Tax Season: The IRS is Only a Slightly Special Creditor As Far As You Getting Immediate Bankruptcy Protection

You are protected from the very powerful collection capacities of the IRS during bankruptcy virtually as if it were just any other creditor.

 

In many ways the IRS and state tax authorities are treated very differently than most other creditors. Even when it comes to the key protection that you get from creditors the minute your bankruptcy case is filed—the “automatic stay”—the tax authorities have a series of exceptions that apply only to them. But these exceptions are relatively minor. For most purposes, whether you file a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” (or for that matter a Chapter 11 “reorganization” or a Chapter 12 for farmers and fisherman), the IRS and state have to play by the same rules as everyone else when it comes to this crucial protection.

The “Automatic Stay”

The very act of filing any kind of bankruptcy case puts into motion the automatic stay, a legal mechanism that is more powerful than virtually any collection power of the IRS and the state.

It is automatic in that it is immediate, does not require any action by the bankruptcy court, and cannot be prevented by the IRS or state. It stays—stops—virtually all action by them against you personally or against any of your property whatsoever.

The Bankruptcy Code includes a list of what creditors cannot do because of the “automatic stay.” Here are the prohibitions most clearly applicable to the IRS and state:

  • Start or continue a lawsuit or administrative proceeding to recover a debt you owe (Section 362(a)(1) of the Bankruptcy Code). They can’t start or continue a proceeding in tax court or any other court, or any other procedure against you to collect a tax debt.
  • Take possession or exercise control over property you own as of the time your bankruptcy is filed (Section 362(a)(3)). No garnishments of paychecks or bank accounts, no “levies” on your vehicle or business equipment.
  • Create or enforce a lien against such property (Section 362(a)(4)). No recording of a tax lien against your home or other property, no foreclosure of a previously recorded tax lien.
  • Setoff of a debt owed by the IRS or state to you that existed before the bankruptcy filing, to pay a tax debt that also existed before the bankruptcy filing (Section 362(a)(7)). No grabbing prior tax refunds to pay a prior tax debt.
  • Collect by any means any debt that existed before the bankruptcy filing (Section 362(a)(6)). Covers any other possible way to try to collect taxes against you.

The IRS and State Must Comply

The Bankruptcy Code says that the automatic stay applies “to all entities” (11 U.S.C. Section 362 (a), and the IRS and state taxing agencies are indeed “entities” because that term specifically includes “governmental units” (Section 101(15). So the IRS and all tax collecting “governmental units” are governed by the “automatic stay.”

Like any other creditor the IRS and the state can get slapped pretty hard by the bankruptcy court if they violate the automatic stay by continuing to collect on a debt.  Just as with any other creditor, if you are “injured by any willful violation of [the automatic] stay… [you] shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages” against the IRS. (Section 362(k).) Indeed, in the past the IRS and state tax collectors have been slapped pretty hard by the bankruptcy court when they did violate the automatic stay, so they now tend to behave themselves and follow the law.  

Special Exceptions to the “Automatic Stay” for “Governmental Units”

As mentioned at the beginning of this blog post, the taxing authorities DO have some special exceptions to the automatic stay which apply only to them. They are allowed to start or continue doing a few select actions in spite of a bankruptcy filing (Section 362(b)(9)). But these are sensible exceptions that apply to determining the amount of a tax debt rather than to its collection. Tax authorities CAN demand that you file your tax returns, can “assess” the tax and tell you how much you owe, and can do an audit to figure out the amount of tax owed. But beyond these, they cannot take any action to collect on the tax debt.

Another exception exists which applies generally, not just to tax authorities, and which is important to include here even if it would VERY rarely be applicable in the conventional tax debt situation. The automatic stay does NOT apply to the “commencement or continuation of a criminal action or proceeding against” you (Section 362(b)(1)). There certainly are state and federal crimes associated with severe abuses of the tax laws. These virtually never arise in conventional bankruptcy cases. If you have any fears in this arena, be sure to tell your attorney about them when you first confer with him or her. In most cases, your concerns will be put to rest. 

 

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