IRS Sovereign Immunity Stands Firm in High-Stakes Bankruptcy Ruling

The Supreme Court’s 8-1 ruling shields the IRS from returning a $145,000 fraudulent transfer due to sovereign immunity, limiting bankruptcy trustees’ recovery options beyond a two-year window.

Quick Takes

The Supreme Court ruled 8-1 that IRS sovereign immunity prevents bankruptcy trustees from recovering “fraudulent” payments made beyond the typical two-year lookback period.
Justice Ketanji Brown Jackson wrote the majority opinion, reinforcing that sovereign immunity waivers are jurisdictional and don’t create new substantive rights against the government.
Justice Neil Gorsuch was the lone dissenter in the case involving a $145,000 transfer to the IRS by All Resort Group Inc. three years before bankruptcy.
The decision reverses a Tenth Circuit ruling and resolves a split among federal appeals courts on bankruptcy trustees’ powers to recover funds from government entities.
The ruling may have significant implications for other bankruptcy cases involving payments to federal agencies.

Court Reinforces Federal Immunity in Bankruptcy Proceedings

In a decisive ruling that reinforces the government’s protection from certain legal claims, the Supreme Court has sided with the Internal Revenue Service in a bankruptcy dispute. The 8-1 decision prevents bankruptcy trustees from using state fraudulent transfer laws to recover payments made to the IRS beyond the standard two-year lookback period established in federal bankruptcy law. The Court’s decision in United States v. Miller effectively limits the tools available to bankruptcy trustees seeking to reclaim assets for creditors when government entities are involved.

The case centered on All Resort Group Inc., a Utah-based company that transferred $145,000 to the IRS three years before filing for bankruptcy. This payment, which was made to resolve personal tax debts of the company’s principals rather than corporate obligations, was deemed fraudulent under state law by lower courts. Nevertheless, the Supreme Court ruled that sovereign immunity shields the federal government from having to return these funds, even when they were obtained through potentially questionable means.

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Legal Complexities of Sovereign Immunity

Justice Ketanji Brown Jackson, writing for the majority, emphasized the fundamental nature of sovereign immunity in our legal system. The Court’s opinion clarified that waivers of sovereign immunity are strictly jurisdictional and do not create new substantive rights against the government. “Waivers of sovereign immunity are jurisdictional provisions that empower courts to hear claims against the government but do not themselves typically create any new substantive rights against the government,” expressed Justice Jackson.

At the heart of the dispute was Section 544(b) of the Bankruptcy Code, which allows trustees to avoid fraudulent transfers using applicable law, typically state fraudulent transfer statutes. The Court determined that while Section 106(a) of the Bankruptcy Code waives sovereign immunity for the Section 544(b) cause of action itself, it does not extend this waiver to the underlying state-law claims that supply the “applicable law” for such actions. This distinction proved decisive in protecting the IRS from having to return the disputed funds.

Implications for Bankruptcy Proceedings

The ruling resolves a split among federal appeals courts over whether bankruptcy trustees can pursue recoveries against government entities beyond the standard two-year lookback period. The Fourth, Ninth, and Tenth Circuits had previously rejected the Seventh Circuit’s approach, which limited trustees’ recovery options. The Supreme Court’s decision now provides clarity, albeit in a way that restricts trustees’ powers when dealing with government creditors compared to private entities.

Justice Neil Gorsuch stood alone in dissent, suggesting an alternative interpretation of the statutory framework that would have permitted the recovery. His dissenting view indicates the complexities of balancing bankruptcy policy goals with sovereign immunity principles. For bankruptcy practitioners, the ruling means trustees will need to carefully consider timing when evaluating potential claims against government entities, as the two-year standard lookback period now represents a firm boundary in most circumstances.