Can the IRS Ignore the Bankruptcy Stay?

17 Feb Can the IRS Ignore the Bankruptcy Stay?

Courtesy Dreamstime

Courtesy Dreamstime

The bankruptcy automatic stay is the first major benefit for the debtor when a case is commenced. Immediately after the filing fee is paid and a bankruptcy 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 §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?

Exceptions to the Automatic Stay

There are a few exceptions to the protection a debtor in bankruptcy is given by the automatic stay in bankruputcy. Collection by the IRS is not an exception. 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? 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 on purpose, andif it is considered a “willful” violation, substantial penalties can apply. In the event of an intentional violation of the bankruptcy stay, federal law provides strong remedies for the debtor. After a willful stay violation, the debtor cannot only recover the money or property that was wrongfully taken, attorney fees and even punitive damages may be available.

What about the IRS?

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 can not 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 or attorney fees can be recovered from the IRS. For details of how the process works and citations to additional information, see a detailed article on In Re Cooper by North Carolina bankruptcy expert, attorney Ed Boltz.

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 toknock it offand count on the court to back them up.

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I was admitted to practice in 1978. I am certified as a Consumer Bankruptcy Specialist by the American Board of Certification. I regularly speak on tax and bankruptcy issues at state, regional and national conferences. Years of experience in practice before the Internal Revenue Service and Oregon Department of Revenue have given me the background to resolve a large variety of consumer tax issues.
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