Reversing the bankruptcy court, a district judge in San Antonio explained why making estimated tax payments isn’t a fraudulent transfer to the Internal Revenue Service.

For 2020, a couple’s tax liability was about $8,500. They filed a chapter 7 petition in December 2021.

Before filing in 2021, the couple made a total of $26,000 in estimated payments toward their 2021 taxes, based on a projected 2021 tax liability of $21,000. They were required to make estimated payments because most of their income in 2021 wasn’t from wages subject to withholding.

When they filed their 2021 tax return, it turned out that their federal tax bill was a little over $23,000. They received a federal refund of about $4,000, which went to the chapter 7 trustee.

The chapter 7 trustee sued the IRS for receipt of constructively fraudulent transfers under Section 548(a)(1)(B). On cross motions for summary judgment, the bankruptcy court granted the trustee’s motion.

In his March 18 opinion, District Judge Xavier Rodriguez paraphrased the bankruptcy court as reasoning “that the estimated payments were voidable as constructively fraudulent because the Debtors did not receive the ‘reasonably equivalent value’ of the estimated tax payments under 11 U.S.C. § 548(a).” The bankruptcy court, he said, believed that the debtor had not received reasonably equivalent value “because their 2021 tax liability had not been assessed by the time they filed for bankruptcy.”

Judge Rodriguez described the bankruptcy court as also having characterized the estimated payments as credits against a future obligation, and not a payment on a present or antecedent debt.

Granting judgment for the trustee, the bankruptcy court found that almost $22,000 in estimated tax payments were constructively fraudulent transfers. The IRS appealed and won, given Judge Rodriguez’s understanding of Section 548(a)(1)(B), which allows a trustee to

avoid any transfer . . . of an interest of the debtor in property . . . that was made . . . within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily — received less than a reasonably equivalent value in exchange for such transfer. . . and . . . was insolvent on the date that such transfer was made. [Emphasis added.]

For Judge Rodriguez, the outcome turned on “the meaning of ‘value’” received by the debtor. To decide whether there was reasonably equivalent value, he said that “many courts have adopted a two-step process. First, a court determines whether the debtor received an economic benefit at the time of the transfers or obligations.”

“Second,” Judge Rodriquez said, “the value provided must be ‘reasonably equivalent’ to what the debtor received.” Significantly, he said, “Section 548 considers an asset’s value to the debtor at the time of transfer, not its eventual value to the bankruptcy estate by the time it is created.” [Emphasis in original.]

Furthermore, Judge Rodriguez said, “Nothing in Section 548 or cases interpreting it requires that property be transferred to satisfy a present or antecedent debt rather than transferred in exchange for property of reasonably equivalent value.” He explained,

Prepayments and tax credits are “assets” under any definition of the term. Indeed, the official forms for asset schedules direct both individual and corporate debtors to disclose ‘Deposits and prepayments’ and ‘Tax refunds’ as assets. Such credits against future liabilities do not lose their status as assets simply because the future liabilities have yet to be determined.

Similar to his analysis that “value” in Section 548 includes value to the debtor, Judge Rodriguez said, “Most courts to consider the question have agreed that estimated tax payments are not recoverable as fraudulent transfers because the debtor receives such a dollar-for-dollar credit against future tax liability.”

The trustee advanced a counterargument based on the idea that the debtors could have made estimated payments of 90% of the prior year’s tax of $8,500, not the current year’s much larger projected tax. Rejecting the argument, Judge Rodriquez saw “no reason to treat tax deposits that reasonably estimate actual, future tax liability as constructively fraudulent simply because they exceed the minimum requirement to avoid penalties.”

Judge Rodriguez therefore held that “the prepetition estimated tax payments made by the Debtors ($26,000) represented reasonable estimates of their 2021 tax liability ($23,177), and thus the Debtors received the reasonably equivalent value of their estimated tax payments at the time the payments were made.” He reversed and remanded, with instructions for the bankruptcy court to enter judgment for the IRS.