come close to showing that the IRS could not prevail on the merits.

The outcome in this case is not remarkable but it shows that in most jurisdictions a debtor will not stop post-discharge collection efforts by the IRS by seeking to use the power of the bankruptcy court. Pre-discharge the automatic stay will stop the IRS from issuing or pursuing collection on a levy.  Post-discharge when the automatic stay has lifted the IRS is free to take collection action without interference from the bankruptcy court; however, if the underlying taxes were discharged in the bankruptcy case, the IRS does so at its financial peril because of the right of the debtor to seek damages.  For this reason, the IRS will only take collection action like a levy where it has a high level of confidence in the discharge case.

Two wrinkles existed here on which the court did not spend much time because of its focus on the AIA issue. One issue is alter ego.  The debtor may not be contesting his liability under the alter ego theory.  That surprises me a little but the court did not lay out the facts supporting that theory.  The second wrinkle involves the pursuit of funds in the retirement plan.  This has two aspects.  First, the IRS does not pursue funds in retirement plans without higher level approval.  Given the amount of uncollected tax and the pursuit of funds in a retirement plan, this account must have received a fair amount of scrutiny at the IRS before it issued the levy.  Second, the retirement account probably did not become an asset of the estate.  I say probably because I do not know enough about the retirement account.  Footnote 4 of opinion states that the IRS argues that it can enforce its lien against the retirement account because it never became property of the estate.  The federal tax lien continues to attach to property exempted, abandoned or excluded from the bankruptcy estate.  The retirement account would almost certainly have been excluded from the bankruptcy estate under section 541(c)(2).  Because of this argument, the IRS may have been more willing to pursue this asset while the dischargeability proceeding was pending since its ability to collect based on its lien does not depend on whether the underlying liability was discharged.

Comments

  1. Unfortunately, the action the IRS took in Mr. Horstemeyer’s case is an all too familiar one. I must therefore disagree with Keith’s conclusion that the IRS “will only take collection action like a levy where it has a high level of confidence in the discharge case.” In my experience, the opposite is true. As a rule, here is how the IRS handles individual bankruptcy cases:

    1. The IRS receives notice of the taxpayer’s bankruptcy petition. It ceases all collection action because of the automatic stay law. It takes no action with respect to the petition.

    2. In due course, the taxpayer receives a discharge order. The discharge order applies to all “applicable” debts; it neither expressly discharges the tax debts nor exempts them from discharge.

    3. With the discharge order issued, the automatic stay dissolves. Now only the discharge order can shield the taxpayer from adverse IRS action.

    4. The IRS sends the taxpayer a 30-day notice of intent to levy. This notice is almost always a “courtesy” administrative notice because the taxpayer has previously exhausted, or defaulted on, his CDP rights. As in the bad old pre-CDP days, the notice allows the IRS to levy on the taxpayer’s assets after the 30-day intent to levy notice period expires.

    5. The taxpayer protests the 30-day intent to levy notice. He tells the IRS that his taxes were discharged in bankruptcy and encloses his bankruptcy discharge order.

    6. The IRS ignores the taxpayer. It then sends the identified levy source a Notice of Levy.

    7. The IRS well knows the tax issue is now the taxpayer’s problem. To void the Notice of Levy, the taxpayer must move to reopen his bankruptcy case and file an adversary proceeding against the IRS–with him bearing the burden of proof.

    8. The IRS also well knows that such a proceeding does not act to stay its levy action. Usually, as Mr. Horstemeyer will soon discover, the IRS will collect on its Notice of Levy while the taxpayer attempts to slog through the bankruptcy court proceedings he thought he had already navigated successfully.

    Despite Keith’s supposition, the IRS does not use its levy power “with care” in (individual) bankruptcy cases. It doesn’t do so for several reasons:

    (1) if the IRS was careful, then the IRS itself would move the bankruptcy court to declare the taxes it seeks as nondischargeable debts. But that would cause it to expend its own time and resources–and bear the burden of proof. So the IRS simply views the discharge order as it wishes to view it.

    (2) The taxpayer is now a bankrupt. He has done the IRS a favor by knocking out all its other competitors, i.e., creditors, for his assets. The taxpayer also doesn’t have many assets with which to fight back against the IRS. Many bankruptcy petitioners (although not Mr. Horstemeyer) act pro se. Most others can ill-afford to rack up more attorney’s fees fighting a Notice of Levy.

    (3) Levying the taxpayer’s assets after a discharge order forces the taxpayer to return to bankruptcy court–and to bear the burden of proving that the taxes were discharged (or are dischargeable).

    (4) Even if the taxpayer ultimately prevails (which Mr. Horstemeyer could still do), he has been irreparably damaged by the IRS’s levy. He could get the levied funds back, but they will be barely enough to pay his attorney’s final bill.

    (5) The IRS (or, precisely, the United States) will not have to pay the taxpayer damages even if he can prove it violated the bankruptcy court’s discharge order. That’s because a discharge order violation must have been “willful.” I.R.C. § 7433(e)(1). Good luck to, in this case, Mr. Horstemeyer on proving willfulness. After all, those alter ego tax liability and bankruptcy discharge provisions can be pretty confusing to the average IRS Revenue Officer…or so would be the IRS’s argument.

    I feel for Mr. Horstemeyer and the others who have suffered from the IRS’s self-serving view of bankruptcy discharge orders. May all would-be tax bankrupts obtain a ruling on their tax dischargeability BEFORE their bankruptcy cases close.

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