June 11, 2018

IRS Cannot Collect Taxes Discharged in Bankruptcy

Tax Relief Articles

Houston Tax Attorney

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In Internal Revenue Service v. Murphy, No. 17-1601 (1st Cir. 2018), the taxpayer discharged his unpaid taxes in bankruptcy.  The IRS continued to try to collect the discharged tax debt.  The case is a must read for taxpayers who find themselves in this same situation.

The Facts & Procedural History

The taxpayer in Murphy filed Chapter 7 bankruptcy.  He included 8 years of unpaid taxes on his bankruptcy petition.  The taxes amounted to just under $600,000.

The bankruptcy court entered an order discharging the tax debt.  The IRS did not object to the discharge.

The IRS then told the taxpayer that the taxes were not discharged and then, in an effort to collect the discharged taxes, it issued a levy to a third party that the taxpayer did business with.

The taxpayer brought suit against the IRS.

The Tax Evasion Exception

The IRS argued that it did not believe the tax debts were discharged in bankruptcy.  This argument relied on the rule that taxes are not discharged in bankruptcy if the taxpayer had willfully attempted to evade the taxes.  Put another way, taxes are not discharged in bankruptcy if the taxpayer committed tax evasion.  The IRS did not present any evidence of tax evasion.

What is a Willful Violation?

The bankruptcy court concluded that a “willful violation” occurs “when, with knowledge of the discharge, [a creditor] intends to take an action, and that action is determined to be an attempt to collect a discharged debt.”

On appeal, the district court agreed.  It concluded that a creditor’s “good faith belief in a right to the property is not relevant to a determination of whether the violation was willful.”

On appeal from the district court, the First Circuit also agreed.  It rejected the IRS’s argument that a good faith belief is not relevant.

The IRS agreed to settle the matter by paying $175,000 to the taxpayer as damages.

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