CAN THE IRS IGNORE A BANKRUPTCY?

The bankruptcy stay is the first major benefit for the debtor when a bankruptcy is commenced. Immediately after the filing fee is paid and a petition is filed, virtually every type of collection activity is called to a halt. An order is entered by the bankruptcy court under 11 USC Section 362 prohibiting nearly all creditors from taking any type of collection action. After months or even years of calls, letters and perhaps wage garnishment the automatic stay of the bankruptcy court is a welcome relief indeed. But does it stop everyone? Does it stop even the Internal Revenue Service?

While there are few exceptions to the protection a debtor in bankruptcy is given by the automatic stay, collection by the IRS is not among them. That is to say, even the IRS is prohibited from collecting after the petition has been filed. While the IRS can continue to audit tax returns during a bankruptcy proceeding, and may even determine that a tax is due, it cannot start or continue enforced collection. The IRS must stop any wage levy and if it files a tax lien after the bankruptcy petition has been filed, it must withdraw the lien.
What happens if the bankruptcy automatic stay is violated? Well, as a general principal, if a creditor violates the automatic stay by accident, it must return the money or stop the collection action as soon as it learns about the bankruptcy. However, if the stay violation is done willfully (ie., on purpose), then the creditor faces serious penalties as federal law provides strong remedies for the debtor. After a willful stay violation, the debtor can not only recover the money or property that was wrongfully taken, attorney fees and even punitive damages may be available.

The IRS instructs its collectors to stop all collection activities when they learn of a bankruptcy. In spite of these instructions, there are times when an overzealous tax collector violates the automatic stay on purpose. While some statutory remedies are available, the debtor cannot recover punitive damages against the government. Special rules apply and, based on 26 USC §7433 (d)(1) an aggrieved taxpayer in bankruptcy must first go through IRS administrative process to fix the problem. Treasury Regulation 301.7433-2(d)(1) sets out a procedure that must first be followed before any damages can be recovered from the IRS.
Despite the additional requirements of IRS regulations, the bankruptcy stay remains powerful protection from the tax collector. There are few other situations in which the debtor can tell the IRS to stop collections and count on the court to back them up. If you are being harassed by the IRS, call us today for a free consultation.