June 29, 2022

Volume XII, Number 180

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4th Circuit Holds Tax Penalty Obligations Are Not Voidable Fraudulent Transfers

  • Federal appeals court holds IRS penalties not fraudulent transfers in bankruptcy, as they do not fall within fraudulent transfer provisions of Bankruptcy Code or local law.

  • Holding consistent with similar 6th Circuit case that found that for an obligation to be incurred by the debtor, an oral or written agreement must take place.

  • Trustee unable to rely on local law to grant him authority under Bankruptcy Code to void debtor’s tax penalty obligations.

The Fourth Circuit in Cook v. United States1 held that federal tax penalty assessments and the payments the debtor made were not voidable fraudulent transfers that generally allow debtors to recover certain pre-bankruptcy payments. The bankruptcy trustee in Cook sought to nullify trust fund recovery penalty assessments the IRS made against the debtor and attempted to recover any penalty payments to the IRS. The trustee sought to void the tax penalties under the Bankruptcy Code’s (the Code) fraudulent transfer provisions under 11 USC §§ 548(a)(1)(B) and 544(b)(1) and local fraudulent transfer law. The trustee asserted that the debtor received nothing of reasonably equivalent value in return for the tax penalties the IRS assessed. In rejecting the trustee’s claims, the court held that IRS penalties do not fall within the fraudulent transfer provisions of the Code or local law.

Governing Law

The Code grants a trustee authority to void certain transfers of interest by a debtor and to recapture any transfers back into the bankruptcy estate. Code Section 544 generally grants a trustee the power to void any transfer of an interest of the debtor in property or any obligation incurred by the debtor if it is voidable by an unsecured creditor under applicable law. In Cook, the court looked to the North Carolina Uniform Voidable Transactions Act (the Act) as the applicable law to determine if the trustee could exercise his power to void the obligations and transfers under Code Section 544. The Act generally provides that obligations or transfers are voidable if: (1) the debtor made the transfers or incurred the obligations without receiving a reasonably equivalent value in exchange for the transfer or obligation, and (2) the debtor was insolvent at that time or became insolvent as a result of the transfer or obligation.2 Thus, for the trustee to be able to void the tax penalties, he was required to show that when the debtor incurred the obligation or transferred payments for the tax penalties, the debtor did not receive reasonably equivalent value, which generally means that the debtor received nothing in return or at least nothing close to the value of the obligation or transferred payments.

Cook Holding

The Fourth Circuit in Cook followed the decision in a similar case by the Sixth Circuit, In re Southeast Waffles LLC,3 in rejecting the trustee’s assertions. In Southeast Waffles, the Sixth Circuit held that tax penalty obligations were not voidable under the Code or the Tennessee law, which had provisions similar to the Act and the Code. The court in Cook, like the Sixth Circuit, looked at the language of the applicable state law and the Code and determined that the statutes presume a voluntary exchange needs to take place between the debtor and the creditor. The court in Cook also determined that the language of the Act suggests that for an obligation to be incurred, an oral or written agreement must take place. In reviewing the IRS tax penalty obligations at issue, the Cook court determined there were no exchanges or any written or oral agreements between the debtor and the IRS. In its opinion, the court stated that “the tax code required the IRS to impose taxes, tax penalties and interest against [the debtor]. The IRS had no choice.” Since the court held that tax penalties were not obligations incurred as contemplated by the Act, the trustee was unable to rely on any local law to grant him the authority under Code Section 544 to void the tax penalty obligations of the debtor.


1 No. 20-1685 (4th Cir. 2022).

2 N.C.Gen.Stat. §39-23.5(a). The Code provides similar voidable provisions as the Act. 11 USC § 548(a)(1)(B) permits voiding debt obligations that received less than a reasonably equivalent value in exchange for the transfer or obligation. The main difference between the Code and the Act is that the statute of limitations for transfers under the Code is limited to two years.

3 702 F.3d 850 (6th Cir. 2012).

©2022 Greenberg Traurig, LLP. All rights reserved. National Law Review, Volume XII, Number 84
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About this Author

Scott Fink, Greenberg Traurig Law Firm, New York, Finance, Tax and Litigation Attorney
Shareholder

Scott E. Fink specializes in civil and criminal federal and state tax controversies and litigation. He represents corporations, partnerships, estates and individuals before the Internal Revenue Service, and state and local tax authorities in examinations, collection problems, administrative appeals, and in court.

Areas of Concentration

  • Federal and state tax controversies and litigation

  • Tax audits

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Pallav Raghuvanshi, Associate, Greenberg Traurig, Tax Attorney
Associate

Pallav Raghuvanshi focuses his practice on U.S. and international tax matters in the context of corporate restructurings and cross-border mergers and acquisitions. He is experienced handling spin-off transactions for large multinational companies, various inbound and outbound transactions involving issues related to foreign tax credits, tax treaties, controlled foreign corporations, and other international reorganization issues. He also handles U.S. federal tax aspects of initial coin offering / first token sales and other tax-related issues on blockchain technology and...

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 Kenneth Zuckerbrot Shareholder New York Tax Tax & Business Group Real Estate Investment Trusts (REITs) Corporate Real Estate Operations Banking & Financial Services Mergers & Acquisitions
Shareholder

Kenneth Zuckerbrot Chairs the Bankruptcy Tax Group and represents public and private corporations and inbound and outbound investment companies in tax and real estate matters and has wide-ranging experience in debt restructurings. Ken's experience in both International taxation and REIT work is combined in the tax efficient acquisition structures of foreign real estate by U.S. REITs.

Concentrations

  • Tax

  • Bankruptcy tax planning

  • International taxation

  • Debt restructuring

  • Real estate

  • ...
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