Supreme Court Rules That Bankruptcy Trustee Can't Claw Back Federal Tax Payments

(Parker Tax Publishing April 2025)

The Supreme Court reversed the Tenth Circuit and held that the waiver of sovereign immunity in Bankruptcy Code Section 106(a)(1) does not apply to a state-law claim that supplies the "applicable law" for a bankruptcy trustee's avoidance claim under Bankruptcy Code Section 544(b). Therefore, the Court held that an avoidance claim brought by a bankruptcy trustee for funds that the shareholders of a corporation misappropriated and used to satisfy their personal federal income tax liabilities, which relied on a state fraudulent transfer statute that gives creditors a cause of action to invalidate certain transfers by a debtor, was barred by sovereign immunity. U.S. v. Miller, 2025 PTC 107 (S. Ct. 2025).

Background

All Resort Group was a Utah-based transportation business that fell into insolvency in 2012 as the result of poor management and financial malfeasance. As the company struggled financially, two of its shareholders began misappropriating company funds for their own personal use, including to pay off personal debts. In 2014, they transferred roughly $145,000 in company funds to the IRS to satisfy their personal income tax obligations. The company received nothing in return for paying off these shareholders' debts. Three years later, the company filed for bankruptcy. The trustee of the bankruptcy estate filed suit against the United States under Bankruptcy Code Section 544(b) seeking to avoid the 2014 tax payments.

Section 544(b) allows a trustee to avoid any transfer of an interest of the debtor that is "voidable under applicable law by a creditor holding an unsecured claim." Although the term "applicable law" can technically refer to any state or federal law outside of the Bankruptcy Code, trustees typically rely on state fraudulent transfer statutes to supply the "applicable law" for avoidance suits under Section 544(b). To show that a transfer is "voidable under applicable law," a bankruptcy trustee must identify the actual creditor or creditors who could have set aside the transaction under applicable law. If there is no creditor against whom the transfer is voidable under the applicable law, the trustee is powerless to act. This actual-creditor requirement mitigates the trustee's potentially disruptive avoidance power by ensuring that the trustee has no greater rights of avoidance than the actual creditor would have if that creditor were asserting invalidity on its own behalf.

The trustee in All Resort Group's bankruptcy invoked Utah's fraudulent transfer law as the source of applicable law for his Section 544(b) claim. Like most fraudulent transfer statutes, the Utah law allows a creditor to void a debtor's transfer of assets if the debtor was insolvent at the time of the transfer and received less than equal value in return. The government objected, arguing that the trustee could not identify any creditor capable of prevailing in a fraudulent transfer suit against the federal government under Utah law because, outside of bankruptcy, any such suit would be barred by sovereign immunity.

The bankruptcy court rejected the government's argument and entered judgment for the trustee. The court based its decision on Bankruptcy Code Section 106(a), which waives the government's sovereign immunity for certain claims arising under the Bankruptcy Code. In particular, Section 106(a)(1) provides that "sovereign immunity is abrogated as to a governmental unit to the extent set forth in this section with respect to" 59 different Bankruptcy Code provisions, including Section 544. The bankruptcy court construed Section 106(a) as waiving the government's sovereign immunity not only as to the trustee's Section 544(b) claim but also "as to the underlying state law cause of action" nested within the Section 544(b) claim. Accordingly, the court held that the trustee was not precluded from satisfying the actual creditor requirement.

A district court adopted the bankruptcy court's decision and, in Miller v. U.S., 2023 PTC 173 (10th Cir. 2023), the Tenth Circuit later affirmed. The Tenth Circuit concluded that in enacting Section 106(a), Congress intended to abolish the government's sovereign immunity in an avoidance proceeding arising under Section 544(b), regardless of the context in which the defense arises. The Tenth Circuit's decision created a conflict among the circuit courts regarding whether Section 106(a) abrogates sovereign immunity with respect to a state law claim that supplies the "applicable law" for a trustee's Section 544(b) claim. The Supreme Court granted certiorari to resolve that conflict.

Analysis

The Supreme Court reversed the Tenth Circuit and held that Section 106(a) does not alter the substantive meaning of Section 544(b)'s "applicable law" clause by providing a waiver of immunity that would not otherwise exist under that external source of law.

The Court found that Section 106(a)'s text, context, and structure make clear that it does not operate to modify Section 544(b)'s substantive requirements. Section 106(a)(5), the Court noted, expressly provides that nothing in Section 106 creates any substantive claim for relief not otherwise existing under some other source of law. Construing Section 106(a) to modify the elements of a Section 544(b) claim would, in the Court's view, give the trustee a substantive claim for relief against the government that does not otherwise exist under Section 544(b) or Utah law in direct conflict with Section 106(a)(5).

The Court also found that the text and structure of Section 544 reinforced this conclusion. Unlike Section 544(b), Section 544(a) has no actual-creditor requirement and thus permits a trustee to invalidate certain transfers that a lien holder could have voided "whether or not such a creditor exists." The Court said that this contrast reflects Congress's deliberate choice to tie the trustee's rights under subsection (b) to the rights of an actual creditor under "applicable law." In the Court's view, eliminating the actual-creditor requirement would upend decades of practice and precedent recognizing that Section 544(b) merely empowers a trustee to step into the shoes of a creditor, subject to the same limitations and defense that would apply to that creditor outside bankruptcy.

For a discussion of the effect of tax distributions by debtors in a bankruptcy, see Parker Tax ¶16,153.

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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