On May 8, 2018, Chief Bankruptcy Judge Isicoff for the Southern District of Florida issued an opinion addressing the question: if a former debtor seeks damages or attorneys’ fees and costs from the IRS for violating the discharge injunction, is the former debtor first required to exhaust administrative remedies prior to seeking recourse from the bankruptcy court?  The answer was yes, administrative remedies must be exhausted.

In re Thal, 09-12434 (Bankr. S.D. Fla. May 8, 2018) dealt with the above-issue as presented in two bankruptcy cases.  In each, the IRS had filed priority and general unsecured claims in the debtors’ chapter 13 cases.  Through their chapter 13 bankruptcy plans, the debtors paid the IRS’ priority claims in full, completed all other plan payments, and received discharges.  Subsequently, the IRS served notices of intent to levy on each of the former debtors, and seized a portion of one debtor’s Social Security benefits and the other debtor’s tax refund.  In response, the debtors filed motions for sanctions against the IRS for violation of the discharge injunction.

Violation of the Discharge Injunction:  The bankruptcy court first held that the IRS’ collection efforts violated the discharge injunction provided by 11 U.S.C. § 1328(a).  With respect to the first debtor’s case, the court dismissed the IRS’ argument against sanctions on grounds that it acted without knowing it was violating the discharge injunction. The court found the IRS had received notice of the debtor’s discharge when the debtor’s bankruptcy case was closed, and its interception of federal funds otherwise payable to the debtor was intentional, notwithstanding the argument that the act was not a deliberate decision to violate the discharge injunction.

Similarly, the court dismissed the IRS’ argument that it did not violate the discharge injunction in the second debtor’s case because priority taxes are non-dischargeable. The court found that the IRS’ claim had been discharged by payment in full under the debtor’s plan. Under Chapter 13 of the Bankruptcy Code, in order to confirm a Chapter 13 plan, a debtor must agree to pay all priority tax debt in full over the life of the plan.  See 11 U.S.C. §§ 507, 1322(a)(2).  Under Section 1238(a) of the Bankruptcy Code, a discharge is granted in a Chapter 13 upon completion of all plan payments.  A Chapter 13 debtor who successfully obtains a discharge is relieved from further liability associated with the priority tax debt.  Thus, the IRS’s actions violated the discharge injunction.

Punitive Damages and Return of Funds: One debtor requested punitive damages and attorneys’ fees arising from the violation.  The second debtor sought a finding of contempt, return of his funds, and attorneys’ fees.  The court held that it was authorized to grant some relief, but could not grant all relief requested without the debtors exhausting the administrative remedies established by applicable IRS regulations.  Concerning the first debtor’s request, the court explained it had no authority to award punitive damages pursuant to 11 U.S.C. § 106(a)(3), a statute abrogating the United States’ sovereign immunity with respect to various provisions of the Bankruptcy Code but specifically carving out the court’s ability to award punitive damages against a governmental unit.  As to the second debtor’s request for return of his funds, the court found it had authority to grant such relief without the need to pursue administrative remedies through IRS regulations, since the request was not a claim for damages under 26 U.S.C. § 7433.

Damages and Costs of Litigation:  The court then turned to the crux of the opinion: that the debtors were required to exhaust their administrative remedies prior to petitioning the bankruptcy court for damages.

Section 7430 of the Internal Revenue Code (the “IRC”) allows the prevailing party in an administrative or court proceeding “brought by or against the United States in connection with the determination, collection, or refund of any tax, interest or penalty” under the IRC an award of reasonable administrative costs and reasonable litigation costs.  Section 7430(b)(1), however, requires the prevailing party to first exhaust administrative remedies available within the IRS.  Under Section 7433(a), a taxpayer may bring a civil action in district court for damages against the United States when the IRS recklessly, intentionally or negligently disregards any provision of the IRC or IRS regulations.  Section 7433(e) provides that a taxpayer may petition the bankruptcy court to recover damage for any willful violation of the automatic stay or discharge injunction.  Again, however, the plaintiff must have exhausted the administrative remedies available to it within the IRC.  26 U.S.C. § 7433(d).  Further, because Section 7433(e) also provides that, other than an action under Section 362(k) of the Bankruptcy Code, the referenced petition is the exclusive remedy for recovering damages resulting from discharge injunction violations, the court found that Section 7433 applies to any claim for damages for violation of the discharge injunction, and exhaustion of administrative remedies is therefore required pursuant to Section 7433(d).

In sum, the court held that a party seeking damages from the IRS for violation of the discharge injunction must make any claim to the bankruptcy court, not the district court, and the claim can only be made after exhaustion of internal IRS administrative remedies.