The Supreme Court has set aside a bankruptcy law ruling the federal government says could thwart efforts to collect back taxes from failed businesses.

The justices told a federal appeals court to restudy the ruling that limits the Internal Revenue Service's authority to collect taxes owed by bankrupt taxpayers.The court's brief order issued Monday suggested the case may have become moot, or legally irrelevant. The justices were told the debt involved has been paid off.

At issue in a case from Tampa, Fla., was whether debtors who seek protection from creditors by filing for reorganization under federal bankruptcy law may designate which back taxes they pay off first.

The IRS in 1984 seized assets of A&B Heating and Air Conditioning Inc.

A&B then filed for reorganization, and a bankruptcy judge ordered the tax agency to return the seized property to the bankruptcy estate.

The government then filed a claim so it could collect the back taxes - both those A&B owed as an employer and trust fund taxes such as Social Security and income taxes A&B withheld from employees' pay.

Under the reorganization plan, A&B was to pay off all debts, including back taxes, within six years. The plan states that all payments to the IRS "shall be credited first to the trust fund portion of the claim until it is paid in full."

Government lawyers objected to letting the bankruptcy trustee designate how the IRS must apply the tax payments.

They argued that payments of priority taxes under bankruptcy protection are involuntary, and therefore the debtor has no right to specify how the payments are to be applied.

A federal bankruptcy judge, a federal trial judge and the 11th U.S. Circuit Court of Appeals ruled against the government. The lower courts found that payments made under a bankruptcy reorganization plan are voluntary and therefore subject to such designations.

The government's chief concern is the possibility that A&B will not be able to comply with its six-year plan. The Administrative Office of the U.S. Courts estimates that 90 percent of all bankruptcy reorganization plans fail.

If back taxes were not fully paid off, the A&B reorganization plan's designation could reduce tax recovery.

Corporate officers and other officials responsible for sending withheld employee taxes to the federal government are personally liable for any amounts withheld but not sent in. Those same officers and officials are not personally responsible, however, for other unpaid corporate taxes.

Justice Department lawyers said the IRS estimates that allowing such designations could cost up to $25 million in lost tax revenues.