Late Filed Return Issue Overlooked in Recent Collection Due Process Case

On July 28, 2017, in the Collection Due Process (CDP) case of Conway v. Commissioner, Docket Number 6204-13S L, the Court issued an order determining that petitioner did not discharge her tax liabilities for several years.  The Tax Court has the authority Washington v. Commissioner, 120 T.C. 114, 120-121 (2003) to determine discharge issues in CDP cases.  The case is interesting for what the IRS did not argue, what it conceded, the standard of review of a CDP case in the 1st Circuit and how timing plays into the outcome.

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Ms. Conway failed to timely file returns for the years 2002 and 2006-2010.  This familiar story lands her in bankruptcy court for the District of Massachusetts on February 10, 2012 where she received a discharge of her chapter 7 case on May 8, 2012.  Regular readers of this blog know that someone living in the First Circuit who does not timely file their income tax return can never discharge the liability on that return because of the decision in Fahey v. Massachusetts Department of Revenue, _ F.3d _ (1st Cir. February 18, 2015).  See blog posts here, here and here discussing the issue.

The funny thing about the Conway decision is that even though Ms. Conway failed to timely file her returns for all of the years at issue and even though controlling circuit law, under the Golsen rule, made the outcome of her case a slam dunk victory for the IRS, the Fahey case never gets mentioned.  This could be because the people involved were not carefully reading PT, or for other reasons, or a combination of both.

After Ms. Conway received her discharge, the IRS did not abate her liabilities for the years mentioned above.  At that time, almost three years before the Fahey decision, a decision with which the IRS does not yet agree, the IRS decision to keep open her liabilities for these years was not based on her late filing but on the timing of the assessments for the years 2006-2010 and on a mistake as to 2002.  In August, 2012 the IRS filed a notice of federal tax lien against her for her outstanding liabilities and sent her the required CDP notice.  She timely filed a CDP request and sought relief, inter alia, because the tax debts were discharged in her recently completed bankruptcy case.  In February, 2013 the Settlement Officer (SO) issued a notice of determination sustaining the NFTL.

Ms. Conway filed a CDP Tax Court petition on March 15, 2013 raising, inter alia, the bankruptcy discharge as a reason for removing the NFTL.  The IRS filed a motion for summary judgment on November 29, 2013.  In that motion, the IRS conceded that the SO made a mistake as to 2002 and should have written off that liability; however, the IRS argued that as to the remaining years the exception to discharge in Bankruptcy Code 523(a)(1) prevented the discharge.  (The IRS attorney pledged to fix the 2002 year and make sure it was abated.) The IRS argued that the “SO did not abuse her discretion under the standard of review adopted by the United States Court of Appeals for the First Circuit in Dalton v. Commissioner, 682 F.3d 149 (1st Cir. 2012), rev’g 135 T.C. 393 (2010).”  On January 6, 2014, petitioner filed an objection to the motion for summary judgment.  At that point, the case stood ready for decision and at that point Fahey was just a glimmer in the eye of the Massachusetts Department of Revenue.

The Court decides in Conway that the 2006-2010 taxes are excepted from discharge because they were assessed within 240 days of the date of filing the bankruptcy petition.  If taxes were at all a factor in the decision to file bankruptcy, and I have no idea, I fault taxpayer’s bankruptcy lawyer for filing during this 240-day window because it prevents them from discharge under 523(a)(1)(A) since these taxes still had priority status; however, even in the pre-Fahey world, she would have had to wait two years after filing her late returns in order to avoid the exception from discharge under 523(a)(1)(B).  The Tax Court had ample reason to find her taxes excepted from discharge here and was correct in doing so.  At the time the IRS filed its summary judgment motion, it was correct to concede 2002 and it was correct not to argue Fahey.

Because the Tax Court took over three and ½ years to decide what appears to be a relatively simple discharge case, the IRS had the opportunity to supplement its summary judgment motion with the intervening Circuit authority.  Based on the docket sheet of the case and the Court’s opinion, it appears that it did not do so; however, the IRS did file a request to file a status report earlier this year and I cannot see what was in that request.  I thought that the IRS, even though not agreeing with the one-day late discharge rule of Fahey and two other circuits, was making the argument in the three circuits with controlling authority on the one day late rule.  So, I do not know if the failure to point Fahey out to the court here was a decision representing a change in position that it would argue the one-day late rule in those circuits, or a failure to recognize the opportunity to make this argument, or simply a decision that it was going to win anyway and why add yet another reason when the opinion should come out at any second.  I bring it up for those watching the one day rule and the IRS reaction to it.  Because of the decision in the Fahey case, the IRS decision to concede 2002 could have been reversed.  I do not know how the Tax Court would have reacted to an effort by the IRS to withdraw its concession because the law of the circuit changed while the Tax Court was working on its opinion.  Because the IRS did not attempt to withdraw its concession, we will never know.

The case also raises the application of the First Circuit’s decision in Dalton.  In Dalton, the First Circuit reversed the Tax Court and held that the findings of law in CDP determination are only tentative and so the Tax Court does not need to give deference to the SO’s legal conclusions.  The IRS argued in its motion that despite the SO’s legal mistake as to the dischargeability of 2002, the Court should sustain the notice of determination because the SO did not abuse her discretion under the standard of review adopted in DaltonDalton seems to stand alone in its view of the deference accorded to SOs.  This issue deserves attention and may get litigated further in other circuits.

Ms. Conway was going to lose her case even before the Fahey decision because of the timing of her late filed returns and her bankruptcy petition.  She benefits here by filing her case before the Fahey decision came out because of the IRS concession with respect to 2002.  She loses most of her case because of late filing.  Somehow taxpayers need to understand the benefits of filing on time even if they cannot pay.  In circuits like the First, it is now critical because it is a lifetime bar on discharge.  Even in other circuits, late filing will create the types of problems Ms. Conway faced here and will not allow debtors to obtain the full measure of the benefits of bankruptcy.

 

Litigating Your Innocent Spouse Claim in Bankruptcy

If you were interested in yesterday’s post concerning the mismanagement over a period of years of the account of Mr. Fagan, please read the comment posted yesterday by Bob Kamman.  Bob took the time to call Mr. Fagan and get the kind of background details not possible to find by just reading the opinion.  Based on the information from Mr. Fagan, his efforts to fix the problem in TAS, Appeals and Chief Counsel where he was working face to face with a real human were totally unsuccessful.  This is the type of case I expected Senator Roth to find in his hearings before the 1998 legislation.  These cases exist because sometimes accounts get badly mangled.  I did not expect to see Chief Counsel litigating such a case.  From the comments it appears that accounts management was not the only place badly managed on this case.

In March, the bankruptcy court for the Southern District of Texas ruled in In re Pendergraft that it had jurisdiction under Bankruptcy Code 505(a) to determine whether Jane Pendergraft qualified for relief from her joint and several liability under IRC 6015(f).  The IRS strenuously objected to the bankruptcy court’s decision that it had the power to decide she qualified for innocent spouse relief.  It views the Tax Court as the exclusive avenue for obtaining such relief.  The case, which maybe the first case to decide this issue – at least the first one to decide the case favorably to the taxpayer, deserves attention because it may open up opportunities for relief in a forum previously unused for this purpose and because the of policy tensions that support the bankruptcy court’s decision even if the language of the statute may not.

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Section 505(a) of the bankruptcy code offers taxpayers in bankruptcy the opportunity to contest their tax liabilities in that forum instead of the more traditional forums of Tax Court, district court, or Court of Claims.  The reason that Congress granted this power to the bankruptcy court is that sometimes the tax liability needs to be final in order to the bankruptcy case to move forward.  The time frame for deciding a tax case in the other forums does not necessarily match the time frame for the bankruptcy case.  By giving the bankruptcy court the ability to decide the tax matter, Congress allowed it to control the timing.

The reasoning behind the grant of jurisdiction to the bankruptcy court to hear the tax matter extends to the determination of innocent spouse status; however, the decision of whether someone is an innocent spouse does not turn on whether the tax is due, i.e., the merits of the liability, but rather whether this person claiming innocent spouse status should be relieved of the liability even though it is due.  The IRS argues that this distinction precludes the bankruptcy court from deciding the innocent spouse issue because its authority under section 505(a) covers determining the merits of the liability and does not extend to the issue of innocent spouse status even though such a determination would clearly have an important outcome on a taxpayer’s bankruptcy case and whether the debtor could confirm a plan.

The facts of the case are not unusual for an innocent spouse argument.  Mrs. Pendergraft, who was 66 at the time of the decision, married Mr. Pendergraft in 1988.  During the period of their marriage, they split household responsibilities with Mr. P taking on “exclusive responsibility for the financial activities of the homestead, including the preparation and paying of taxes.”  Mrs. P operated a private psychotherapy practice part time and took primary responsibility for child care and household maintenance.  For the years 2001-2006, the Pendergrafts failed to file tax returns or to pay the taxes.  Mrs. P alleged that she did not know of the failures and signed returns for each year expecting her husband to file them.

She learned of the problem when the IRS levied on her separate bank account in 2008.  Although Mr. P initially denied knowledge of the problem he eventually confessed to her he had forgotten to pay the taxes for one year.  He later informed her that he had retained attorneys and accountants to fix the IRS problem, that the agreement required they pay the IRS $10,000 a month for an extended period, and that he would make sure all future returns were timely filed.  She alleged that he may have misappropriated money she gave to him between 2008 and 2016 to deal with the IRS and that he caused the IRS to mail all correspondence to his office address preventing her from learning of ongoing problems.

In late June 2016, she attended a meeting with their attorney in which she alleges that she learned for the first time that their income and property taxes had not been paid for 15 years and that they faced criminal prosecution.  According to her, this attorney advised her that she must join her husband in filing for bankruptcy in order to prevent the IRS from seizing their house and from prosecuting them.  I note that if the attorney gave such advice, it incorrectly described the effect of bankruptcy on possible criminal tax prosecution.  Bankruptcy code section 362(b)(1), one of the exceptions to the automatic stay, provides that bankruptcy has no impact on criminal prosecution.  By October of 2016, she had obtained permission of the bankruptcy court to proceed with divorce and in November she asked the bankruptcy court to determine that she qualified as an innocent spouse.  The IRS filed a motion to dismiss the request for an innocent spouse determination arguing ‘that a bankruptcy court’s jurisdiction is limited by the fact that it is a judicial offer of the district court, that the structure of 26 U.S.C. 6015(f) vests the determination of innocent spouse relief strictly in the IRS and tax courts, and that the United States has not consented to being sued on the innocent spouse issue in bankruptcy court.”

The bankruptcy court looked at section 6015(e)(1)(A) which allows a court to grant innocent spouse relief if the IRS fails to make a determination within 6 months.  The bankruptcy court pointed to the language of the statute providing that the remedy available in Tax Court for innocent spouse determinations is “[i]n addition to any other remedy provided by law.”  Bankruptcy section 505(a) is another “remedy provided by law.”  The bankruptcy court looked at applicable 5th Circuit law on the application of section 505(a) which it found supported the court’s ability to make an innocent spouse determination.  The court acknowledged the case law cited by the IRS finding bankruptcy court an inappropriate forum for innocent spouse determinations.

The bankruptcy court rejected the authorities provided by the IRS for three reasons: 1) the case law did not address 5th Circuit precedent interpreting 505(a); 2) the plain language of the statute; and 3) a decision by the bankruptcy on this matter would not lead to inconsistent judgments or conflict with basic principles of judicial economy.

Having decided that it can decide the innocent spouse issue, the bankruptcy court then determines that it must wait for the IRS to make a decision.  It required Mrs. P to submit to the IRS Form 8857 and indicated that it will make a decision if the IRS fails to do so in six months (not adopting the four-month rule for claims for refund as the shortened time period in 505 cases) or after the IRS makes an adverse decision.  It is possible, of course, that the IRS will decide in her favor in the administrative process.  If it does not, watch this case as I expect the IRS will not give up this issue at the bankruptcy court level.  We looked quickly at the bankruptcy case  and did not see any developments yet on this issue.

 

 

Another Circuit Weighs in on the Discharge of Unfiled Returns

We have discussed how courts, IRS and debtors are struggling with Bankruptcy § 523(a) and its infamous hanging paragraph. Addressing exceptions to discharge that language states the term ‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). A number of courts have held that unless a return is filed by the appropriate due date, the tax liability is not eligible for discharge; other courts have pushed back on the one-day rule.

In Giacchi v. United States, the Third Circuit continued a trend away from the one-day rule and held that the debtor’s taxes were non-dischargeable based on the application of the Beard test.  Following the pattern of other recent cases on this issue discussed here and here, the Third Circuit stated that it did not need to reach the one-day rule because it found that the Forms 1040 filed by Mr. Giacchi after the IRS had already assessed the taxes based on IRC 6020(b) determination of the liability and a failure by Mr. Giacchi to petition the Tax Court in response to a statutory notice of deficiency were not a genuine effort to file a tax return but were simply forms filed to qualify Mr. Giacchi for discharge.  Of course, the Court could have avoided having to make the determination based on the valid return issue if it had decided based on the one-day rule.  So, the decision, like the recent decisions in other circuits, serves as an implicit repudiation of the one-day rule even though the Third Circuit does not directly take on the statutory language and seek to resolve the issue directly.

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As discussed before, the resolution of the issue in the manner in which the Third Circuit resolves this case does little to fix the problem the IRS has of administering discharges to determine when it may write off tax liabilities.  The Court did not adopt the bright line rule sought by the IRS that would make any Form 1040 filed after the IRS makes an IRC 6020(b) assessment unqualified to meet the test of a return; however the Court comes about as close as you can come to setting out that conclusion without explicitly doing so.  The case presents a strong victory for the IRS and will prevent just about any taxpayer in the Third Circuit from getting a discharge once the IRS makes an IRC 6020(b) assessment.

The facts of this case follow the normal fact pattern for someone filing a late return and seeking discharge.  He failed to file returns for 2000, 2001, and 2002.  In 2004, the IRS prepared substitute returns for 2000 and 2001, sent him a statutory notice of deficiency, he defaulted on that notice and then filed the Forms 1040 for 2000 and 2001 about one month after the IRS assessed the taxes based on the defaulted notice.  The only thing unusual about these facts is how quickly he filed the returns after the assessment.  The assessment would have triggered a notice and demand letter but he should also have received several letters leading up to and including the notice of deficiency.  So, it is not clear why the notice and demand letter would have prompted action.  The IRS went through the same process for the unfiled 2002 return.  It ended up assessing that liability in 2005 and he filed the delinquent Form 1040 in 2006.  He filed a chapter 7 bankruptcy in 2010.  When the IRS did not remove the tax liabilities for these three years, he then brought an adversary proceeding against the IRS seeking to have the court determine that the taxes were discharged.  The bankruptcy court and the district court held the taxes were excepted from discharge.

Mr. Giacchi made three arguments which the court rejected in relatively short order.  First, he argued that the filing of the returns represented an honest attempt to comply with the tax law.  In rejecting this argument, the Third Circuit specifically declined to follow the Eighth Circuit decision in Colsen v. United States, 446 F.3d 836 (8th Cir. 2006).  This repudiation of Colsen definitely benefits the IRS as it tries to consolidate the Circuit court opinions and the reasoning, similar to the Fourth Circuit’s decision in In re Moroney, 352 F.3d 902, 905-6, leaves little room for any taxpayer who files a Form 1040 after an IRC 6020(b) assessment.

Second, Mr. Giacchi argued that because his late filed Forms 1040 showed less taxes than the amounts assessed by the IRS and the IRS abated the taxes down to the amounts on the late filed returns, the documents had meaning and should be treated as returns.  This situation almost always arises when taxpayers file the late Forms 1040.  The court noted that he should not benefit just because the IRS made an imprecise estimate of his liability (and because it abated his liabilities in response to the late filed Forms 1040.)

Lastly, Mr. Giacchi argued that he should be excused because of his emotional state during the years.  The Court did not describe his emotional state.  In effect, Mr. Giacchi seeks an IRC 6511(h)-like suspension of the time to file due to his incapacitating emotional condition.  The Court suggested that under the right circumstances someone might be able to demonstrate a good faith effort to comply with the tax laws but his emotional state did not fit the bill.

Unless Mr. Giacchi succeeds in convincing the Supreme Court to take his case, the circuit split between the three “one-day rule” circuits, the Eighth Circuit in Colsen and the five or so relatively pure Hindenlang circuits will persist.  Look at earlier posts here, here, and here for a greater discussion of this issue.

Almost immediately after the Giacchi decision, a bankruptcy court in the Northern District of California cited to the Giacchi decision favorably in the case of Van Arsdale v. Internal Revenue Service.  Mr. Van Arsdale, whose facts were essentially similar to the Giacchi facts, argued that he panicked because he did not have enough money to pay his taxes for the year at issue and then he stuck his head in the sand until after the IRS made the assessment.  In citing to Giacchi, the bankruptcy court found that this explanation, without more, simply did not help.  The Ninth Circuit decision in In re Smith, 828 F.3d 1094 (2016) sets up a test similar to the one adopted by the Third Circuit.  The decision in Van Arsdale was very predictable based on circuit precedent but shows continuing attempts to seek discharge even in circuits that have recently made pronouncements on this issue.

False Return Conviction Provides Basis for Collateral Estoppel to Prevent Discharge

For a brief period the Tax Court treated a conviction for filing a false return, IRC 7206(1) as the basis for sustaining the civil fraud penalty using collateral estoppel.  The period ran from the decision in Considine v. Commissioner, 68 T.C. 52 (1977) to its reversal in Wright v. Commissioner, 84 T.C. 636 (1985) (reviewed).  In the recent unpublished bankruptcy appellate panel (BAP) case of Terrell v. IRS, BAP No. WO-16-007 (Bankr. 10th Feb 17,2017), the 10th Circuit BAP sustained the decision of the bankruptcy court and held that a guilty plea for filing a false return provides the basis for collaterally estopping the debtor from challenging the discharge of his taxes for the year of the plea.  Though unpublished, the opinion, without much analysis, pushes the scope of collateral estoppel on the issue of criminal conviction and civil fraud toward a more favorable position for the IRS.  Reasons exist for drawing a distinction between collateral estoppel in the bankruptcy discharge context and civil fraud penalty.  Had the court articulated those reasons, I would have come away from the opinion with a more comfortable feeling.

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The Tax Court opinions, cited above, determining first that collateral estoppel applies to civil fraud and then subsequently determining it does not provide lengthy analysis concerning the scope of a false return plea.  From the perspective of punishment both tax evasion, IRC 7201, and filing a false return will get the taxpayer to the same prison sentence almost every time.  Because the elements of the two crimes differ slightly and because proving the filing of a false return is slightly easier, prosecutors lean towards a false return conviction at times. Chief Counsel attorneys used to complain bitterly when Assistant United States Attorneys would accept a plea to a false return count rather than evasion because it meant a lot more work in the subsequent civil case; however, the change to 6201(a)(4) to allow assessment of the restitution amount may have taken some of the sting off of the situation.

The difference in the elements of the two crimes plays a role in deciding whether collateral estoppel applies.  The Tax Court examined this difference closely in its opinions applying the elements of the crimes to the civil fraud penalty while the BAP does not do spend as much time applying the elements of the crime to the elements of the applicable discharge statute.

In Considine the Tax Court reasoned:

(a) that it had previously held that a conviction for willfully attempting to avoid tax (I.R.C. § 7201) established fraudulent intent justifying a civil fraud penalty, see Amos v. Commissioner, 43 T.C. 50, aff’d, 360 F.2d 358 (4th Cir. 1965); (b) that the Supreme Court had held that “willfully” has the same meaning in section 7206(1) (false return) as in section 7201 (attempt to evade tax), see United States v. Bishop, 412 U.S. 346, 93 S.Ct. 2008, 36 L.Ed.2d 941 (1973); and (c) therefore that a conviction for filing a false return, without more, establishes fraud justifying the civil penalty.

Considine v. United States, 683 F.2d 1285, 1286 (9th Cir. 1982)(the 9th Circuit criticizes the Tax Court’s decision in citing to Considine v. Commissioner, 68 T.C. at 59-61)

In reconsidering and reversing Considine, the Tax Court in Wright stated:

“In a criminal action under section 7206(1), the issue actually litigated and necessarily determined is whether the taxpayer voluntarily and intentionally violated his or her known legal duty not to make a false statement as to any material matter on a return. The purpose of section 7206(1) is to facilitate the carrying out of respondent’s proper functions by punishing those who intentionally falsify their Federal income tax, and the penalty for such perjury is imposed irrespective of the tax consequences of the falsification. As noted above, the intent to evade taxes is not an element of the crime charged under section 7206(1). Thus, the crime is complete with the knowing, material falsification, and a conviction under section 7206(1) does not establish as a matter of law that the taxpayer violated the legal duty with an intent, or in an attempt, to evade taxes.” (internal citations omitted)

The IRS Chief Counsel’s office at page 63 of its Tax Crimes Handbook states that “there is no collateral estoppel as to civil fraud penalties under this section. The section 7206 (1) charge is keyed into a false item, not a tax deficiency. Collateral estoppel arises only with a conviction or guilty plea to tax evasion.”  Similarly, IRM 25.1.6.4.3 provides that “A conviction under IRC 7206(1), filing a false return, does not collaterally estop the taxpayer from asserting a defense to the civil fraud penalty since conviction under IRC 7206(1) does not require proof of fraudulent intent to evade federal income taxes. In these cases, additional development is required to establish the taxpayer’s intent to evade assessment of a tax to be due and owing.”

At issue in Terrell is whether the his guilty plea for a false return places him squarely within the elements of 523(a)(1)(C).  Section 523 of the bankruptcy code sets out the actions with respect to individual debtors that prevent, or except, the discharge of a debt.  Congress has added to the list over the years since the adoption of the bankruptcy code in 1978.  The list of excepted debts in 523 numbers 19 and several of those 19 subparagraphs of section 523(a) have more than one basis for excepting the debt from discharge.

The provision relating to tax debts, 523(a)(1), has three separate bases for excepting a debt from discharge.  Subparagraph (A) excepts debts that achieve priority status under section 507(a)(8).  This subparagraph, in general terms, prevents debtors from discharging relatively new tax debts.  Subparagraph (B), which has been the subject of many posts, prevents debtors from discharging tax debts for which the debtor has never filed a return or filed a late return within two years of the filing of the bankruptcy petition.  Subparagraph (C) at issue in this case prevents debtors from discharging tax debts “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”

The question before the BAP concerns the language of the discharge exception for making a fraudulent return and the language of IRC 7206(1) for filing a false return.  Section 7206(1) holds a taxpayer liable for a felony tax offense if he “willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter.”  Does this statute, which does not require any understatement of tax but merely a false statement, match the elements of bankruptcy code section 523(a)(1)(C) such that the conviction under IRC 7206(1) requires a finding of collateral estoppel regarding the discharge of the underlying taxes.

The BAP, after acknowledging that Mr. Terrell presented “no arguments as to why the bankruptcy court’s application of collateral estoppel was in error” says yes because (1) “the issue in the Criminal Case is identical to the issue presented in the Adversary Proceeding” because the same factual issues existed in both statutes; (2) his “guilty plea in the Criminal Case constitutes a full adjudication on the merits”; (3) both the debtor and the IRS were parties to the criminal case; and (4) the debtor “had a full and fair opportunity to litigate the Criminal Case.”

The language in 523(a)(1)(C) “made a fraudulent return” may sufficiently line up with the language of IRC 7206(1) to allow collateral estoppel to work here but I would like the court to work a little harder to make that connection for me.  The Tax Court eased into a similar conclusion with respect to the fraud penalty and an IRC 7206(1) conviction and then had to walk it back after the 9th Circuit brought its attention to the elements of that crime.  The standard of proof for the IRS in a 523(a)(1)(C) case is preponderance of evidence unlike the clear and convincing standard needed for sustaining the civil fraud penalty.  There are certainly differences between the Considine situation and the Terrell case but enough similarities to deserve more analysis.  I am not yet convinced.

Does Failure to List a Refund Claim in a Debtor’s Bankruptcy Schedules Provide the IRS a Defense Barring the Refund

The case of Martin v. United States (C.D. Ill 1-5-2017) examines the jurisdictional objection raised by the Department of Justice Tax Division to a claim for refund filed by taxpayers who went through a chapter 7 bankruptcy proceeding prior to filing the claim for refund.  The bankruptcy proceeding matters because the refund claims here relate to pre-bankruptcy petition years.  Because the refund claim existed at the time of the bankruptcy, the claim became property of the bankruptcy estate under B.C. 541.  The taxpayers had a duty to list all of their property and rights to property when they entered bankruptcy.  The taxpayers did not list the refund claims on their bankruptcy schedules and did not file the refund claims until just prior to closure of their bankruptcy case in 2005.

In this case, the IRS seeks to knock out their claim because of the failure to list it in the bankruptcy proceeding regardless of the merits of the claim.  The position of the IRS has a sound basis.  The district court does not dismiss the refund claim but discusses several theories raised by the IRS.  The court signals that it may dismiss the claim once it acquires more facts.

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I first saw this issue almost 30 years ago in a Third Circuit case Oneida Motor Freight, Inc. v. United Jersey Bank, 848 F.2d 414 (3rd Cir. 1988). Citing to In Re Hannan, 127 F.2d 894 (7th Cir.1942), the Court stated

“a long-standing tenet of bankruptcy law requires one seeking benefits under its terms to satisfy a companion duty to schedule, for the benefit of creditors, all his interests and property rights.”

The Court also pointed to the debtor’s statutory duty stating

“Section 521 of the current Bankruptcy Code outlines a non-exhaustive list of the debtor’s duties in a bankruptcy case. Foremost for our purposes, the debtor is required to ‘file a … schedule of assets and liabilities … and a statement of the debtor’s financial affairs….’”

Oneida argued that at no point in the bankruptcy case prior to the time it filed its action against the bank did the right moment exist to bring such an action.  The Court gave little weight to this argument stating

“Although Oneida may be technically correct in its argument that it was never procedurally compelled to raise its claim, we are satisfied that its failure to mention this potential claim either within the confines of its disclosure statement or at any stage of the bankruptcy court’s resolution precludes this later independent action. Even absent a specific mandate to file a counterclaim, complete disclosure is imperative to assist interested parties in making decisions relevant to the bankrupt estate.”

In Oneida, the debtor brought a suit against a bank for breach of duty but failed to list the chose in action in its schedules and failed to mention it in its plan of reorganization.  Because Oneida was a chapter 11 case, it presents a slightly different setting than Martin but most of the principles remain the same.  I should also note that there was a vigorous dissent in Oneida pointing out the negative impact to the estate of barring the suit against the bank.

The issue presents the question of fair play.  The law has some doctrines that apply when a party fails to treat others properly while seeking benefits for themselves.  By failing to list the claim for refund, which exceeds $100,000, the taxpayers here misled their creditors regarding the amount of assets available from the bankruptcy estate.  The creditors received distributions from a bankruptcy estate that did not include all of the assets owned by the debtors.  Based on those facts, it seems unfair to allow the debtors to benefit, in this case to substantially benefit, from their own failure to properly file their schedules which they signed under penalties of perjury.  I acknowledge that it is possible that at the time of filing the schedules they may not have been aware of the existence of the refund claim but that still raises a question of whether the timing of their becoming aware of an asset is the controlling event for a determination of who should benefit.

A logical way to prevent the debtors from benefiting would be to deny their claim, but there is more to the story.  I want to paint a fuller picture of fairness before I go back to the doctrines examined by the Court.  Here, the debtors in Martin did go back to the trustee and notify him of the possible refund many years after the closing of the bankruptcy case.  The trustee did seek to find and notify the creditors of the estate but none stepped forward to renew their claims.  I did not go and pull the schedules in this case to see what kind of payout occurred from the bankruptcy estate, how many creditors existed, what type of creditors existed, etc.  Depending on the type of creditors and the distance in time between the close of the case and the correspondence from the trustee, it is almost certain that the creditors had written the taxpayers’ accounts off several years prior to the inquiry from the trustee about a possible additional distribution.  If they looked back on their computerized accounts they may have seen that no liability was due from the debtors and may not have had a good way to recreate the account.  The creditors had a duty to write off all dischargable debt in order to avoid violating the discharge injunction imposed by the bankruptcy code and would have taken steps to do so many years before the trustee wrote to them.  If the creditors had not taken immediate steps to write off the debt following discharge, they would have incurred the significant penalties that arise when it is violated.  While it is easy to question why the creditors of the taxpayers’ bankruptcy estate did not raise their hands and request the money when given the opportunity to do so, it may not have been easy or possible for them to identify the debt so long after writing it off.  Because no creditor came forward to ask that their long forgotten debt be paid, the trustee told the bankruptcy court that no creditor of the estate had an interest in the taxpayers’ pre-bankruptcy refund even though it was potentially a six figure refund and even though the creditors probably got paid only a fraction of what they were owed.

First, the taxpayers allege that they did not know of the refund claims until 2005.  If they did not allege this, or at least allege that they did not know of the claims at the time they filed their bankruptcy petition and the attendant schedules under penalty of perjury, they would risk prosecution.  By bringing the refund action and exposing their failure, the debtors would know that this issue would arise.  Without knowing more, I believe them that they were unaware of the refunds at the time of filing their bankruptcy petition because of the defense such belief provides to the possible prosecution for bankruptcy fraud.  So, their failure to list the refund claims may well have resulted not from an effort to deceive their creditors but rather from a desire to claim a benefit once discovered.

Second, the IRS, assuming the taxpayers’ refund claim deserves acceptance, would itself become the beneficiary of a windfall at the expense of the debtors pre-bankruptcy creditors should the court deny the debtors the refund under a theory that no pre-bankruptcy refund could ever be paid if not listed in the schedules.  Unlike the Oneida case, in which the unlisted asset the debtor sought to later recover was against a creditor of the estate, nothing in the facts suggests that the IRS had an unpaid claim in the bankruptcy case.  Should the remedy for a situation such as this provide a windfall to the IRS as it argues?  While the IRS might receive a windfall, it did nothing wrong.  The denial of the refund would result from the debtors’ failure and not due to any actions by the IRS.

Third, maybe an appropriate remedy in a case like this should not allow debtors or the IRS to reap a benefit that, had debtors submitted a timely claim, would have gone to the creditors.  Perhaps a doctrine such as Cy Pres should apply to send the funds to a deserving charity.   The equities at issue here do not favor the debtor even though the debtor did eventually go back to the trustee and bring up the existence of the claim.  It will be interesting to see what remedy the bankruptcy court fashions out of the mess created by the failure to list an asset.  Because the debtors may not have had a good way to identify the refund at the time of filing their bankruptcy petition, the debtors here do not have the same level of culpability that the debtor in the Oneida case had because the cause of action against the bank in the Oneida case would have something that debtor knew or should have known existed at the time of filing the schedules and at the time of presenting a plan of reorganization.  With tax refunds, the existence of the refund sometimes does not become clear for some period after the refund potentially arises, what is a fair method of dealing with parties when such an even occurs.  Maybe Martin will shed some light on the best answer.

Update on Splitting Refunds in Bankruptcy Cases

In May of 2014, I wrote a post describing the way that bankruptcy courts approach splitting refunds in the circumstance in which one spouse goes into bankruptcy the other does not and then the couple files a joint return which generates a refund.  That post has, in a surprise to me, been one of the most popular posts in terms of the number of people who have accessed it.  Last month, another bankruptcy court opined on the issue while coming at the issue from a slightly different position than in the case from the prior post.  The recent case gives me a chance to update the post and describe bankruptcy procedure regarding the automatic stay, but also to bring up the filing season issue of injured spouse.

I recently wrote on the filing season issue of superseding returns.  I hope to write soon on another filing season issue updating another popular prior post regarding offset bypass refunds.

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As a prelude to the discussion of the problem of splitting refunds in bankruptcy cases, a quick reminder of injured spouse rules will assist those facing the situation as filing season approaches.  I wrote about the injured spouse provisions in September of 2016 in the context of discussing the statute of limitations for making an injured spouse request.  In that post I noted that if a taxpayer knows at the time of filing a joint return that their spouse owes the IRS but the taxpayer does not owe the IRS, the IRS has created a form to file with the return to alert the IRS to the desire of the spouse with no liability to have their portion of the refund actually refunded rather than offset:

When someone believes they qualify for injured spouse status, they should attach a Form 8379 to their tax return. Of course, a spouse may not know that their partner has a debt which will cause an offset of refund on the joint return and may not know that they should proactively file the Form 8379 to avoid the problem.

Unlike the innocent spouse provisions which apply when the IRS determines an additional liability on a joint return, the injured spouse provisions apply when one of the spouses already owes the IRS a liability.  When a couple knows that one partner owes the IRS a liability (or any other liability subject to the 6402 offset provisions such as student loans, child custody, state tax, etc) and the couple desires to file a joint return nonetheless, usually because of the tax benefit of joint return status, then the couple should attach the Form 8379 to the return.  If the spouse who does not owe the IRS (or the other offset entities) had no knowledge of their spouse’s debt to the IRS (or the other offset entities) at the time of filing the joint return, then he or she can file the Form 8379 when they learn of the problem which will generally occur not too long after the filing of the return because of the failure to receive the anticipated refund.  The outside time period for making the request, is discussed in the prior post.

While the IRS has issued rulings and a form making the path to injured spouse relief from the IRS relatively straightforward, the path takes on a different form if the fight over the refund occurs outside of the IRS.  Outside of the IRS, the fight over the refund usually takes place in a bankruptcy court or a domestic relations court.  The IRS rules regarding the splitting of the refund do not bind these courts but do provide context for deciding how to do so.

In the recent case of In re Nevins No. 15-10003 (Bankr. N.H. December 23, 2016), the application of the rules came up in a fight between the debtor and the IRS, rather than the debtor and the debtor’s spouse or the debtor and the bankruptcy trustee, in the context of a potential violation of the automatic stay.  Mr. Nevins filed a voluntary chapter 13 petition on January 4, 2015.  The court confirmed his plan on March 18, 2015, a normal time period between filing and confirmation of the plan.  The plan provided for payment of the IRS claim under terms that varied depending on the different types of claims held by the IRS.  In a twist on the injured spouse situation, Mrs. Nevins, who did not join her husband in filing bankruptcy, did also owe the taxes.  So, the Nevins case does not involve an injured spouse claim although the analysis applied here could also apply in an injured spouse context.

Married couples can make an election when filing bankruptcy to file a joint bankruptcy or to have just one spouse file bankruptcy.  Like the tax code, the bankruptcy code does not dictate the filing of a joint bankruptcy petition just because of marriage.  If one spouse files bankruptcy, the automatic stay of bankruptcy code section 362 applies to that spouse but not necessarily to the other spouse.  Bankruptcy code section 1301 does create a stay that can cover the non-filing spouse in chapter 13 cases; however, this stay only applies to consumer debts and the definition of consumer debt does not include taxes.

So, when Mr. Nevins filed bankruptcy and Mrs. Nevins did not, she remained exposed to the full panoply of collection weapons available to the IRS while he fell under the shield of the bankruptcy code.  In this case, the issue of offset involves not only the shield of the bankruptcy code but also the ultimate impact of discharge.  Most of the liabilities owed by Mr. Nevins fell into the general unsecured claim category.  He owed slightly over $40,000 but the IRS claim and the chapter 13 plan classified about $32,000 of that debt as general unsecured debt.  General unsecured debt is the worst type of debt a creditor can hold.  In Mr. Nevins’ plan he proposed to pay about 2% this debt.  This means that over the five year life of his plan he would pay the IRS about $640.00 and the balance of the debt would go away upon completion of the plan together with all of the interest and penalties on the debt.  For Mrs. Nevins, however, the full amount of the debt continued to exist and continued to accrue interest and, possibly, penalties.

This situation provides the IRS with an incentive to take the joint refund and apply it to Mrs. Nevins’ debt.  The automatic stay prevented the IRS from applying it to his debt since it must take payment through the plan on his debt.  The IRS calculated how much of the $1,293.00 refund each party should receive.  It determined that using its formula for allocation of refunds Mrs. Nevins should receive the entire refund and so it offset the entire refund in partial settlement of her debt.  By doing so, it collected in one action more than his five year plan would pay on this debt.  Mr. Nevins objected, arguing that the offset of the refund violated the automatic stay because it acted as a taking of property of the estate during the period of the stay.  The IRS countered that its actions did not violate the stay since none of the refund belonged to Mr. Nevins and nothing prevented the IRS from collecting on Mrs. Nevins’ liability.

The bankruptcy court faced a situation in which it needed to decide how it should calculate the refund in order to know if the taking of the refund violated the stay.  After noting the absence of controlling precedent in its jurisdiction, the court went through the same type of analysis the Lee court had done in the case previously blogged.  It also came to the same conclusion.  It rejected the 50/50 rule as too simplistic.  It rejected the income rule because it divides the refund based on “a factor which may have very little to do with actual contributions to the total tax obligations between spouses.”  It similarly rejected the withholding rule for similar reasons, noting that it may apply anyway in cases with no credits.

This led the court to the so-called separate filings rule adopted by the IRS in the revenue procedures.  The court notes that the majority of the courts are falling in line with the separate filings rule as it does.  The court described the rule as follows:

[The Separate Return Rule] allocates the refund based on each spouse’s hypothetical individual tax liability (hypothetical liability) had the spouses filed their tax returns as married parties filing separately. First, each spouse’s contribution to total payments is determined. Second, each spouse’s share of the joint tax liability is calculated based on the ratio of that spouse’s hypothetical liability to the sum of both spouses’ hypothetical liabilities. Each spouse owns that portion of the joint refund equal to the amount by which his or her contribution exceeds his or her share of the joint tax liability.

Because it lacked all of the facts necessary to rule on the precise disposition of the refund, it reserved the ruling on the outcome for another day.  The case caused the bankruptcy court to spend lots of energy over a $1,293 refund but a decision that sets precedent should the issue arise again.  If the IRS correctly calculated the refund based on the separate filings rule, the offset will stand.  If it did not, in whole or in part, some of the refund will come into the estate to satisfy the liability of Mr. Nevins under the plan and the IRS will potentially face damages for violation of the automatic stay.  I suspect any damages here would be small but it is a risk for the IRS anytime it takes money that arguably belongs to a bankruptcy estate.

New Developments in the Cases Involving Discharge of Late Filed Returns

We have reported on numerous occasions regarding the issue of whether a taxpayer who files a return late may discharge the taxes owed on the late-filed returns in bankruptcy.  See prior posts here, here, here, and here.  The recent case of Biggers v. Internal Revenue Service decided by the District Court in the Middle District of Tennessee on September 9, 2016, demonstrates yet again the difficult administrative position that IRS put itself in by embarking on this argument almost 20 years ago.  In Biggers, the District Court reversed the bankruptcy court and determined that the application of the Beard test requires a subjective determination of the taxpayer’s intent in filing the late return.  The case has other interesting facets which I will discuss below.

Additionally, some new developments in the 3rd and 9th Circuits on this issue deserve mention for those following this line of cases.  In the 3rd Circuit, an attempted appeal to the Circuit Court bypassing the district court or Bankruptcy Appellate Panel has been turned back.  In the 9th Circuit, a case on which we reported previously has requested cert.

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I will start with the Biggers case.  Mr. and Mrs. Biggers did not timely file tax returns for the years 2001 through 2004 for reasons that the court does not explain.  The IRS prepared substitute returns for Mr. Biggers for each of these years, sent him notices of deficiency on which he defaulted, and then assessed the taxes.  After the IRS had assessed taxes through this process for all of the years, Mr. and Mrs. Biggers filed joint Forms 1040 for each of these years on February 15, 2007.  On three of those returns, the reported liability decreased from the amount previously assessed; however, on the return for 2002, the joint return reported an increased liability of about $15,000.  The Biggers then waited slightly more than two years and filed a joint chapter 7 petition in December of 2009 after which they received a discharge three months later.

The IRS conceded that the discharge relieved Mrs. Biggers of liability for the four years.  It also conceded that the discharge relieved Mr. Biggers of the $15,000 increase in tax reported on the Form 1040 for 2002 but not for the amount assessed through the substitute for return process.  For the other three years the IRS abated the taxes down to the amount shown on the late filed Forms 1040 but argued that the bankruptcy petition did not relieve Mr. Biggers of the liability because it had prepared the substitute returns first and made assessments before he filed the Forms 1040.  The bankruptcy court agreed with the IRS citing to the seminal case in this area, United States v. Hindenlang, 164 F.3d 1029 (6th Cir. 1999) as controlling circuit precedent.  On appeal, the district court took a different tack.

Before I get to what the district court decided, I need to pause to point out what the district court said that the IRS argued.  The principal argument of the IRS focused on the prior assessment through the substitute for return process.  The argument of the IRS did not exactly mirror the holding in Hindenlang, the controlling circuit authority.  Hindenlang adopted a subjective test based on the Tax Court’s Beard case and found that Mr. Hindenlang, whose return filed subsequent to the preparation of the substitute return, matched the substitute return exactly.  That, said the 6th Circuit, was not a good faith attempt to file a return, and good faith is one of the Beard elements.  The IRS primary argument morphed the Hindenlang argument into an essentially per se rule that once the IRS has assessed based on a substitute for return any Form 1040 filed thereafter can never meet the Beard test and lead to discharge.  This is standard stuff in these cases; however, the district court reports that the IRS went further.  Alternatively, it argued that if the court did not want to adopt its primary argument, the court should adopt the position of the three circuits holding that for bankruptcy cases filed after the 2005 amendments the language in the handing paragraph of B.C. 523(a) means that a late return can never satisfy the discharge requirements because it does not meet the additional statutory requirements in the hanging paragraph.

The district court noted that this argument by the IRS represented a change in its position from other cases.  It does.  This argument goes directly against the Chief Counsel Notice giving guidance on this issue.  It is unclear if the alternative argument the IRS appears to have made in Biggers represents an unannounced shift in the IRS position, a disagreement between Chief Counsel’s office and the Tax Division on this issue or merely a rogue argument by the Tax Division attorney arguing this case.  Unless making this argument represents a mistake by the trial attorney in the heat of battle, the ground seems to have shifted in these cases from a situation in which only certain states argue for the per se rule that filing a return one day late forever  prevents it from receiving a discharge to one where the IRS will also make this argument.  If it will make this argument, it will change the way it administratively processes these cases upon discharge.  This change comes as quite a surprise.

The district court did not adopt the per se rule argued by the IRS as its lead argument or its alternate argument of the one day late rule.  It concluded “that ‘applicable bankruptcy law’ as used in section 523(a)(*) includes pre-BAPCA [the 2005 legislative amendments to the bankruptcy code] case law, which encompasses the Beard test, as well as any other non-bankruptcy law as to requirements for a return.”  So, the district court finds that in deciding whether a document filed as a tax return satisfies the test for being a tax return requires a look at Beard and other case law deciding what constitutes a return.  The court cited a Tax Court case, Swanson v. Commissioner, 121 T.C. 111 (2003) which carefully examined the debtor’s intent before deciding that the taxpayer in that case did not have an intent to file a return.  Imagine IRS bankruptcy examiners doing that in every case.  Impossible.  The IRS cannot administer the subjective test which explains why it has morphed to its own form of per se rule when it has made an assessment pursuant to a substitute for return.

The district court also went back to a long standing anomaly in the IRS argument concerning how it treats taxpayers in bankruptcy cases versus offer in compromise cases.  In bankruptcy cases, it says that Forms 1040 filed after the IRS has made an assessment based on a substitute for return exist only as claims for abatement; however, in offer cases, it requires taxpayers to file Form 1040 even where it has already made an assessment based on a substitute for return.  The district court found the IRS treatment of taxpayers in the offer context suggestive of the continued possibility that Forms 1040 filed in this context could meet the Beard test or otherwise meet the statutory requirement necessary for consideration as returns.  As a result, the district court remanded the case to the bankruptcy court for it to look into the subjective intent of Mr. Biggers in filing the late Forms 1040 in order to determine if they might, in fact, be returns.  If the district court’s analysis of the applicable test holds up, the IRS must carefully investigate the taxpayer’s intent in each of these late file return cases and have courts second-guess its conclusions in hearings involving the violation of the discharge injunction.  Because the IRS cannot handle such a test, I suspect it will seek to appeal this decision.

Meanwhile, a petition for cert has been filed in the Smith case out of the 9th Circuit which we blogged here.  The petition, partially written by Professor John Pottow at University of Michigan, does an excellent job of explaining the state of the law and the various splinters into which it has broken over this issue.  The Supreme Court has denied cert on this issue before, but I do not think that it has previously received a request of this quality.  Whether the Smith case provides the best vehicle for cert is something about which parties will disagree.  Those in the 9th Circuit which averted the per se rule in Smith may prefer to live with Smith rather than face the possibility of the McCoy per se rule, but Mr. Smith can choose to seek cert if he wishes.  Will the IRS, which declined to seek cert before when it had the chance after the creation of the first circuit split based on the decision of the 8th Circuit not to follow Hindenlang, join in this request or will it continue to find that the current state of the law provides it the best avenue for administering the discharge of late-filed returns?  The brief cites to the importance to individual debtors to have consistency in the law across the country.  Will the IRS also find administrative importance in the need for consistency?  Does the alternative argument it made in Biggers signal a new litigating strategy that will play out in its response to the cert request?

Another, meanwhile, concerns the Third Circuit.  We posted previously on a case headed to that circuit; however, it appears that the Third Circuit has turned down the direct appeals, meaning that it will be longer before that circuit joins the parade of circuits weighing in on this issue.

District Court Reverses Bankruptcy Court and Finds that Emotional Distress Alone Insufficient to Justify Awarding of Damages When IRS Violates Stay on Collection

Earlier this year in Migraine Caused by Improper IRS Collection Action During Bankruptcy Stay Triggers Damages for Emotional Distress I discussed Hunsaker v US, where a bankruptcy court held that IRS was on the hook for damages arising for violations of the stay on collection even when the only damages were from the emotional distress and were not actual economic damages. Last week a district court in Oregon reversed the bankruptcy court, finding that there was no clear waiver of the government’s sovereign immunity  in the absence of direct economic damages.

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In my post earlier this year, I described what led to the Hunsakers suing the government. It started with financial problems when they realized that their “homestead was discovered to be subject to disputed claims by secured creditors, in turn complicated by claims of Marion County, Oregon, that the purchase of the homestead created an unlawful partition.” In September 2012 the Hunsakers filed a Chapter 13 bankruptcy reorganization. IRS received notice of the filing, and it filed a proof of claim for $ 9,301. As I previously discussed, “at the moment of the Chapter 13 filing, the automatic stay under the Bankruptcy Code came into place. In a Chapter 13 case it continues throughout the life of the case, which usually means it lasts for three to five years until completion of the plan or dismissal of the case.”

So IRS had notice of the plan, and should have backed off on collection. IRS however failed to back off and on numerous occasions sought payment and in fact served levies on Social Security payments even though the Hunsakers’ attorney contacted IRS and reminded IRS of the stay and the illegality of the IRS collection actions.

At the Bankruptcy Court, the judge found a specific connection between the IRS misconduct and an increase and aggravation of the Hunsakers’ anxiety and stress and awarded them $4,000 on account of that stress and anxiety, which in the judge’s opinion contributed to the onset and severity of Mrs. Hunsaker’s migraines. In reaching that conclusion, the bankruptcy court relied on and discussed a 9th Circuit case, In re Dawson that, on reconsideration, concluded that emotional distress stemming from violations of the bankruptcy stay can give rise to actual damages even if the debtor suffers no pecuniary losses.

On appeal, the district court noted that Dawson did not address the government’s violations of the stay; that case involved a private creditor. That was a key difference.

I will avoid the temptation to provide the NSFW link to Mel Brooks’ History of the World Part 1 where he reminds us that it is indeed good to be the king. While we no longer have royalty, sovereign immunity remains and limits the opportunities for private parties to sue the government. It stems from the adage that the king can do no wrong. While IRS most certainly can and does do wrong, the principal protects IRS from damages unless there is a specific and clear Congressional expression allowing the government to be sued.

The district court provided the framework:

Section 106(a) of the Bankruptcy Code clearly waives sovereign immunity for some claims under § 362(k). See 11 U.S.C. § 106(a) (“[S]overeign immunity is abrogated as to a governmental unit to the extent set forth in this section with respect to . . . [§] 362[.]”). Section 362(k) allows individual debtors injured by a creditor’s willful violation of the automatic stay to recover “actual damages.”

The opinion then goes on to discuss how in Dawson the 9th circuit provided that “allowing emotional distress damages best fulfills legislative intent to protect debtors from excessive psychological and emotional harm.” But that was not enough for the Hunsakers, as the creditor in Dawson was a private party and not Uncle Sam:

That emotional distress damages are available against private parties does not automatically authorize them against the federal government. After all, “when it comes to an award of money damages, sovereign immunity places the Federal Government on an entirely different footing than private parties.” Lane v. Pena, 518 U.S. 187, 196 (1996).

The opinion discusses how that different footing requires a clear expression that Congress meant for the government to be sued, and the district court said that was not present in these circumstances:

The Dawson court concluded the phrase “actual damages” was ambiguous even given the text and context of § 362(k) as a whole. 390 F.3d at 1146. The legislative history discussed in Dawson cannot waive sovereign immunity where the text of § 362(k) otherwise remains ambiguous. See Cooper, 132 S. Ct. at 1448 (“Legislative history cannot supply a waiver that is not clearly evident from the language of the statute.”). Because the phrase “actual damages” is ambiguous, this Court must construe § 362(k) in favor of immunity. See id. (any ambiguities in the statutory language must be strictly construed in favor of immunity, including ambiguities regarding the scope of the waiver). Reinforcing this conclusion is the fact that, before concluding “actual damages” includes emotional distress damages, the Dawson panel came to the opposite conclusion in an opinion it later withdrew. Dawson v. Washington Mutual Bank, F.A., 367 F.3d 1174 (9th Cir.), withdrawn, 385 F.3d 1194 (9th Cir. 2004). The two Dawson opinions provide compelling proof that any waiver of sovereign immunity as to emotional distress damages in § 362(k) is, at best, implicit.

(emphasis added).

The cite in the above block quote is to a 2012 Supreme Court case, F.A.A. v. Cooper, 132 S. Ct. 1441, 1448 (2012). The district court notes that Cooper supports its holding as well, as in that case the Supreme Court in examining a possible cause of action under the Privacy Act looked to “essentially the same question: if a statute waives sovereign immunity for “actual damages,” does that waiver include emotional distress damages? Id. at 1447–48. The Supreme Court answered no.”

Parting Thoughts

For good measure, the Hunsaker opinion discusses how even if there were no sovereign immunity issue it was skeptical that in fact there was an injury that was sufficient to warrant damages anyway, pointing to “alleged only brief losses of appetite, stress, and mounting frustration after receiving the IRS notices.” When I wrote my original post on the bankruptcy court case I said I was somewhat surprised at the outcome and I am not surprised that the district court reversed. On the other hand, the IRS conduct in this case is nothing to write home about.

I understand the government wanting to limit the possibility that other debtors similarly suffering from IRS mistakes in this process would sue and connect their stress from the IRS mistakes to an award, even a smallish one. It does seem that there should be some ramification for IRS mistakes, especially when the mistakes are repeated and the taxpayer/debtor has made a good faith effort to ensure that the government is aware of the stay. I note that Congress last systematically looked at these issues was in 1998 when it added Section 7433(e), allowing for an alternate statutory hook for taxpayers to petition the bankruptcy court for actual, direct economic damages and costs of the action if the IRS willfully violated the automatic stay injunction (7433(e) is also now the exclusive means for IRS violations of the discharge). I am not aware how often IRS whiffs on respecting these provisions so perhaps the issue is one rarely encountered in practice.