Byron Jha

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UNITED STATES BANKRUPTCY COURT
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AUTHENTICAT,
U.S. GOVERNMENT,
INFORMATION

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Entered on Docket
October 07, 2011

GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA

FILED

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In re Case No. 08-53283-ASW

BYRON JHA, Chapter 13

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MEMORANDUM DECISION RE MOTION FOR DAMAGES FOR
VIOLATION OF THE AUTOMATIC STAY

Before the Court is the motion (“Motion”) by debtor Byron Jha
(“Debtor”) for damages against the United States of America,
Internal Revenue Service (“IRS”), for violation of the automatic
stay. The IRS concedes that the IRS violated the automatic stay by
sending nine Notice of Intent to Levy letters to Debtor post-
petition. Debtor also seeks a determination that the IRS violated
the automatic stay by not revising the amount of withholdings from
Debtor’s post-petition wages that were subject to a letter sent by
the IRS pre-petition to Debtor’s employer setting the amount of
taxes to be withheld from Debtor’s wages. The IRS opposes that
aspect of the Motion as well as Debtor’s damages.

The Court heard lengthy oral argument on the Motion and the

matter was taken under submission upon the filing of supplemental

EMORANDUM DECISION RE

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UNITED STATES BANKRUPTCY COURT
For The Northern District Of California

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pleadings by the IRS. Debtor is represented by Cathleen Cooper
Moran, Esq. of Moran Law Group, Inc. Special Assistant United
States Attorney Chong S. Hong, Esq. represents the IRS.

This Memorandum Decision constitutes the Court’s findings of
fact and conclusions of law, pursuant to Rule 7052 of the Federal

Rules of Bankruptcy Procedure.

I.
FACTS

Pre-petition, on or about August 3, 2007, Debtor provided a
Form W-4 Employee’s Withholding Allowance Certificate (“Withholding
Request”) to Debtor’s employer requesting that Debtor’s federal
income tax withholding be based on single status with 5 withholding
allowances.’

On April 17, 2008, the IRS sent a letter to Debtor (“Lock-in
Letter”)* informing Debtor that the IRS was going to instruct
Debtor’s employer to disregard the Withholding Request and instead
instruct Debtor’s employer to withhold income tax from Debtor’s
wages based on a marital status of single and no withholding
allowances. The Lock-in Letter was sent based on a Withholding
Compliance Referral dated February 29, 2008. The Withholding
Compliance Referral was based on the fact that Debtor had owed

taxes for every year since 1999 and Debtor had not voluntarily

' Exhibit B to the Declaration of Chong S. Hong in Support of

Supplemental Response to Motion for Damages for Violation of Stay,
filed on December 15, 2008 (“Hong Dec.”).

2 Exhibit B to Debtor’s Motion for Damages Against the United
States of America, Internal Revenue Service for Violation of the
Automatic Stay, filed on September 17, 2008 (“Debtor’s Motion”) and
attached to this Memorandum Decision.

MEMORANDUM DECISION RE .
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UNITED STATES BANKRUPTCY COURT
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changed Debtor’s Form W-4.? Specifically, for the tax years 2001-

2007, Debtor underwithheld taxes as follows:

Tax Year | Tax Per Return | Withholding Credit | Underwithholding
2001 $26,937 $15,540 $11,397
2002 $26,026 $7,876 $18,150
2003 $17,718 $2,637 $15,081
2004 $10,931 $7,211 $3,720
2005 $14,316 $9,825 $4,491
2006 $11,639 $6,898 $2,495%
2007 $15,233 $10,411 $4,822

Debtor’s bankruptcy schedules filed on July 8, 2008 show Debtor
owed the IRS an aggregate of $145,575.00 in secured, priority and
unsecured taxes for the tax years 1999-2007.

The Lock-in Letter provided that if Debtor disagreed with the
IRS’ determination of the withholding allowance, Debtor was to call
the IRS at a telephone number provided in the Lock-in Letter and
explain to the IRS why Debtor would be entitled to a different
marital status and/or number of withholding allowances. Debtor
could also contest the proposed withholding allowances in writing.
If the IRS did not hear from Debtor within 30 days from the date of
the Lock-in Letter, Debtor’s employer was instructed to withhold
taxes at the status and allowance provided by the Lock-in Letter.
The Lock-in Letter provided that if Debtor believed at a later time

that Debtor was entitled to claim a different marital status and/or

3 Exhibit A to the Declaration of Cathleen Cooper Moran in

Support of Motion for Damages for Violation of Stay, filed on
July 22, 2009 (“Moran Dec.”).

4 Debtor made 2 estimated tax payments in 2006 in the amount
of $1,123 each, resulting in total credits of $9,144 for 2006.

MEMORANDUM DECISION RE

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UNITED STATES BANKRUPTCY COURT
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more withholding allowances than the IRS determined, Debtor could
complete a new Form W-4 as well as a written statement to support
the claims made on the new Form W-4 and submit both documents to
the IRS at an address provided in the Lock-in Letter. The Lock-in
Letter withholding allowances took effect sometime after the pay
date of May 23, 2008.° The Lock-in Letter increased the amount
withheld by $148.97 per two-week pay period.®

On June 23, 2008, Debtor filed a voluntary petition under
Chapter 13 of the Bankruptcy Code. According to Debtor’s schedules
filed on July 8, 2008, Debtor is a single father with two minor
children.’ At the time Debtor filed Debtor’s bankruptcy petition,
Debtor earned $5,384.57 per month working as an operations
manager,® and his monthly expenses were $4,855.00.° Debtor’s only
significant asset is a 2004 Dodge Caravan.’°

Debtor scheduled secured debt on the 2004 Dodge Caravan and

for income taxes owed to the IRS.'4 Debtor scheduled priority taxes

5 Exhibit A to Declaration of Byron Jha in Support of Motion

for Damages for Violation of Stay, filed on September 17, 2008
(“Original Jha Dec.”).

6 Exhibit B to Original Jha Dec.

ee Schedule I.
8 Schedule I shows Debtor earned $5,384.57 per month working
as an operations manager for Taymor Industries. This is Debtor’s
only source of income.

° ee Schedule J.
"0 See Schedule A and Schedule B. Debtor’s Schedule B lists
personal property with a current market value of only $6,305.00 --
of which $5,730.00 is attributable to the 2004 Dodge Caravan.

| The two secured claims noted on Schedule D is a tax lien by
the IRS securing a claim of $575.00 and a lien for Debtor’s 2004
Dodge Caravan in the amount of $9,677.00.

MEMORANDUM DECISION R

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UNITED STATES BANKRUPTCY COURT

For The Northern District Of California

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owed to the IRS in the amount of $18,500.00 on Schedule E. Debtor
also scheduled $163,995.00 in unsecured claims on Schedule F, of
which $126,500.00 was for income taxes owed to the IRS for the
years 1999-2003, plus dischargeable penalties.

On June 24, 2008, Debtor’s bankruptcy counsel, Ms. Moran,
provided notice of the commencement of Debtor’s bankruptcy case to
the IRS Special Procedures office in San Jose.’* On July 4, 2008,
the Bankruptcy Noticing Center sent a Notice of Chapter 13
Bankruptcy Case, Meeting of Creditors and Deadlines to the IRS.

On July 3, 2008, Ms. Moran left a substantive message for IRS
attorney James Whitten.'? On July 16, 2008, Ms. Moran called Mr.
Whitten who referred Ms. Moran to IRS attorney Chong Hong.!* On
July 16, 2008, Ms. Moran called Mr. Hong and faxed to Mr. Hong a
copy of the Lock-in Letter.*

Also on or about July 16, 2008, Debtor received in the mail
nine separate Notices of Intent to Levy issued by the IRS relating
to Debtor’s delinquent taxes for the tax years 1999 through 2007.'®
On July 17, 2008, Ms. Moran called Mr. Hong and left a substantive
message regarding the nine Notices of Intent to Levy.!’ The nine
Notices of Intent to Levy caused Debtor increased stress such that

Debtor took six vacation days from work and did not take Debtor’s

Moran Dec. at 1:24-26 and Exhibit A thereto.
Moran Dec. at 2:2.

Moran Dec. at 2:3-4.

Moran Dec. at 2:5-6.

'@ Exhibit D to Debtor’s Motion.

7 Moran Dec. at 2:7-8.

MEMORANDUM DECISION R

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UNITED STATES BANKRUPTCY COURT
For The Northern District Of California

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children on vacation as planned, representing $2,318.36 in
earnings. Debtor spent an additional $20 on medication for stomach
distress. On July 21, 2008, Ms. Moran received a telephone call
from Mr. Hong confirming that the IRS would not pursue any levies
or liens against Debtor.'®

On July 23, 2008, the IRS filed its proof of claim against
Debtor asserting a secured claim of $575.00; a priority claim of
$16,904.79; and an unsecured claim of $124,588.85 for income taxes
due for 1999-2007.

On August 6, 2008, Debtor filed an amended Chapter 13 plan to
reduce the monthly plan payments from $525 per month to $300 per
month for the first 12 months and provide for stepped-up plan
payments thereafter because Debtor did not have sufficient income
with the Lock-in Letter in place for Debtor to make the original
proposed plan payments of $525. The attorneys fees associated with
the amendment to Debtor’s plan total $112.50.

Debtor filed this Motion on September 17, 2008 seeking damages
for violation of the automatic stay for both the IRS sending the
nine Notices of Intent to Levy sent post-petition as well as the
IRS’ failure to lift the Lock-in Letter post-petition.

The Lock-in Letter was in effect through December 2008.19

Debtor was entitled to a federal income tax refund of

$5,131.00 for the 2008 tax year.”°

'8 Moran Dec. at 2:9-10; Hong Dec. at 2:8.

9 Declaration of Byron Jha in Support of Motion for Damages

for Violation of Stay, filed on July 22, 2009 (“Jha Dec.”), at
1:22-23.

20 Sha Dec. at 1:24-25.

MEMORANDUM DECISION RE

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UNITED STATES BANKRUPTCY COURT
For The Northern District Of California

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Il.
ANALYSIS
A party seeking damages for violation of the automatic stay
must prove by a preponderance of the evidence that: (1) a
bankruptcy petition was filed; (2) the debtor is an individual;
(3) the creditor received notice of the petition; (4) the
creditor’s actions were in willful violation of the stay; and

(5) the debtor suffered damages. In re Henry, 328 B.R. 664, 667

(Bankr. E.D.N.Y. 2005) (citations omitted). The first three
elements are met in this case. The IRS concedes that the IRS’
issuance of the nine Notices of Intent to Levy post-petition
violated the automatic stay. The issues before the Court are
whether: (1) the IRS’ failure to lift the Lock-in Letter post-
petition was a willful violation of the automatic stay; and
(2) what, if any, damages, Debtor suffered as a result of any
willful violation of the automatic stay.

A. lLock-in Letter

Debtor asserts that the pre-petition Lock-in Letter
impermissibly asserts control over property of Debtor’s bankruptcy
in violation of Bankruptcy Code § 362(a) (3), which provides:

(a) Except as provided in subsection (b) of this

section, a petition filed under section 301, 302, or

303 of this title, or an application filed under

section 5(a) (3) of the Securities Investor Protection Act

of 1970, operates as a stay, applicable to all entities
of --

(3) any act to obtain possession of property of the
estate or of property from the estate or to exercise
control over property of the estate;

11 U.S.C. § 362(a) (3). According to Debtor, Bankruptcy Code

§ 1306(a) (2) classifies post-petition earnings as property of the

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bankruptcy estate. Because the Lock-in Letter required Debtor’s
employer to turn over wages in excess of the taxes owed for the tax
year to which the Lock-in Letter applied, as demonstrated by the
fact that Debtor received a federal income tax refund of over
$5,000 for the 2008 tax year, the compulsory overwithholding of
Debtor’s wages violated the automatic stay.

The IRS contends that lock-in letters sent pre-petition do not
violate the automatic stay for three reasons. First, lock-in
letters are not an attempt to collect pre-petition taxes. Instead,
lock-in letters only target withholding for the current tax year.
Because Debtor did not bifurcate Debtor’s tax year, all taxes due
in 2008 are post-petition taxes. See 26 U.S.C. § 1398(d). Second,
monies withheld by an employer are not property of the bankruptcy
estate and, rather, are held in trust for the IRS. Begier v.

United States, 493 U.S. 53 (1990). Third, even if monies withheld

by an employer are considered to be property of the bankruptcy
estate, the issuance of a lock-in letter falls within the exercise
of police and regulatory powers exception of Bankruptcy Code
§ 362(b) (4). Because the Court determines that the monies withheld
by Debtor’s employer pursuant to the Lock-in Letter were not
property of the estate, the Court does not address the IRS’
argument that leaving the Lock-in Letter in place falls within the
exercise of police and regulatory powers exception of Bankruptcy
Code § 362(b) (4).
1. Nature and Purpose of Lock-in Letters
As explained by the United States Tax Court:
In 1943, Congress required the withholding of income
taxes at the source on wages, see Current Tax Payment Act

of 1943, ch. 120, 57 Stat. 126, and this pay-as-you-go
system for employees has been in place ever since.

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Withholding alleviates the burden on wage earners of
having to make large payments of tax at one time, and it
benefits the Government not only by providing a more
constant stream of receipts but also by protecting
“against deaths, disappearances, and insolvencies, and to
catch the itinerants who were moving from place to place
with incomes taxable in the aggregate but with whom the
Treasury could not keep pace.” 13 Mertens, Law of
Federal Income Taxation, sec. 47A.02, at 47A-8 (2005
rev.).

The Commissioner has described income tax
withholding as other than a tax in itself. Rev. Rul.
60-220, 1960-1 C.B. 399; see sec. 3402; sec.
31.3402(a)-1, Employment Tax Regs. During the taxable
year, a taxpayer’s liability is inchoate and not
precisely determinable. After the close of the year,
however, the taxpayer determines his or her liability,
reports it on a return, and offsets the tax withheld
against that liability. If there is excess withholding,
it may be claimed as an overpayment, and in most
instances it is promptly refunded to the taxpayer.

There are those who may seek to avoid withholding by
claiming to be exempt therefrom or by overstating their
withholding allowances on Form W-4. The Commissioner’s
Withholding Compliance Program is designed to deal with
such situations:

The mission of the Withholding Compliance
Program is to ensure that taxpayers who have
serious under-withholding problems are brought
into compliance with federal income tax
withholding requirements. The program uses
Form W-2 Wage and Tax Statement (W-2)
information to identify taxpayers with
insufficient withholding. The goal is to
correct withholding to ensure that taxpayers
have enough income tax withheld to meet their
tax obligations. [IRM 5.19.11.1(1) (May 1,
2006) .]

Integral to the Withholding Compliance Program is
the “Lock-in Letter”:

Letters 2800C and 2801C, mailed to the employer
and the taxpayer, respectively, are commonly
known as the “lock-in letters”. Letter 2800C
instructs the employer to disregard the Form
W-4 submitted by the taxpayer and withhold at
the marital status and the number of allowances
determined by the Service. Letter 2801C
advises the taxpayer that the employer has been
instructed to disregard the Form W-4 submitted
by the taxpayer and withhold at the rate

MEMORANDUM DECISION RE
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UNITED STATES BANKRUPTCY COURT

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specified in Letter 2800C. [IRM 5.19.11.3.2(1)
(May 1, 2006) .]

Internal Revenue Manual provisions contemplate
taxpayer responses to “Lock-in Letters” and provide for
redeterminations, specifically including a release of the
“lock-in”. E.g., IRM 5.19.11.3.9 (May 1, 2006); IRM
5.19.11.3.10 (May 1, 2006). These provisions are based
on authority granted by regulations. See sec.
31.3402(f£) (2) -1(g), Employment Tax Regs.

Davis v. Commissioner, T.C. Memo. 2008-238, 2008 WL 4703706, *4

(2008) (footnotes omitted).

The Court finds that the purpose of the Lock-in Letter was to
insure Debtor’s payment of taxes owed in 2008 by mandating Debtor’s
withholding allowance. The Lock-in Letter was issued solely
because Debtor failed to provide for sufficient withholdings for at
least seven years prior to the 2008 tax year. However, there is no
evidence in the record that the Lock-in Letter attempted to collect
taxes owed for any year prior to 2008.

The Lock-in Letter provided a 30-day opportunity for Debtor to
provide information to the IRS and to seek an adjustment of the
proposed withholding allowances. The Lock-in Letter also provided
a mechanism for Debtor to seek adjustment to the withholding
allowance after the initial 30-day period. Specifically, the Lock-
in Letter provided in relevant part:

If you disagree with our determination please call

us at the number shown below to explain why you are

entitled to a marital status and/or number of withholding

allowances (or complete exemption from withholding)

different from that shown above. Please have the

following information available to discuss. (If you file

jointly you must have the same information available for
your spouse.)

1. Form W4 and worksheet.

2. Most current pay stub. (If you have more than one
job, the most current pay stubs for all of your
jobs.)

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3. Number of allowances you (and your spouse) are
currently claiming on your Form(s) W-4.

4. The number of allowances you (and your spouse) are
entitled to claim.

5. The Social Security Number and/or dates of birth for
any children claimed on your return and a copy of
your most recent Schedule A deductions (if any).
If you prefer, you may write to us at the address
shown below. Please send a written statement to support
your claim explaining why you are entitled to a marital
status and/or number of withholding allowances (or
complete exemption from withholding) different from that
shown above.
In either case if we do not hear from you within 30
days from the date of this letter, your employer(s) has
been instructed to withhold at the status and allowances
shown above. If you later believe that you are entitled
to claim a different marital status and/or more
withholding allowances (or complete exemption from
withholding) than we determined, you can complete a new
Form W-4 and a written statement to support the claims
made on the Form W-4. You must submit the Form W-4 and
the written statement to us at the address shown below.
Lock-in Letter at pages 1-2.
Debtor’s counsel, Ms. Moran, contacted the IRS on April 25,
2008 with respect to the Lock-in Letter. The IRS would not speak
with Ms. Moran because the Tax Information Authorization Form, IRS
Form 8821, signed by Debtor in March 2008 did not cover the current
tax year, 2008. Ms. Moran concluded that by the time Ms. Moran
obtained an updated IRS Form 8821 to include the 2008 tax year,
Debtor would have filed Debtor’s bankruptcy petition and the Lock-
in Letter would be withdrawn upon the filing of Debtor’s bankruptcy
case. There is no evidence in the record that Debtor himself
sought an adjustment to the proposed withholding allowances during
the 30-day opportunity provided in the Lock-in Letter. There is
also no evidence in the record that either Debtor or Debtor’s

counsel later completed a new Form W-4 and a written statement to

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