IRS Refund “Freeze” Not in Violation of Automatic Stay

Posted by NCBRC - September 23, 2012

The Sixth Circuit recently affirmed the lower courts’ holding that the IRS’s failure to immediately issue a post-petition tax refund was not a violation of the automatic stay. In re Harchar, No. 10-4201 (6th Cir. Sept. 12, 2012). After confirmation of the debtor’s chapter 13 plan, which proposed to fully repay priority tax arrearages, she became entitled to a tax refund. The IRS “froze” the refund by removing it from the automated system and processing the refund manually while it sought modification of the plan to include the refund. The court denied the motion to modify and the IRS issued the refund with interest.

The debtor nonetheless filed a complaint asserting claims for, inter alia, violation of the automatic stay, the discharge plan, and the debtor’s right to due process under the Fifth Amendment.

Through several interim appeals, the case found its way to the Sixth Circuit. That court found that the bankruptcy court properly dismissed the claims for violation of the confirmation order, and due process. It held that section 1327, governing the effect of confirmation, does not give the debtor a private right of action and, section 105, as an alternative basis for the claim, does not, under Sixth Circuit precedent, permit damage awards. The due process claim was also properly dismissed because when the government filed its proof of claim it waived its immunity only with respect to the transaction giving rise to that proof of claim, and the refund, relating to more recent tax year, was not the “same transaction.”

As to the violation of automatic stay claim the Sixth Circuit upheld the bankruptcy court’s grant of summary judgment. The court emphasized that the action taken by the IRS was not a “freeze” on the money but was a reasonable removal of the refund from the automated processing system while it considered the appropriate action to take with respect to the refund. In fact, the court reasoned, under the Tax Code, the debtor had no affirmative right to the refund until a date after the IRS had moved to modify the plan, and the IRS’s immediate issuance of the refund upon denial of that motion, indicated that it was not “exercising control” over the funds in violation of the automatic stay. The court also rejected the debtor’s argument that the filing of the motion to modify was merely a “smokescreen” to provide an excuse for withholding the refund and coerce the debtor into paying her IRS debt. Again, the court found that the evidence did not support that finding.

This decision, while disappointing for Ms. Harchar, is limited in its application. The court did not make a broad rule that the IRS may withhold tax refunds even in the face of outstanding tax debt without violating the automatic stay. Nor did it limit in all cases the application of due process to IRS actions with respect to refunds.

NCBRC worked with debtor’s counsel in this case.

Harchar opinion




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