Income Tax Debt Can Extend Trustee’s Time to Set Aside Asset Transfers

It is generally true in a New York bankruptcy case that the Chapter 7 Trustee has a “look back” period of six years prior to the bankruptcy filing to examine asset transfers and commence litigation to set aside any that are deemed to be fraudulent transfers. This is because the Bankruptcy Code allows a Chapter 7 Trustee to set aside asset transfers that would be “voidable under applicable law by a creditor holding an unsecured claim…”. Essentially the Trustee steps into the shoes of any unsecured creditor in the case to pursue actions to avoid fraudulent transfers. However, when the IRS has an unsecured claim in the case recent case law suggests that the Trustee’s “look back” period is extended by many years.

Federal law (i.e., applicable law) authorizes the IRS to pursue tax collection efforts for ten years from the date of their assessment of a tax being due. In addition, it is well settled that the United States (of which the IRS is an agency) is not bound by state statutes of limitations when it brings suit in either federal court or state court. The net result is the collection remedies available to the IRS include the right to avoid transfers under state law without being hindered by state statutes of limitations. Cases have held that if the IRS has an unsecured claim on the filing date of a bankruptcy case, and if at said time the IRS could have commenced an action to avoid a fraudulent transfer, then the Trustee can step into the shoes of the IRS and avoid any fraudulent transfer that the IRS could, even those beyond the state’s statute of limitations period (i.e., six years in New York).

A recent article in the American Bankruptcy Journal (Jan. 2017, Vol. 36, No. 1) took the fact that the IRS is not bound by state statutes of limitations to its “logical” conclusion and demonstrated how truly scary this can be for debtors. Assume the following hypothetical facts: (1) in 1985 the debtor engaged in a fraudulent transfer when he gifted (i.e., no consideration) valuable art work to his sister, who still has the art work; (2) the IRS assesses a tax liability against debtor in January 1, 2006, which means their ten year period to institute a collection proceeding would end on December 31, 2015; and (3) on December 1, 2015 the debtor files a Chapter 7 case in which the IRS has an unsecured claim, and during the course of the case the Trustee becomes aware of the 1985 fraudulent transfer. Could the Trustee, stepping into the IRS’s shoes, set aside the asset transfer to the sister that occurred 30 years prior to the bankruptcy filing? The case law suggests “yes”. If the IRS would not be barred from setting aside the 30 year old transfer, neither would the Trustee who steps into their shoes.

This is a developing area of law where all of the questions have not yet been answered. However, many of the answers that Courts have issued have not been favorable to debtors. Examples of transfers subject to being set aside are those commonly employed in the area of estate planning and financial planning, and usually involve transfers to family members—the people you least want to see get hurt by your financial problems. When the IRS is a creditor in a case it is imperative that a New York debtor and his attorney examine not only transfers that occurred within the six years prior to the bankruptcy filing, but all transfers going back ten years and beyond.