Suing the IRS

The IRS is often painted as the bad guy taking advantage of taxpayers. For the most part, IRS personnel act professionally in dealing with taxpayers. However, from time to time there are some bad apples. What can an aggrieved taxpayer do?

1. Recovering attorney’s fees

A taxpayer who wins against the IRS may be able to recover some costs from the government (Code Sec. 7430). To do so, a taxpayer must meet all of the following conditions:

• The taxpayer must be the prevailing party. This means the taxpayer must win against the IRS.
• The taxpayer must show that the IRS position taken against him/her was not substantially justified. The IRS is presumed to not be substantially justified if it fails to follow its own published regulations, rulings, etc.
• The amount to be recovered must be reasonable.
• The taxpayer cannot have a net worth exceeding $2 million at the time the action begins. For married couples, this limit applies separately to each spouse, whether or not filing jointly.

Currently, the cap on the hourly rate for attorney’s fees that can be recovered in this way is limited to $200 (in 2016 and 2017). However, a court can increase the award to account for special factors, such as the difficulty of the issues and the availability of local tax expertise. An attorney’s general expertise in tax law or experience in tax litigation is not treated as a special factor justifying a higher fee award.

An attorney who is owed a fee by a client he/she represented cannot sue the IRS for unpaid fees. The Tax Court said no. The case involved a Florida attorney who represented a taxpayer in administrative proceedings against the IRS. The matter was resolved in the taxpayer’s favor and the attorney agreed to accept as his fee any administrative costs recovered from the government. The attorney sent a letter to the IRS seeking administrative costs for his client, and another letter on his own behalf. The IRS did not award any costs and the attorney filed a petition in Tax Court. The Court dismissed the case for lack of jurisdiction.

In the Court’s view, only the taxpayer who is the prevailing party has the right to sue for administrative costs, including attorney’s fees. Here, the attorney was not the prevailing party; his client was. Treating an attorney representing a party in an underlying proceeding as a possible prevailing party conflicts with the express requirement of the statute that administrative costs be “incurred” by the prevailing party.

2. Suing for unauthorized collection

If an IRS employee or officer recklessly, intentionally, or negligently disregards the law or IRS regulations when taking a collection action, you can sue for actual economic damages that result, as well as your costs for the action (Code Sec. 7433). Potential recovery is capped at:

• $100,000 for damages for negligence
• $1 million for damages for reckless or intentional misconduct

You must exhaust administrative remedies before you sue the IRS. If you’ve done this to no avail, the suit must be filed within two years of the date the unauthorized collection action was taken.

3. Suing for emotional distress

Sometimes, being pursued by the IRS gets to be too much to handle. One couple continued to receive IRS letters demanding payment even after they’d filed for bankruptcy. Under the law, once there is a bankruptcy filing, IRS collection activity must stop. Because it did not stop in this case, the couple sued for damages for emotional distress. The bankruptcy court awarded them $4,000, but a district court has reversed the decision. According to the district court, the IRS cannot be sued for emotional distress because of sovereign immunity.

4. Failure to release a tax lien

As in the case of unauthorized collection activities, similar action can be taken if the IRS improperly fails to release a lien on your property (Code Sec. 7432). Again, you must exhaust administrative remedies first and then commence the lawsuit within two years after your claim arose. You can sue for actual economic damages, plus the costs of the action. The same caps applicable to unauthorized collection activities apply here.

5. Disclosure of tax information

IRS employees are barred from unauthorized disclosures of taxpayer information. If they do so negligently or knowingly, a taxpayer can bring an action for civil damages (Code Sec. 7431). Damages are limited to the greater of:

• $1,000 for each act of unauthorized disclosure, or
• The sum of actual damages sustained as a result of the disclosure and punitive damages in cases of willful or grossly negligent disclosure.

The recovery can also include costs of the legal action. Once again, the action must be commenced within two years of the unauthorized disclosure.

What is an unauthorized disclosure? One case said that an IRS press release about the amount of taxes owed by one taxpayer was not a disclosure of a tax return where the information was part of the record in Tax Court.

Conclusion

If you’re unlucky enough to experience misconduct from the IRS, determine whether you can seek a recovery. It may not make you whole financially, but it can go a long way in making you feel better.