Detrimental Reliance on the IRS

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The Tax Clinic at Harvard has, so far, unsuccessfully litigated on behalf of individuals misled by the IRS regarding the last date to file a Tax Court petition as discussed here. Getting bad advice on when to file a Tax Court petition represents only one way in which bad advice from the IRS can mislead a taxpayer. In Kerger v. United States, No. 3:17-cv-00994 (N.D. Ohio 2018) another situation in which incorrect advice can harm a taxpayer surfaces. In all of these cases the individual at the IRS does not seek to mislead but a wrong answer from someone who would seem to hold a position of knowledge and authority can send taxpayers down the wrong path.

In this case the Kergers seek a declaration that certain taxes were discharged in a prior bankruptcy case. The IRS argues that the Declaratory Judgment Act prohibits such an action against the United States. Of course, as discussed in a recent post, the debtors could obtain a determination of wrongful collection if the taxes were discharged and the IRS kept pursuing them. Here, the IRS not only defended against the suit but used the suit as an opportunity to reduce the taxes to judgment which will have the effect of keeping them around forever (or at least until the taxpayers can successfully discharge them in their next bankruptcy.)

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The Kergers asked the court to equitably estop the IRS from collecting taxes they contend a previous bankruptcy discharged. In 2008 the Kergers filed a chapter 11 bankruptcy case in 2008 but eventually converted to a chapter 7 in 2010. Individual chapter 11 cases do not happen with great frequency. I did not study their bankruptcy case to determine why they needed to convert. The tax debt may have caused the conversion because they would have to commit to full payment of all priority taxes in order to confirm their chapter 11 plan. Following the conversion, they obtained a discharge after which the IRS pursued collection of the liabilities at issue in this case. The Kergers disagreed that the tax debt survived bankruptcy but could not obtain a response from the IRS.

In 2014 they had to abandon their home due to the presence of mold. The cost to fix the mold problem was estimated at $100,000. They decided to sell the house; however, the IRS had filed a notice of federal tax lien which created a problem in selling the property since the sale would result in payment of the tax liability prior to their ability to receive any proceeds. Their attorney contacted the IRS to obtain a payoff amount since the amount they would need to pay could influence their decision to sell. The IRS representative told the attorney that the Kergers did not owe any taxes. The IRS sent transcripts showing no liability and a conversation with an Appeals Officer confirmed that the lien would release due to the absence of a liability.

Relying on the representations of the IRS, the Kergers spent the money to clean the house, prepared for an auction and purchased a new home. The home sold on August 15, 2015, “with the understanding that the IRS liens would fall off before the thirty day closing period concluded.” Before the running of the 30 days, the Kergers received several pieces of certified mail notifying them of the taxes owed. The Kergers learned that the IRS had moved their liabilities from master file accounts to non-master file accounts due to the bankruptcy. Of course, the IRS individuals with whom the Kergers and their attorney spoke looked only at the master file accounts and did not access the non-master file accounts where the data about their liabilities resided.

The Kergers brought the case seeking a declaratory judgment that the bankruptcy discharged the liabilities or, in the alternative, that the actions of its employees equitably estopped the IRS from collecting on these liabilities. The opinion does not state why the Kergers brought suit seeking a declaratory judgment rather than an action for a determination that the action of the IRS violated the discharge injunction. The court does mention that their complaint expressly states “there is no issue as to the discharge raised in this Complaint.” The district court had little trouble determining that it could not grant a declaratory judgment because the language of the statute clearly bars the court from doing so because it lacks subject matter jurisdiction.

In an effort to save the Kergers, the court found that the claim of equitable estoppel could survive bankruptcy because an issue regarding the discharge of the liability exists. The court does not decide this aspect of the case but allows the case to continue so that the debtor can present information about the tax liability and show that the discharge provisions apply. The case does not contain enough information to allow me to speculate whether they have a chance to show the taxes were disqualified in the prior bankruptcy. The court does not say that it intends to hold for them as a result of the bad advice they received from the IRS. As of the writing of this post, the court had not issued a ruling on the discharge of the liabilities.

The court also discusses the pleadings and finds Twombly and Iqbal concerns. We have discussed this issue previously. Here, it finds the pleadings adequate.

We have discussed it before but switching accounts from master file to non-master file can cause confusion at the IRS as well as with the taxpayer. If the taxpayer whom you represent has a liability that you think exists and you see an IRS transcript that says nothing is owed, you need to talk to the IRS about the possible existence of a non-master file account. Do not get joyous prematurely. Taxpayers who have filed a joint return and who go into bankruptcy, request innocent spouse relief, or otherwise have some action on their account that causes it to need to be split must exercise caution when reading master file transcripts. Usually, the master file transcript has a transaction code removing the liability that hints of the creation of another account. If you are concerned, get someone at the IRS to pull the non-master file transcript before celebrating the end of the liability. Maybe the Kergers will still find relief in this case but generally, relying on bad advice from the IRS in this setting does not eliminate the liability. The IRS may apologize as it takes the next collection action.

 

 

 

Comments

  1. Keith, as a former IRS attorney, what do you think the IRS could or should have done in this case to ameliorate the harm done to the taxpayers as a result of their reliance on the information they had received from IRS employees? For example, could the IRS have initiated an action to have the Bankruptcy court provide an expedited ruling on whether the tax debt had been discharged? How would you have felt if you had been required to take the position asserted by the IRS in this case?
    Ron Wiener

    • Ron

      I am not sure what I would have done and there may be facts not yet brought to light. The IRS could do an ETA offer here as a way to eliminate some or all of the liability and maybe reach a result that is fair to the taxpayers and to the IRS. The detrimental reliance on bad advice given by multiple persons at the IRS suggests that some assistance to these individuals should occur as well as training at the IRS.

      Keith

  2. Norman Diamond says:

    “The IRS sent transcripts showing no liability”

    I thought IRS transcripts were supposed to be considered reliable except when a party presents evidence to the contrary? The IRS had a perfect opportunity to present evidence that its transcript was not reliable, but the IRS passed on the opportunity.

  3. When you request a Tax Mod A transcript from the IRS, I haven’t found a single person who knows what this means. My question to Mr. Wiener is, why are we using taxpayer dollars to pay Federal employees to do a job where they aren’t providing due diligence for the taxpayer? Provide all documents/transcripts from all sources so we can avoid these conflicts and adequately represent the client.
    Thank you.

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