When someone pays their federal income taxes, but it turns out the money used was a fraudulent transfer (or is avoidable under Bankruptcy Code § 544(b)), can creditors claw that money back from the IRS? And if not, does sovereign immunity leave unsecured creditors without recourse? Courts have answered these questions in ways that turn on two basics: what kind of transfer occurred and how bankruptcy’s sovereign-immunity waiver works.
Key Terms, Briefly
“Fraudulent transfer” (or “voidable transaction”) generally means a debtor moved property or incurred an obligation without getting reasonably equivalent value while insolvent. Section 544(b) lets a bankruptcy trustee use state fraudulent transfer law; § 548 is the federal version. “Sovereign immunity” is the government’s general protection from suit. Section 106(a) of the Bankruptcy Code abrogates that immunity for certain bankruptcy actions, including §§ 544, 548, and 550.
The Sovereign Immunity Question: Can the IRS Be Sued?
Two appellate courts have tackled whether sovereign immunity blocks trustees from suing the United States to avoid tax payments as fraudulent transfers under § 544(b). The Ninth Circuit held that Congress’s waiver in § 106(a)(1) applies not just to § 544(b) itself but also to the state-law cause of action the trustee invokes through § 544(b), allowing use of state-law lookback periods against the IRS. In re DBSI, Inc., 869 F.3d 1004 (9th Cir. 2017), affirmed avoidance of prepetition IRS tax payments under Idaho’s UFTA, reasoning that § 106(a) abrogates sovereign immunity “with respect to” § 544, which includes the derivative state-law claim. A Florida bankruptcy court reached the same bottom line under Florida law. In re Pharmacy Distributor Services, Inc., 455 B.R. 817 (Bankr. S.D. Fla. 2011), held that the United States waived sovereign immunity for § 544(b) actions relying on Florida’s FUFTA, rejecting a separate-waiver requirement for state law.
There is contrary authority. A Maryland district court applied a state “voluntary payment” doctrine to bar a § 544(b) fraudulent transfer claim against the IRS, effectively foreclosing recovery. Wolff v. United States, 372 B.R. 244 (D. Md. 2007), held Maryland’s voluntary payment doctrine barred a trustee’s strong-arm claim to unwind IRS tax payments. And the Seventh Circuit (not included here) disagreed with the Ninth Circuit’s sovereign-immunity analysis. Still, DBSI and Pharmacy Distributor showed a strong path for trustees to proceed.
In a more recent ruling, however, the U.S. Supreme Court addressed the issue. In U.S. v. Miller, 145 S. Ct. 839 (2025), the court tackled the issue regarding the powers given to a bankruptcy trustee under Section 544(b) of the Bankruptcy Code to set aside, or “avoid,” certain fraudulent transfers of a debtor’s estate. The respondent was the bankruptcy trustee of a failed Utah-based business whose shareholders misappropriated $145,000 in company funds to satisfy their own personal federal tax liabilities. The bankruptcy trustee sought to claw back the misappropriated funds for the benefit of the bankruptcy estate.
Respondent filed the action pursuant to Section 544(b) of the Bankruptcy Code, which allows a trustee to “avoid any transfer of an interest in the debtor . . . that is voidable under applicable law by a creditor holding an unsecured claim.” However, to prevail under Section 544(b), the trustee must identify an “actual creditor” who could have voided the transaction under applicable law outside of bankruptcy proceedings. Respondent invoked Utah’s fraudulent transfer statute, which gives creditors a cause of action to invalidate certain transfers by a debtor—as the applicable law underlying his Section 544(b) claim. Respondent asserted that such transfers were avoidable because an unsecured creditor could have challenged them under state law. The lower courts agreed, ruling that Section 106(a) of the Bankruptcy Code waived sovereign immunity of the IRS, which received the targeted funds as tax payments, in connection with such assertions, even when based on state law.
The United States Supreme Court, however, reversed the lower court’s decision, holding that Section 544(b) allows trustees to assert only the rights of an actual creditor under applicable law and that the IRS’s sovereign immunity is not waived in this circumstance. If no such creditor could sue the government outside of bankruptcy due to sovereign immunity, neither can the trustee.
This U.S. Supreme Court decision limited trustees from attempting to recover assets transferred to the federal government. As a result, sovereign immunity waivers must be explicit, and Section 106(a) does not extend to state law-based claims incorporated via Section 544(b).
Bottom line: different courts have different views, but the more recent U.S. Supreme Court decision must now be taken into account.
What Counts as “Reasonably Equivalent Value” When the IRS Gets Paid?
Even if sovereign immunity is abrogated, the merits may matter. If a payment reduced a legitimate tax debt, courts often treat it as giving “reasonably equivalent value,” defeating a constructive fraudulent transfer theory. The Fourth Circuit emphasized this in a case about tax penalties. In re Yahweh Center, Inc., 27 F.4th 960 (4th Cir. 2022), the court held that tax penalty obligations were not avoidable under § 544(b) or analogous state law, and that payments on those penalties provided dollar-for-dollar “reasonably equivalent value,” so they were not recoverable as constructively fraudulent.
That defense fits best when the debtor paid its own valid tax obligations. The analysis shifts where a debtor used its funds to pay someone else’s taxes (for example, corporate funds paying principals’ personal taxes). In that setting, courts have allowed trustees’ claims to proceed. In re Pharmacy Distributor Services, Inc., 455 B.R. 817, permitted § 544/FUFTA claims to avoid the debtor’s federal tax payment made for its principals, rejecting a state voluntary-payment bar and the government’s limitations and immunity defenses at the pleading stage.
Can State “Voluntary Payment” Doctrines Bar Recovery?
Some states bar common-law refund claims for voluntarily paid taxes. One court extended that bar to a trustee’s § 544(b) avoidance claim under Maryland law. Wolff v. United States applied Maryland’s voluntary payment doctrine to prevent a trustee from unwinding IRS tax payments via the Maryland Uniform Fraudulent Conveyance Act. Florida courts, however, have refused to apply the state doctrine to federal tax payments in § 544(b) actions. Pharmacy Distributor Services held Florida’s voluntary payment rule does not apply to federal tax payments and that the trustee’s suit was not a “refund” claim but a fraudulent transfer action seeking an estate money judgment.
Remedies: Money Back or Leverage Through Claim Disallowance
If a trustee avoids a transfer, § 550 authorizes recovery of the property or its value from the initial transferee—here, potentially the United States. Courts have permitted monetary recovery, consistent with § 106(a)’s waiver. In re DBSI, Inc. affirmed a judgment requiring the IRS to return approximately $13.4 million of avoided tax transfers (excluding amounts already refunded to shareholders), applying § 550 alongside § 106(a).
If direct monetary recovery is constrained, trustees have another tool: disallowing the IRS’s claims until disgorgement. In re Larry’s Marineland of Richmond, Inc., 166 B.R. 871 (Bankr. E.D. Ky. 1993), recognized that if an IRS payment is avoidable, the court can enjoin allowance of the IRS’s claim under § 502(d) until the avoided amount is repaid.
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