Tax penalties are not fraudulent transfers in bankruptcy: Court of Appeals

The Internal Revenue Service (IRS) building is seen in Washington, U.S. September 28, 2020. REUTERS/Erin Scott

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  • Judges cite lack of voluntary exchange of tax penalties
  • The nonprofit organization cannot recover payments to the IRS

(Reuters) – The Internal Revenue Service on Tuesday rejected an attempt by a bankrupt North Carolina nonprofit to recoup tax penalties it had previously paid to the agency.

The 4th U.S. Circuit Court of Appeals said Yahweh Center Inc, which provided support services for at-risk children, could not recover $180,000 in tax penalties in its Chapter 11 case, because they do not fall under the laws governing fraudulent transfers in the event of bankruptcy. .

Bankruptcy law allows debtors to recover certain payments made by a person or entity before a bankruptcy filing as so-called fraudulent transfers if they did not receive “reasonably equivalent value” in exchange.

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Richard Cook, the Yahweh Center’s bankruptcy trustee, argued that the organization’s multi-year penalty payments to the IRS should be waived under North Carolina and bankruptcy law because the center did not receive “reasonably equivalent value” in exchange. He tried to collect payments to distribute to creditors, including former employees, saying Congress failed to exempt the IRS from fraudulent conveyance laws and the U.S. Supreme Court ruled tax penalties detrimental to creditors.

The IRS argued that fraudulent conveyance laws were not intended to allow debtors to escape tax penalties.

A panel of three 4th Circuit judges upheld two lower court rulings that agreed with the IRS.

In the Tuesday decisionWritten by Circuit Judge A. Marvin Quattlebaum, the panel held that fraudulent conveyance laws do not apply to tax penalties because they do not involve any voluntary exchange between a debtor and a creditor.

The law suggests that an “oral or written agreement must take place” for the laws to apply, the panel said.

“Applying the fraudulent conveyance provisions to tax penalties would be like pushing a square peg into a round hole,” Quattlebaum wrote. He was joined in the decision by circuit judges Steven Agee and Stephanie Thacker.

The panel cited a 2012 6th Circuit decision that made similar findings.

Cook said Tuesday the court’s decision was disappointing and barred former workers who owed $200,000 in back wages from collecting further collections.

“Perhaps Congress can educate the courts and the public on whether tax penalties should be avoided in bankruptcy cases through future legislation,” he said.

An IRS spokesperson said it does not comment on ongoing litigation.

The case is Cook v. United States, US 4th Circuit Court of Appeals, No. 20-1685.

For Yahweh: Richard P. Cook

For the United States: Rachel Ida Wollitzer of the Department of Justice

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