Bankruptcy and the Voluntary Payment Rule

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The IRS has a rule that if a taxpayer makes a payment voluntarily the taxpayer can direct the tax debt to which the IRS must apply the payment. In the absence of a valid designation, the IRS takes the position that it can apply payments in the manner most beneficial to the government. It frequently occurs that a taxpayer will owe for multiple periods and perhaps multiple types of tax debt. Having a payment go to pay down certain tax debts before others can greatly enhance a taxpayer’s position in certain circumstances. Persons assessed the trust fund recovery penalty (TFRP) find designation particularly important.

The policy regarding designation leaves open then the question of the voluntariness of a payment. If the IRS obtains the payment via levy, that generally presents an easy case of a non-voluntary payment. On the other hand, if the taxpayer mails in a check to partially satisfy a debt, that generally presents an easy case of a voluntary payment. Payments made in situations not as clear as these provide opportunity for discussion and debate which occurred in the case of In re Donaldson, No. 16-14126 (Bankr. N.D. Miss. July 2, 2018) a chapter 13 case.


Mr. Donaldson served as President and CEO of a charitable organization that failed to pay its payroll taxes for several quarters. A few quarters passed prior to Mr. Donaldson learning of the failure to pay the payroll taxes. Upon learning of the problem, he did not insure payment of the taxes, past or current, but determined that the assets of the entity could cover the arrearages should the entity fail to rectify its cash flow.

The entity had two parcels of real estate and a claim against BP for the Deepwater Horizon Settlement. The entity passed a resolution that it would use the proceeds of the claim to make a voluntary payment to the IRS of the past due taxes; however, this resolution was an internal document to which the IRS was not a party. Eventually, the IRS levied on the BP Claim. The levy resulted in the IRS receiving funds with a designation on the settlement check that the funds be applied to the trust fund taxes. The IRS ignored the designation since it received the funds pursuant to a levy and arguably applied in its best interest by applying the funds to both trust fund and non-trust fund taxes. The opinion does not state exactly what the IRS did but I suspect that it applied the money to the oldest periods and just paid them off in chronological order until the money ran out. Doing so provided a significant benefit to Mr. Donaldson since the IRS could have applied the money first to all of the outstanding non-trust fund liabilities which, in my opinion, would have been its best interest.

The two parcels proved worthless for paying the past due taxes. Since the BP settlement funds did not fully satisfy all of the outstanding taxes, the IRS used the other tool at its disposal to collect the unpaid portion of the taxes that represented monies held in trust for it, viz., the TFRP. Found in IRC 6672, TFRP allows the IRS to assess against all persons responsible for the failure of the taxpayer to pay over money collected for the IRS and held by the taxpayer in trust. The IRS determined that Mr. Donaldson, and others at the charitable entity bore responsibility for the failure to pay. It made assessments against several individuals. In doing so the IRS seeks to collect the unpaid taxes only once. So, if one of the other persons responsible pays off the debt, Mr. Donaldson no longer owes the IRS on this debt but may owe the individual who paid if that individual seeks contribution from him. In this case it does not appear that one of the other responsible officers made any payment and certainly none of the other responsible officers made a payment sufficient to eliminate the liability.

Once the IRS turned its collection attention to him, Mr. Donaldson filed a chapter 13 petition, and the IRS filed a claim for $87,564 based on his obligation as a responsible officer of the entity. Because the claim resulted from unpaid trust fund liabilities, it acquired priority claim status pursuant to BC 507(a)(8)(C). Because it had priority status, Mr. Donaldson had to provide for full payment of the claim in order to confirm his chapter 13 plan. (Though not at issue here, Mr. Donaldson will also find out to his sorrow that when the chapter 13 ends he will owe interest on the liability for the full life of the chapter 13 plan even if he has fully paid the amount of the IRS claim. The IRS cannot claim postpetition interest from the chapter 13 debtor but can seek this interest from the individual after the lifting of the stay.) TFRP represents the worst type of debt to carry into bankruptcy because it always has priority status no matter how old and it will haunt the taxpayer coming out of bankruptcy even if the full amount of the prepetition debt gets paid through the bankruptcy.

Mr. Donaldson argues that the IRS must honor the designation on the payment written on the BP claim payment designating that the IRS apply the funds to trust fund taxes. The IRS argues that the bankruptcy court does not have jurisdiction to reallocate the payments (and that the payment here fails to meet the voluntary payment test.) The court agrees that it lacks authority to order the IRS to reallocate the payment to satisfy the trust fund portion of the entity’s liability. It notes that the entity is not before it. Because the entity is not before the bankruptcy court, the court lacks the ability to dictate the manner of the application of the funds recovered by the IRS as a result of a levy. What the IRS does with a payment of the entity’s liability is simply outside the scope of an individual officer’s bankruptcy case.

It distinguished U.S. v. Energy Resources Co., Inc., 495 U.S. 545 (1991) which held that an entity in bankruptcy could designate payments in its chapter 11 plan to trust fund liabilities. In Energy Resources the Supreme Court determined that a bankruptcy court has the power to determine that designation of payments is necessary for a successful reorganization. I have always had trouble understanding how designation, as a factual matter, benefited the entity and not the individual but the Supreme Court decided the issue on the basis of the power of the court and not the logic of the decision. The bankruptcy court in Donaldson, which does not have the entity before, lacks the power that the court had in Energy Resources where the entity that failed to pay the tax was the entity seeking to confirm the plan.

Next the court addressed Mr. Donaldson’s TFRP liability. He argued that while he met the statutory definition of responsible person he should not be liable because “(1) other, perhaps more culpable, responsible persons also failed to pay the trust fund taxes,” and (2) his nonpayment was not willful. His first argument totally falls flat. The court cites a couple of cases but could have cited many more. This argument has no legs. The TFRP statute allows assessment against many people and makes no provision for allocating the amount of the liability based on the amount of culpability.

His willfulness argument also fails. He knew of the liability and thought that the entity could cover it with available assets. The fact that his mistaken calculation of the value of the entity’s assets occurred in good faith does not provide any cover for him in avoiding the liability. He knew other creditors received payment instead of the IRS. That’s all it takes.

So, he will need to commit to full payment in order to confirm his chapter 13 plan and he will have to make those payments in order to obtain his discharge. Assuming he succeeds in his chapter 13 plan, he can also look forward to a bill from the IRS for the interest on the TFRP liability it could not charge the bankruptcy estate. A nice parting gift from chapter 13.



  1. One wonders, as I often do, if the debtor/taxpayer/non-taxpayer or the attorney representing said non-taxpayer is the boob putting forth the incredibly weak argument seen in this case. In any event, this is an easy a Darryl Dawkins backboard breaking dunk as I’ve ever seen noted on these pages.

  2. Norman Diamond says

    “The IRS has a rule that if a taxpayer makes a payment voluntarily the taxpayer can direct the tax debt to which the IRS must apply the payment.”

    Close. Here’s what it says, emphasis added by Diamond:

    ‘The purpose of this revenue procedure is to update and restate the Internal Revenue Service’s position regarding the application, by the Service, of a PARTIAL payment of tax, penalty, and interest for one or more taxable periods’

    When the IRS refuses to state the exact amount owing (including accumulated interest) and the taxpayer voluntarily tenders an overpayment and the taxpayer provides specific written instructions as to the application of the payment, the IRS seizes the excess. If the IRS has alleged some other debt but has used procedural tricks to deny due process, the IRS uses offset power to apply the excess towards the other alleged debt instead of refunding the, and no court will accept jurisdiction.

    Even if an exactly correct payment could be made with proper designation, an exact payment is not a partial payment so this revenue procedure does not apply. Furthermore if the payment made with proper designation is exact, then surely it isn’t voluntary and the IRS can do whatever it wants.

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