Debtors Cannot Hide Funds by Parking Them With the IRS as Estimated Tax Payments

(Parker Tax Publishing January 2023)

A bankruptcy court granted a bankruptcy trustee's motion for summary judgment against the IRS after finding that (1) five transfers of tax payments to the IRS by the debtors in the case were transfers of an interest of the debtors in property, (2) the transfers were made within two years of the debtors filing their bankruptcy petition, (3) the debtors received less than a reasonably equivalent value in exchange for the transfers, and (4) the debtors were insolvent or became insolvent as a result of the transfers. The court thus concluded that the tax payments to the IRS were voidable under 11 U.S.C. Section 548(a)(1)(B). In re Rouquette, 2022 PTC 381 (Bankr. W.D. Tex. 2022).

Background

Debtors Michael Rouquette and his wife, Etta, filed a Chapter 7 bankruptcy petition on December 8, 2021. Between June 15, 2021, and December 6, 2021, the couple made estimated tax deposits totaling $26,000 toward their expected 2021 tax year Form 1040 individual tax liability. According to the IRS, the debtors filed their 2021 Form 1040 individual tax return on July 22, 2022, reflecting a tax due of $23,177, and claiming an overpayment of $4,112. The $4,112 refund was forwarded to the bankruptcy trustee (Trustee). Based on representations by the couple in their bankruptcy petition, they were insolvent at the time of the transfers. Code Sec. 6654(d) requires estimated tax payments in the lesser of 90 percent of a taxpayer's current year's (2021) tax liability or 100 percent of the taxpayer's previous year's tax liability. The Rouquette's previous year's liability for 2020 was $8,552. Their extension request for 2021 showed an estimated tax liability of $21,100.

The Trustee argued that the $26,000 belonged to the bankruptcy estate because: (1) the debtors made fraudulent transfers to the IRS that were voidable under 11 U.S.C. Section 548; and (2) the IRS was the transferee of avoidable transfers which have not been returned to the bankruptcy estate, and such transfers are thus disallowed under 11 U.S.C. Section 502(d). According to the trustee, as the result of the debtors not making a short year election, the debtors' chapter 7 estate had no IRS tax liability for 2021 individual income taxes. The Trustee argued that because the debtors' estate has no tax liability for 2021, the $26,000 of estimated tax payments were not the reasonably equivalent value of zero. Moreover, the Trustee said, where there is no short year election, there is no "claim" against the estate and where there is no claim, there is no debt within the meaning of 11 U.S.C. Section 101(12).

In response to the IRS's assertion that the estimated tax payments were not fraudulent transfers, the Trustee pointed to Code Sec. 1398(d) as being fatal to the IRS's argument. Code Sec. 1398(d) provides a general rule which says that, except as provided in Code Sec. 1398(d)(2), the tax year for a debtor is determined without regard to a case under title 11 of the U.S. Code to which Code Sec. 1398 applies. Code Sec. 1398(d)(2) provides that a debtor may elect to treat the debtor's tax year which includes the beginning date of the bankruptcy petition as two tax years: (i) the first of which ends on the day before the beginning date of the petition, and (ii) the second of which begins on the date of the petition.

The Trustee noted that the debtors did not make a short year election for the year 2021. That is, the debtors did not make an election to break the calendar year 2021 into two tax years, the first beginning January 1, 2021, and ending December 7, 2021, with the second beginning on December 8, 2021, and ending on December 31, 2021. As such, the Trustee said, because the debtors did not make a short year election, no part of the year 2021 Form 1040 liability may be paid from assets of the estate. The Trustee argued that, as a result of the debtors not making a short year election, the debtor's chapter 7 estate had no IRS tax liability for 2021 individual income taxes. As such, the Trustee argued that the estimated tax payments totaling $26,000 were not the reasonably equivalent value of zero. Moreover, citing In re Turboff, 93 B.R. 523 (Bankr. S.D. Tex. 1988), the Trustee said that where there is no short year election, there is no claim against the estate. and where there is no there is no claim, there is no debt within the meaning of 11 U.S.C. Section 101(12).

Section 548 and fraudulent transfer law generally attempt to protect creditors from transactions which are designed, or have the effect, of unfairly draining the pool of assets available to satisfy creditors' claims, or which dilute legitimate creditor claims at the expense of false or lesser claims. Section 548 covers two classes of transactions in which fraud is presumed. The first class of improper transactions are those made with actual intent. In the second class, the unfairness stems from a disparity of exchange coupled with the debtor's lack of other assets.

Generally, Section 548(a)(1)(B) provides in part that a bankruptcy trustee may avoid any transfer of an interest of the debtor in property that was made within two years before the date of the filing of the bankruptcy petition if the debtor voluntarily or involuntarily received less than a reasonably equivalent value in exchange for such transfer or obligation and was insolvent on the date that such transfer was made or such obligation was incurred.

Analysis

The bankruptcy court held that the Trustee had proven all four elements of 11 U.S.C. Section 548(a)(1)(B)(i) and (ii) and that the estimated tax payments to the IRS were thus voidable under Section 548(a)(1)(B). As a result, the court ordered the IRS to turn over the remaining balance of the voidable transfers.

The court found that, in order to prove that the estimated payments were voidable, the bankruptcy trustee had to prove the following requisite requirements under Section 548(a)(1)(B) in order to prevail: (1) that the transfers were the transfers of an interest of the debtors in property; (2) the transfers were made within two years before the date of the filing of the petition; (3) the debtors received less than a reasonably equivalent value in exchange for the transfers; and (4) the debtors were insolvent or became insolvent as a result of the transfers. Joint stipulations by the parties, the court said, proved three of the four elements and the only remaining element the trustee had to prove was whether the debtors received less than a reasonable equivalent value in exchange for the five transfers.

The court noted that, because the Bankruptcy Code does not define "reasonably equivalent value" as it is used in Section 548(a)(1)(B), courts have been left to judicially define the term for purposes of Section 548. Many courts, the bankruptcy court observed, have adopted a two-step process. First, a court determines whether the debtor received an economic benefit at the time of the transfers or obligations. Second, the value provided must be "reasonably equivalent" to what the debtor received. This two-step inquiry, the court stated, considers the value of what was transferred and what was received at the time of the transfer. The bankruptcy court concluded that the debtors in the instant case received less than a reasonably equivalent value in exchange for the transfers to the IRS and the court ordered the IRS to pay $21,888 ($26,000 - $4,112) over to the Trustee.

For a discussion of bankruptcies filed under Chapter 7, see Parker Tax ¶16,130.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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