Are Estimated Tax Payments Paid to the IRS Protected from Seizure in Bankruptcy?

Yes, estimated tax payments made to the IRS immediately before filing bankruptcy could be protected from seizure by the Chapter 7 trustee, according to In re Mooney, 526 B.R. 421 (Bankr. M.D.GA 2015).  In Mooney, an individual taxpayer tendered to the IRS $36,700 in estimated tax payments two days before filing Chapter 7 bankruptcy.  The Chapter 7 trustee wanted to seize those payments and filed a motion for turnover pursuant to 11 U.S.C. §542(a), arguing that the estimated tax payments were credits against the future tax liability and constituted “credits” that are property of the bankruptcy estate which are subject to turnover.  The taxpayer opposed the turnover motion and argued that the tax payments/credits are not within the taxpayer’s “control” because those payments can only be refunded by the IRS after the payments are applied to taxes due for the year in which the payments were made, citing Rev. Rul. 54-149, 1954-1 CB 159-60.

The Georgia bankruptcy court noted that the Eleventh Circuit in which it sits has never published a decision on the issue. But, the court noted that the Ninth and Tenth circuits have published conflicting opinions.  So the bankruptcy court analyzed both approaches.

Adopting the reasoning of the Tenth Circuit in the case of Weinman v. Graves (In re Graves), 609 F.3d 1153 (10th Cir. 2010), the Mooney court started its analysis by finding the tax credits were property of the bankruptcy estate.  But, the court noted that the Chapter 7 trustee succeeded only to the title and rights in the tax credits that the taxpayer had at the time the bankruptcy case was filed, nothing more.  The Mooney court believed the trustee’s interest in the tax creditors were limited to the same extent as a taxpayer’s interest in the application of a prior year tax refund, by the strictures of 26 U.S.C. §6513(d), which makes a taxpayer’s refund application election irrevocable.  A taxpayer would have no right to any cash refund of the estimated tax payments until their current tax liability is determined and then only if they are entitled to a further refund.

Finally, the court held that the bankruptcy estate’s interest in the pre-payment is limited to the taxpayer’s contingent reversionary interest in the pre-payment attributed to pre-petition earnings.  Stated differently, if the taxpayer is entitled to a refund after their current year tax liability was satisfied, then the Chapter 7 trustee is entitled to demand turnover of any amount of such refund attributable to the prepetition earnings.

Practice Pointer:  Tendering estimated tax payments to the IRS for the current year (or applying a tax refund from a prior year) prior to filing bankruptcy is a clever strategy to deplete non-exempt assets that would otherwise be seized by the trustee and distributed to the unsecured creditors.  Step two of the strategy would be to minimize the tax refund in the current year since the Chapter 7 bankruptcy trustee would be entitled to demand turnover of any amount of the refund attributable to the prepetition earnings. Taxpayers receiving a paycheck could reduce their tax withholdings in an effort to minimize the tax refund.  Self-employed taxpayers could seek to minimize refunds by minimizing net income from delayed income recognition and expedited expense recognition.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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