Court: IRA Payments to IRS for Taxes Recoverable

January 18, 2005 ( - A US bankruptcy court has found that the funds transferred from a bankrupt individual's individual retirement account (IRA) to the Internal Revenue Service (IRS) for tax purposes are subject to recovery.

>The ruling, by Bankruptcy Judge Dennis O’Brien of the US Bankruptcy Court for the District of Minnesota, stated that since the IRS was an initial transferee and not a subsequent transferee, the funds are not exempt for a bankruptcy estate.

>The case revolves around Cyril and Rae Bauer, who filed a chapter 7 bankruptcy petition in February 2002. Cyril Bauer was the owner of an IRA with Kemper Insurance Co., and had originally claimed that the account was off limits to bankruptcy courts, a claim that was denied by a court in October 2003. Bauer instructed Kemper Insurance to withhold funds from the IRA distribution and instead deposit over $33,000 with the IRS for tax purposes.

>After the transfer was made, the bankruptcy trustee claimed that since the IRS was an initial transferee, the funds were recoverable under 11 US C. Section 550(a)(1). The IRS argued that it was not an initial transferee, but a subsequent transferee, which would make the funds unrecoverable.

>O’Brien, in his ruling, stated that the IRS was an initial transferee. Whereas the IRS claimed that Bauer was the initial transferee, O’Brien ruled that because the owner of the IRA was never a recipient of repository for the funds – having not received the funds in actuality or essence – the tax agency was in fact the initial transferee. O’Brien also ruled that Kemper was not a transferee, having never been in possession of the IRA funds in a form that allowed it to effectively control the money. Therefore, the funds deposited with the IRS are recoverable by a bankruptcy court.

>The ruling in Iannacone v. IRS (In re Bauer), Bank. D. Minn., No. 04-3099, is available  here .