Bankruptcy Adequate Protection Payments Were Not Voluntary So IRS Not Required to Apply Payments to Trust Fund Taxes as Designated on Checks

A taxpayer’s attempt to designate her corporation’s adequate protection payments made in the corporation’s bankruptcy case failed in the case of Riggs v. Commissioner, TC Memo 2015-98. 

The taxpayer in this case had been the sole owner and president of a corporation that had run up significant payroll tax liabilities with the IRS.  The corporation ended up in bankruptcy and, although she attempted to start up a new corporation, the IRS found that corporation was a successor in interest to the tax liabilities, pulling it into the bankruptcy case that had been filed on behalf of the first corporation.  As well, the IRS found that Ms. Riggs, as President and sole shareholder of the corporation, was a responsible party who had willfully allowed trust fund taxes to go unpaid, finding her liable for the trust fund penalty under IRC §6672.

Eventually the bankruptcy court ordered the corporation to make adequate protection payments to the IRS to begin to pay down its debt to the IRS for the trust fund taxes, employer payroll taxes, penalties and interest.  Ms. Riggs had a notation placed on each check designating that the payment was to be applied to the corporation’s trust fund taxes. 

Generally a taxpayer making a voluntary payment of taxes to the IRS is allowed to designate the specific liability the payment is meant to offset.  The trust fund recovery penalty at §6672 is only assessed based on trust fund taxes that are and remain unpaid—thus, if the corporation’s payments were applied specifically to the trust fund taxes, Ms. Rigg’s liability would be reduced by the amount of the payments made.

But, as the Tax Court noted, the IRS is only required to respect the designation of  payment if it is a voluntary payment or, as this payment was ordered by the bankruptcy court, if the bankruptcy court had ordered the IRS to apply the payments to the trust fund taxes.  

The Tax Court notes that the bankruptcy court had not specified that the payments must be applied against trust fund taxes.  As well, the payments were being compelled by the bankruptcy court—thus the corporation’s payments failed the voluntary payment requirement.  Only if Ms. Riggs had convinced the bankruptcy court to designate the payment as for trust fund taxes would the IRS have been forced to apply the payments there.

Rather the IRS was free to apply the payments as it wished—and, in accordance with the IRS’s normal practice, that was not against the outstanding trust fund liabilities.