A debtor is a person or business that incurs financial liability and owes money to another person or business, which is considered the creditor. When debtors cannot meet financial obligations to their creditors, debtors can petition (file) for bankruptcy with the Federal Bankruptcy Court. The Bankruptcy Code, 11 U.S.C. Section 362, prohibits creditors from acting against individuals after they have filed for bankruptcy, which is known as the "automatic stay." As long as the automatic stay is in effect, creditors generally cannot take actions, such as initiating or continuing lawsuits, garnishing wages, or even making telephone calls demanding payments.

During Fiscal Year (FY) 1999, approximately 1.35 million individuals and businesses filed for bankruptcy. While the Internal Revenue Service (IRS) is not a creditor for each debtor filing for bankruptcy protection, a significant number of the debtors have outstanding tax liabilities. For FY 1999, IRS data show approximately 575,000 debtors entered bankruptcy status owing the IRS $3.4 billion.

The IRS Restructuring and Reform Act of 1998 (RRA 98) allows taxpayers to sue when an IRS employee willfully violates the automatic stay provisions. The Internal Revenue Code (I.R.C.), 26 U.S.C. Section 7433(e), generally provides that taxpayers can recover damages from the IRS if an employee willfully violates the provisions of the Bankruptcy Code (11 U.S.C.). The I.R.C. provides for actual damages up to $1,000,000 for reckless or intentional disregard for provisions of the I.R.C. and $100,000 for instances involving negligence.

Our overall objective was to determine if the IRS effectively prevents and identifies violations of the Bankruptcy Code automatic stay provisions.

The IRS is not always accomplishing its objective of effectively preventing and identifying violations of the Bankruptcy Code automatic stay provisions. For the 3 districts in our review, approximately 86,000 bankruptcies were input to the Automated Insolvency System (AIS) during FY 1999. Of the 86,000 bankruptcies, we identified 7,825 cases in which some collection actions (e.g., payments made) may have been taken after the taxpayers filed for bankruptcy. We reviewed a sample of 420 of the 7,825 cases and found violations of the automatic stay provisions in 143 (34 percent).

The IRS is vulnerable to taxpayers recovering damages when violations of the automatic stay occur and are not properly identified and corrected. As of January 2000, the IRS indicated that only one taxpayer nationwide had filed an administrative claim because of the IRS violating the automatic stay provisions. However, taxpayers may not be aware of their rights to file an administrative claim, and, should they become aware, this number could increase significantly.

The Special Procedures functions (SPf) in the IRS’ field offices receive computer-generated litigation transcripts for accounts that are in bankruptcy status. These transcripts identify activity (e.g., payments) that has posted to the taxpayer’s account after the bankruptcy status was input. However, the number of transcripts generated is voluminous, and the SPfs are not reviewing them for potential violations of the automatic stay in order for the IRS to identify and remedy the violations that may occur.

Our review of the 420 cases identified 115 payments received from taxpayers, 16 liens filed against taxpayers, and 12 credit transfers made after the bankruptcy petition date. These situations are considered violations of the automatic stay provisions of the Bankruptcy Code. Since litigation transcripts were not effectively used, the SPfs did not identify these violations and did not correct them (e.g., returning the payments or releasing the liens).

Even when the IRS identifies payments received after the bankruptcy petition date, the payments are not being consistently refunded to the taxpayers or trustees. The IRS’ procedures do not adequately address payments received from payroll deduction agreements, direct debit agreements, or installment agreements (i.e., monthly payment arrangements). As a result, the rights of taxpayers and other creditors are not being protected.

Finally, although they are not violations of the automatic stay, we identified 40 statutory assessments made during the bankruptcy proceedings. In these cases, the 90-day statutory notice period did not expire prior to the bankruptcy petition date. As a result, these assessments are not valid. These cases could also be identified on the litigation transcripts if they were appropriately reviewed.

To prevent violations of the automatic stay, employees in the SPf input freeze codes to taxpayers’ accounts located on the IRS computer system known as the Masterfile. Generally, we did not identify any significant delays on the input of the bankruptcy freeze once the case had been recorded on the AIS. However, two controls to monitor this process could be improved.

• One important control is a report that measures the timeliness of initial case processing. This is the period from the IRS’ receipt of bankruptcy notification to the input of the bankruptcy freeze. Instead of using the actual date the IRS received the bankruptcy notification, the measure is based on the date of input to the AIS, which can be days or weeks after the actual date received.
• Another control is the Potentially Invalid Taxpayer Identification Number (PIT) report that identifies differences between names and taxpayer identification numbers on the Masterfile and the AIS. Managers are not ensuring that SPf employees are timely and appropriately resolving the potential differences on this report to prevent inappropriate collection actions on the taxpayers’ accounts. In 1 district, employees did not timely and effectively address the PIT report and, as a result, cases up to 2 months old were still appearing on the listings.

IRS Collection function management needs to ensure that the bankruptcy examiners are monitoring the litigation transcripts upon receipt to identify any violations of the automatic stay and that appropriate action is taken if violations have occurred. They also need to determine if an electronic version of the transcripts can be matched against the AIS so examiners can more easily identify and review cases that have payments, liens, or credit transfers after the bankruptcy was input. The Internal Revenue Manual needs to be updated to include procedures for refunding payments received after the bankruptcy petition is filed. Management needs to provide consistent guidelines on how and when to notify the Examination function that a taxpayer is currently in bankruptcy. The AIS also needs to be reprogrammed so the actual IRS receipt date of the case can be input to provide more accurate management information system data. Finally, steps need to be taken to ensure employees timely and effectively address the PIT report to resolve all cases appropriately and ensure posting of the bankruptcies to taxpayers’ accounts.

Management’s Response: Management’s response was due on September 25, 2000. As of September 26, 2000, management had not responded to the draft report.