We all make mistakes. It happens. This includes inadvertent disclosure of confidential information.
There is a remedy when a private party that makes an unauthorized disclosure. The aggrieved party can simply bring suit. There are basically no restrictions on the amount of damages that are available and when one qualifies for damages.
The rules are different when it comes to the Federal government and, in particular, the IRS. The IRS is not held to the same standard that private citizens and businesses are. This does not mean that the IRS cannot be held financially liable for its unauthorized disclosures. It just means that one has to review the applicable statues and case law to see if and how they can be compensated for the disclosures.
This brings me to the recent Castillo v. United States, No. 21CV00007 (S.D.N.Y. 2022), case. This court case involves an unauthorized disclosure by the IRS and a dispute over whether the taxpayer can recoup punitive damages against the IRS.
Facts & Procedural History
The IRS determined that the taxpayer underpaid her income taxes for the 2014 tax year. The IRS then filed a lien for the unpaid taxes. The taxpayer responded timely by requesting a collection due process hearing (“CDP hearing”). In her CDP hearing request, the taxpayer disputed the underlying tax liability.
The IRS concluded that the taxpayer could not challenge the underlying tax liability as she had a prior opportunity to do so. The taxpayer asked the U.S. Tax Court to review the IRS’s decision The U.S. Tax Court sided with the IRS.
This is where this dispute starts. The IRS also admitted that the taxpayer made numerous attempts to reach the IRS, but was unable to do so as the IRS employee and his manager were furloughed at the time.
The taxpayer hired a tax attorney and submitted a Form 2848, Power of Attorney and Declaration of Representative, for that representative. The taxpayer then notified the IRS that she revoked the Form 2848 for this tax attorney and she submitted another Form 2848 for her new representative. The IRS agrees that it was aware of the revocation for the tax attorney and appointment of the new representative. Even though the IRS was aware of the change, the IRS erred by sending its Notice of Determination in the CDP hearing to the prior representative. The copy sent to the taxpayer was basically lost by the U.S. Postal System. So the taxpayer had no notice that the IRS had reached a decision in her CDP hearing. The taxpayer learned of it for the first time when the IRS attorney attached a copy of the Notice of Determination to its petition to dismiss the U.S. Tax Court case for the CDP hearing.
The taxpayer filed suit in district court to recover damages for the IRS’s error. The suit was brought as an unlawful disclosure case.
Section 6103 provides taxpayers with a cause of action if the IRS discloses their tax return information.
Congress enacted and has amended Section 6103 to provide that tax returns and return information are confidential and are not subject to disclosure, except in the limited situations delineated by the Code. In each area of authorized disclosure, Congress attempted to balance the IRS’s need for the information with the citizen’s right to privacy, as well as the impact of the disclosure upon continued compliance with the voluntary tax
The term “tax return information” includes disclosure of the taxpayer’s personal information, such as the taxpayers name, address, social security number, tax liability, and the IRS conclusions.
Section 7431 provides for an award of damages if the IRS makes an unauthorized disclosure. The damages are the greater of $1,000 per unauthorized disclosure or actual damages plus punitive damages. It also includes an award of costs, such as attorneys fees.
For a taxpayer to prevail under Section 7431(a)(1), he must demonstrate that an unauthorized inspection or disclosure of his returns or return information was made by an officer or employee of the United States, the inspection or disclosure was made knowingly or negligently, and that the inspection or disclosure was made in violation of section 6103. Christensen v. United States, 733 F. Supp. 844, 848 (D.N.J. 1990), aff’d, 925 F.2d 416 (3d Cir. 1991) (table cite); Flippo v. United States, 670 F. Supp. 638, 641 (W.D.N.C. 1987), aff’d mem., 849 F.2d 604 (4th Cir. 1988) (table cite).
Other Non-Section 7431 Remedies
This is different from the criminal sanction IRS employees may face for unauthorized disclosures under Section 7213. This type of disclosure can be a felony and the IRS employee could face up to 5 years in prison for unauthorized disclosures. See United States v. Richey, 924 F.2d 857 (9th Cir. 1991); In re Seper (United Liquor Co. v. Gard), 705 F.2d 1499 (9th Cir. 1983); Reporters Comm. for Freedom of the Press v. Am. Tele. and Tele. Co., 593 F.2d 1030 (D.C. Cir. 1978).
Congress amended 18 U.S.C. § 1030(a)(2) to make the unauthorized access of government computers a felony, amended by Pub. L. No. 104-294, 110 Stat. 3488. This provision includes the unauthorized access of returns or return information in government computer files. In 1998, Congress enacted Section 7213A to specifically make the unauthorized inspection of returns or return information, whether in paper or computer files, a misdemeanor. See Pub. L. No. 105-206, 112 Stat. 711 (1998).
Amount of Damages the IRS Has to Pay
While there are some disputes about these rules, my experience has been that taxpayers are very forgiving when it comes to unauthorized disclosures. Most are never reported. And many taxpayers simply give the IRS the benefit of the doubt. Others may not know that there are laws that protect them in these situations. Those who learn of the rules often do so when the IRS makes attempts to contact third parties about their tax balances or liabilities. The IRS is able to have some limited third party contacts.
In the present case, the IRS admitted that it violated Section 6103 by sending the IRS Notice of Determination to the former tax attorney. However, the IRS argued that the taxpayer’s damages were limited to $1,000.
The taxpayer argued that she was entitled to actual damages and punitive damages.
The court concluded that the taxpayer was not entitled to actual damages as the disclosure did not lead to the damage she incurred. The damage was the inability to litigate the underlying tax liability without first paying it (i.e., the ability to sue in U.S. Tax Court) and the consequences she suffered due to the IRS lien, etc. The court noted that the disclosure did not produce these damages. Put another way, these damages would have been sustained even absent the unauthorized disclosure. For example, these damages would have been sustained even if the IRS did not mail anyone the Notice of Determination.
The question the court had to deal with then was whether taxpayers can get punitive damages against the IRS when there are no actual damages. Punitive damages are a form of punishment for harmful conduct. It is intended to deter the bad actor and other would-be bad actors from engaging in harmful conduct.
Are Punitive Damages Available?
This case puts the question about punitive damages directly in issue.
The district court noted that there is a split in the circuit courts as to whether punitive damages are available when there are no actual damages.
The Ninth Circuit Court of Appeals has held that there are no punitive damages absent actual damages. The Fourth Circuit has reached the opposite conclusion. This district court that heard the present case is in the Second Circuit, which apparently has not weighed in on the issue yet.
The district court concluded that Section 7431 allows punitive damages even absent actual damages. It based this decision on the reading of the statute. The court basically concluded that the statute was clear and, therefore, there is no need to construe or interpret the statute.
The situation where there are no actual damages is likely rare. Unauthorized disclosures will usually result in actual damages in some amount. For example, in this case, the discharged tax attorney might have sent the client a bill for $1 for reviewing the IRS notice or responding to the call from the taxpayer about this after the fact. This $1 of attorneys fees would be an actual damage. The same goes for postage for a letter sent in response. It seems like crafty tax attorney could find other examples.
Setting aside that nuance, even absent actual damages, the IRS may still have to pay punitive damages. This case makes it clear that the IRS may be on the hook financially for unauthorized disclosures.