Bankruptcy court awards damages for automated IRS notices By: National Association of Tax Professionals
June 22, 2022

A West Virginia bankruptcy court has ordered the IRS to pay damages after the agency sent automated notices to taxpayers who’d had their tax debt discharged through bankruptcy. The court rejected the IRS’s claim that it had not willfully violated the discharge order because the collection attempts were made through automated delivery systems that were affected by the COVID-19 pandemic

The In re. Williams-McAuliffe (Bankr. N.D.W. Va. 2022) decision by the U.S. Bankruptcy Court for the Northern District of West Virginia found the IRS must pay damages when an employee willfully violates a discharge order by sending a collection notice. It is a violation of federal law to attempt to collect a debt after it has been discharged in bankruptcy.

While the court only awarded the taxpayers $498 in damages (and refunded the $235 fee for reopening the bankruptcy case), the decision is notable for finding the IRS liable for damages taxpayers suffered because of erroneously issued collection notices. In February the IRS suspended most of its automated collection notices after coming under pressure from the Taxpayer Relief Coalition — which includes NATP — and other advocacy organizations because many of the notices were being issued erroneously due to the IRS’s substantial backlog of unprocessed returns.

Couple files for Chapter 13 bankruptcy

The McAuliffes are a married couple who filed for Chapter 13 bankruptcy in 2016, the bankruptcy court said. The IRS filed a bankruptcy court claim seeking $13,625 in unpaid taxes for 2010 and 2011, $7,230 of which was secured. While the couple entered into an installment agreement to repay the IRS, they terminated their agreement and paid their outstanding debt through the Chapter 13 repayment plan. The McAuliffes received a bankruptcy discharge in September 2019 and the IRS received 22% of the unsecured portion of its claim, which was roughly $1,400.

Despite the IRS debt having been discharged, the bankruptcy court said the agency sent the McAuliffes demand letters in February and March 2020 seeking to collect the monthly payment due under the terminated installment agreement. The husband, a bankruptcy attorney, sent a letter to the IRS in March 2020 explaining the error, but sent it to the wrong office. The couple received another collection letter in August 2020.

Despite the third demand letter, the IRS failed to acknowledge the McAuliffes’ March 2020 letter until Sept. 29, 2020, at which point the IRS said it would need 60 days to review their liability. However, contrary to the statement that it would review the couple’s liability, the IRS had already abated their 2010 and 2011 taxes the day before the letter was sent. The IRS attributed the seven-month delay in responding and miscommunication to a combination of the COVID-19 pandemic and the McAuliffes’ mailing their letter to the wrong office.

While the couple’s bankruptcy case was before the bankruptcy court, they incurred additional tax liabilities for the 2018 tax year, which they did not contest. The McAuliffe’s said they intended to enter into an installment agreement for those debts but were prevented from doing so by the IRS’s claims they had unpaid 2010 and 2011 tax debts. The court said they tried to contact the agency in an attempt to enter into an installment agreement regarding their debts for 2018 as early as January 2020.

The bankruptcy court reopened the McAuliffes’ bankruptcy case in December 2020 and the couple filed for an adversary proceeding shortly thereafter. The IRS was granted no relief through administrative remedies, but in August 2021 it sent the couple a letter stating its intent to end their installment agreement and that $1,150 must be paid immediately to avoid default. It also sent a notice of intent to levy. About this time the couple was notified by the IRS that it was accepting their installment agreement to pay their 2018 debts, which was almost 20 months after their initial request.

Taxpayers seek damages based on bankruptcy law

The McAuliffes sought damages under §7433(e) of the U.S. Bankruptcy Code, which allows debtors to seek damages for violations of a bankruptcy discharge.

The IRS claimed the automatic collection notices were “non-threatening” and should not be viewed as a collection action. The court disagreed, noting the letters state that a monthly payment is due immediately and threatens the taxpayer with default if no payment is made. Additionally, the court observed the notice contained no disclaimers stating that it was not trying to collect a debt. “This surely gives the appearance of an attempt to collect, whether sent to a layperson or a well-experienced bankruptcy attorney and his spouse,” it concluded.

Next, the IRS argued that to find a willful violation, the court needed to find that a specific employee violated the discharge order; it also cited cases where courts found that clerical errors were inadvertent. The bankruptcy court found the IRS failed to enter the discharge into its system for almost 12 months and the McAuliffes made multiple attempts to resolve the issue only for the agency to continue trying to collect the debt. It said that those did not qualify as clerical errors.

The IRS also contended the automatic nature of the collection notices removed them from the control of IRS employees, which should shield the agency from penalties intended to punish employee misconduct. The bankruptcy court rejected the argument, finding that if the IRS employees and automated systems are disconnected from the actions of other offices, it is the agency that should be held responsible and not the taxpayer.

Finally, the bankruptcy court did not agree with the IRS’s claim that the COVID-19 pandemic should be taken into account when assessing the agency’s actions. “While COVID-19 is having a significant impact on all levels of the federal government, it does not excuse repeated attempts to collect on a Plaintiff doing everything possible to correct any miscommunications,” the court explained.

Damages based on interest and penalties accrued

The McAuliffes asked the court for damages related to the IRS’s unlawful collection attempts, court costs and legal fees. Among other things, the couple claimed they accepted an offer for their house that was $15,000 below its market value because they were concerned about the notices they were receiving from IRS about the discharged tax debt. However, the court found the sale took place nearly a year after they received an abatement for their 2010 and 2011 taxes from the IRS; therefore, the claim was speculative and not concretely proven.

The bankruptcy court did award the McAuliffes damages based on the interest and penalties assessed by the IRS on their 2018 tax liability. It found that the interest and missed payment penalties the couple accrued between the time they received their first collection letter until the IRS’s decision to accept their settlement offer were actual damages resulting from the agency’s violation of its discharge order. It concluded that the interest and failure to pay penalties had increased by $498 during the time between the IRS issuing the March 2020 notice and the time the IRS accepted an installment agreement.

For more information on bankruptcy, installment agreements and other collection alternatives, check out the NATP’s on-demand online workshop on resolving back tax debts.

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penAbout National Association of Tax Professionals

The National Association of Tax Professionals (NATP) is the largest association dedicated to equipping tax professionals with the resources, connections and education they need to provide the highest level of service to their clients. NATP is comprised of over 23,000 leading tax professionals who believe in a superior standard of ethics and exemplify professional excellence. Members rely on NATP to deliver professional connections, content expertise and advocacy that provides them with the support they need to best serve their clients. The organization welcomes all tax professionals in their quest to continually meet the needs of the public, no matter where they are in their careers.

The NATP headquarters is located in Appleton, WI. To learn more, visit www.natptax.com.

Information included in this article is accurate as of the publish date. This post is not reflective of tax law changes or IRS guidance that may have occurred after the date of publishing. All taxpayer circumstances are different, and NATP recommends contacting research services if you have specific questions about your clients’ tax situations.

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