Recent Changes in the IRS Bankruptcy Program
by Tommy Mathews
Internal Revenue Service; Washington, D.C.
Consistent with the Internal Revenue Service’s (IRS) broader strategy to reduce the tax gap, the IRS has gradually stepped up activity in the bankruptcy program during the last 18 months – in part by increasing compliance and enforcement actions to better protect the public interest.
The Bankruptcy Abuse and Consumer Protection Act of 2005 (BAPCPA) has helped in two significant ways: First, BAPCPA, on balance, has been favorable to the IRS, shifting some of the tax return filing and payment responsibility back to the debtor as a condition in bankruptcy and requiring the IRS to use fewer resources to compel compliance.
Second, the drop in filings under BAPCPA has reduced the bankruptcy workload so the IRS can devote more resources to the compliance part of the program. The pre-BAPCPA surge in filings lifted bankruptcy inventory to more than 500,000 cases. Since then, the inventory has gradually declined more than 40 percent to today’s level, which is under 300,000. At a caseworker level, the inventory is manageable.
Another improvement that has been structural is the 2005 reorganization of the IRS insolvency program. Most open bankruptcy cases – chapter 7 and confirmed chapter 13 cases – are now handled by the Centralized Insolvency Operation (CIO) in Philadelphia. The CIO inventory is best suited for processing and monitoring in a bulk processing environment. By shifting this routine workload to CIO, the reorganization has enabled the more than 800 bankruptcy personnel in the IRS field offices to focus on cases with the most serious compliance issues and the highest collection potential: chapter 11, pre-confirmation chapter 13 and targeted chapter 7 cases.
Finally, the IRS has increased compliance-training provided to the core field-enforcement personnel, bankruptcy specialists and revenue officers. The curricula have included training in investigative and analytical skills, bankruptcy tax fraud, communication and negotiating techniques and application of administrative enforcement tools.
This combination of the new law, program reorganization and enhanced training has begun to manifest itself in ways that will be a change for some trustees and bankruptcy practitioners. These areas include the following:
Increased Presence at §341(a) Hearings
Bankruptcy specialists have had an active presence at 341 hearings, but in some locations, the IRS missed the opportunity afforded creditors to question the debtor under oath. Because of a good working relationship with the local practitioner community, the issues have often been resolved off line. Other times, the IRS had not yet completed the underlying review and analysis necessary to make that determination – reviewing the schedules, cross-checking assets and valuations with internal and external sources, and conducting a full tax compliance review.
That is changing. In fiscal year 2007, despite the decline in filings, bankruptcy specialists have increased attendance by 40 percent over fiscal year 2006, and are attending about 2,000 hearings monthly.
Although the IRS has field personnel in 47 states and Puerto Rico, providing coverage in some geographic areas is still a change. Over time, staffing will follow workload. For example, the IRS placed staff in Corpus Christi, Texas, to handle work in that part of the state – an area formerly covered by the Austin office more than 200 miles away.
Earlier Investigations of Trust Fund Recovery Penalties
In corporate bankruptcies involving unpaid employment taxes, the IRS is accelerating investigations of individuals responsible under Internal Revenue Code §6672.
Post-discharge Collection from Exempt and Abandoned Property
In cases where there is a pre-petition notice of federal tax lien, the IRS is looking carefully at equity in assets encumbered by the lien prior to releasing it on dischargeable tax periods. Where the asset is substantial, the IRS is able to negotiate and reach an agreement with the debtor on an amount equal to the government’s interest in exchange for a lien release in most cases. In other cases, the lien interest in the property is enforced. Enforcement can be administrative or judicial. For example, in March 2007 the IRS seized and sold realty netting more than $375,000. In other cases, the IRS has referred recommendations to counsel to refer the case to the Department of Justice to file suit to foreclose the tax lien and have the court sell the property.
Post-discharge Collection from Excluded Property
An area the IRS has only recently begun to pursue is collection from property excluded from the estate under Bankruptcy Code §541 – interest in ERISA-qualified pension plans. Unlike collection from exempt or abandoned property that is conditioned on a pre-petition notice of federal tax lien, the IRS is able to rely solely on its statutory lien to collect from excluded property.
As is the case involving exempt property, the IRS prefers, and is usually successful in reaching, a voluntary resolution of excluded property cases. Sometimes that is not possible. For example, the debtor may have no ability to borrow against the asset and have no other ability to pay.
In these situations, the IRS will not enforce the lien interest in retirement accounts except as a last resort. Factors to consider include the debtor’s age and health, employment history, and dependence on the retirement plan to meet necessary living expenses.
These are just a few areas where bankruptcy practitioners may notice a difference in the level and nature of their interactions with the IRS. The IRS has just begun to realize the collection potential in much of the bankruptcy inventory and expects the positive trend in this program to continue.