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IRS Violates the Automatic Stay If It Refuses to Allow Debtor to Modify Withholding to Prevent Over-Withholding

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Moulden v. IRS (In re Moulden)(Alquist, J. 2020)

Th Debtor asserts that the IRS sent a “Lock-In Letter” to her employer which directed her employer to disregard her W-4 form and instead withhold taxes using a “Single” filing status and no exemptions. The Debtor asserts that this caused a compulsory over-withholding and that the IRS violated the automatic stay of the 11 U.S.C. § 362(a) by refusing to allow the Debtor to adjust her tax exemptions. The Debtors allege that their wages are property of the estate, and that the IRS has violated the automatic stay by refusing to allow the Debtor to adjust her tax exemptions.

The automatic stay prohibits, among other things, any act to obtain possession of or control over property of the estate. An individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorney’s fees, and, in appropriate circumstances may recover punitive damages. The Debtors assert that Ms. Moulden’s wages are property of the estate; the IRS contends that the portion of the wages that are withheld are not property of the estate because they are held in trust for the United States.

In a Chapter 13 bankruptcy case, “property of the estate includes, in addition to the property specified in section 540 . . . earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed or converted.” If the IRS’s refusal to allow Ms. Moulden to adjust her exemptions does not transform that over withheld amounts into a “tax” and as a result, the IRS’s control over such amounts constitutes “control” over property of the estate and is a violation of the automatic stay.

The IRM is not “law” and is not binding authority on the Court or the IRS. Additionally, two related and overlapping tests are used to determine whether the Police and Regulatory Power exception applies: (1) the “pecuniary purpose” test, which examines whether the government’s primary purpose is to protect the pecuniary interest of the government rather than public safety or health and (2) the public policy. In this case, the “Lock-In Letter” is to ensure that sufficient amounts are withheld from the Debtor’s wages to pay the taxes owed. Therefore, because the primary purpose it to protect the governments pecuniary interest, the police powers exception does not apply. Therefore the IRS’s motion is denied.

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