Section 6103 protects taxpayer information and takes the general position, subject to many exceptions, that tax returns and return information residing with the IRS may not be disclosed. Despite the general rule, exceptions exist. One of the exceptions allows the IRS to use this information in proving matters related to a taxpayer in a case in litigation. This exception provides a basis for disclosing taxpayer information that would otherwise remain secret within the IRS. In re Lawrence offers a look at the amount of disclosure of a taxpayer’s information allowed in a bankruptcy case. The taxpayer loses in his effort to keep the IRS from disclosing certain information. The Court goes through the statutory tests in crafting an opinion that follows the law and leaves the door almost wide open in the litigation context.
Debtors filed an individual chapter 11 case. Such cases are not common but happen regularly because of the debt limitations of chapter 13. They tried several plans seeking to obtain confirmation and failed each time. The United States Trustee moved to dismiss the case and the IRS joined in that motion. The IRS apparently wanted the case dismissed because the taxpayers were not keeping current on their tax obligations while the bankruptcy case was proceeding. When that happens, it signals to the IRS that success after confirmation of a chapter 11 plan will not likely occur because the debtors cannot pay their taxes during the period they have no obligation to repay prepetition debts. Before the hearing on the motion to dismiss, the IRS filed the required list of prospective witness and exhibits. The debtors objected to the testimony of a Revenue Officer and a Revenue Agent. They also objected to all of the IRS exhibits except the IRS proof of claim. Debtors based their position on 6103(h)(4) which, they argued, prohibited this evidence based on the disclosure laws and the restrictions on making public a taxpayer’s information.
The IRS countered that in the context of a motion to dismiss putting on evidence of the debtors’ failure to keep current on their post-petition taxes, the unreasonable delays caused by the debtors and the lack of a reasonable likelihood of rehabilitation supports the motion and becomes permissible under the exception in IRC 6103 based on disclosures pursuant to tax administration. The IRS took the position that the exception allowing disclosure under 6103(h)(4)(A) and (B) allows the IRS to make disclosure of taxpayer information in circumstances in which (1) the taxpayer is a party or the proceeding arose out of the taxpayer’s civil or criminal liability and (2) the treatment of an item on a return directly relates to the resolution of an issue in the proceeding.
The bankruptcy court found that bankruptcy cases can implicate tax law enforcement and that “the intent to adjudicate tax liability is inherent in the bankruptcy filing, regardless of the final outcome of the adjudication.” In this case the debtors have substantial liabilities due to the IRS and the resolution of their tax liabilities is a critical part of their attempted reorganization. Debtors argue that the motion to dismiss their case has nothing to do with their tax liability and, therefore, cannot fit within the judicial proceeding exception to disclosure set out in 6103(h)(4).
Citing In re Guidry, 354 B.R. 824, 831(Bankr. S.D. Tex. 2006) the bankruptcy court quoted:
In the end, it is immaterial whether the IRS files a claim, or a discharge is granted or denied. The substance of a judicial proceeding [within the contemplation of 26 U.S.C. § 6103(h)(4)] is determined prospectively, as of the initiation of the action. A debtor files chapter 13 bankruptcy with the intent that all of the debtor’s assets and liabilities will be determined and accounted for in a payment plan. This includes tax liability. The intent to adjudicate tax liability is inherent in the bankruptcy filing, regardless of the final outcome of the adjudication.
Debtors knew from the outset that they owed the IRS a substantial amount. Their argument tries to read into 6103(h)(4) an unusual meaning for the term “proceeding.” Debtors argue that if they objected to the IRS claim then a proceeding as envisioned by the statute would occur but for other matters that a bankruptcy court might hear the term proceeding does not apply. The bankruptcy court rejected this narrow reading of the disclosure provisions holding that while disclosure of their tax information might be even more relevant in a claim objection proceeding, it was also relevant in a creditor motion to dismiss the case. The court stated: “Debtors’ attempt to cabin the evidence and allow it only in later claim-specific litigation they advance, but foreclose its use in connection with the matters brought by creditors under § 1112(b), is unpersuasive and untenable under the authorities.”
Conclusion
The decision here makes sense and debtors attempt to limit what the IRS could say about their case would create a very one sided situation. The IRS regularly finds itself in one-sided situations vis a vis disclosure because taxpayers can say whatever they want about their returns outside of court while the IRS must remain silent absent a waiver from the taxpayer allowing the IRS to make the information public. In the 1998 legislation Senator Roth called lots of witnesses who told of all the bad things the IRS had done to them but the IRS was not allowed to respond. We see candidates say things or not say things about their tax returns and the IRS is not allowed to respond. In public discourse, this one sided discussion of taxes can be frustrating but the public can take into account the inability of the IRS to talk. That same type of situation cannot exist in the courtroom. If someone brings a matter to court, the IRS must be able to respond if it is a party whose interest are impacted by the proceeding. The decision here seems logical, and it is; however, it averts a very strained reading of the statute offered up by the debtors who want their cake and to have eaten it too.