Begier v. U.S., I.R.S.

• Decision Date: 28 July 1989
• Docket Number: No. 88-1788,88-1788
• Citation: 878 F.2d 762
• Parties: -5260, 58 USLW 2032, 89-2 USTC P 9416, 21 C.B.C. 358, 19 Bankr.Ct.Dec. 955, Bankr. L. Rep. P 73032A Harry P. BEGIER, Jr., Trustee v. UNITED STATES of America INTERNAL REVENUE SERVICE, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 762

878 F.2d 762

64 A.F.T.R.2d 89-5260, 58 USLW 2032, 89-2

USTC P 9416,

21 C.B.C. 358, 19 Bankr.Ct.Dec. 955,

Bankr. L. Rep. P 73032A

Harry P. BEGIER, Jr., Trustee v. UNITED STATES of America INTERNAL REVENUE SERVICE, Appellant.

No. 88-1788.

United States Court of Appeals, Third Circuit.

Argued Jan. 31, 1989.

Decided June 30, 1989.

As Amended July 13, 1989.

Rehearing and Rehearing In Banc Denied July 28, 1989.

William S. Rose, Jr., Asst. Atty. Gen., Garry R. Allen, Wynette J. Hewett, Gary D. Gray (argued), Attys., Tax Div., Dept. of Justice, Washington, D.C. (Michael Baylson, U.S. Atty., of counsel), for appellant.

Paul J. Winterhalter (argued), Ciardi, Fishbone & DiDonato, Philadelphia, Pa., for appellee.

Before HUTCHINSON, SCIRICA and NYGAARD, Circuit Judges.

OPINION OF THE COURT

SCIRICA, Circuit Judge.

This case presents the question whether Sec. 547 of the Bankruptcy Code allows a bankruptcy trustee to avoid as preferential transfers, payments of non-segregated funds to the Internal Revenue Service by the debtor during the pre-bankruptcy petition period in satisfaction of the debtor's tax withholding obligations.

The Internal Revenue Service appeals from a judgment of the district court upholding a decision of the bankruptcy court permitting appellee Harry P. Begier, Jr., the trustee in bankruptcy of debtor American International Airways, Inc., to recover pre-petition withholding tax payments from American International's general operating account. The bankruptcy court determined that the payments were transfers of property of the debtor's estate, not transfers of funds held in trust for the IRS under Sec. 7501 of the Internal Revenue Code. For reasons that follow, we hold these payments, transferred to the IRS before American International's bankruptcy petition was filed, to be a special fund in trust for the government under I.R.C. Sec. 7501 and not recoverable as preferential transfers of the debtor's property. Therefore, we will reverse.

I.

The facts in the case are not disputed. Debtor, American International Airways, Inc., was in the airline business. By the spring of 1984, it had become delinquent in remitting social security and income taxes withheld from employee wages, as well as excise taxes collected from airline passengers, to the United States. On March 1, 1984, the IRS notified American International of this delinquency and required it to file monthly (as opposed to quarterly) returns of its wage withholding and excise taxes, and to open a separate bank account to receive these tax deposits in trust for the IRS. ¹

On March 6, 1984, American International opened a bank trust account and made deposits of wage withholding and excise taxes. On April 30, 1984, American International paid the IRS $695,000 from the separate trust account and $734,798 from its general operating bank account. On June 22 and 27, 1984, it made two more payments from the general operating account of $200,000 and $11,636, respectively. Thus, American International made payments to the IRS of $695,000 from the separate trust account and $946,434 from its general operating account, for a total payment of $1,641,434. All payments were allocated by agreement between American International and the IRS to specific social security, income withholding and transportation excise taxes due from January 1984 to April 1984, except for the payment of $11,636 which was allocated to 1982 and 1983 excise taxes.

On July 19, 1984, American International filed a petition in bankruptcy under Chapter 11 of the Bankruptcy Code. For three months thereafter, the debtor attempted to operate the business as a debtor-in-possession, but failed. Consequently, the bankruptcy court appointed a trustee and the case was converted to a liquidation under Chapter 11 of the Bankruptcy Code. The trustee then filed this adversary proceeding to recover the $1,641,434 tax payments as voidable preferences under 11 U.S.C. Sec. 547(b).

The bankruptcy court did not allow the trustee to recover the transfer of $695,000 from the separate withholding tax account, holding that this was a transfer of funds held in trust, rather than from the debtor's estate. Begier v. United States Internal Revenue Service, 83 B.R. 324, 327 (Bankr.E.D.Pa.1988). This decision has not been appealed. However, the bankruptcy court determined that the trustee could recover as preferential transfers the $946,434 in payments made from the debtor's operating account, less $246,024. ² In total, the court allowed the trustee to avoid $700,410 out of the $1,641,434 sought. Id. at 328. In explaining why it had treated as voidable preferences the transfers from the general operating account, the court reiterated the conclusion it had drawn in previous cases that, "only where a tax trust fund is actually established by the debtor and the taxing authority is able to trace funds segregated by the debtor in a trust account established for the purpose of paying the taxes in question would we conclude that such funds are not property of the debtor's estate." Id. at 329 (citing In re American Airlines, Inc., 70 B.R. 102, 105 (Bankr.E.D.Pa.1987); In re Rimmer Corp., 80 B.R. 337, 338-89 (Bankr.E.D.Pa.1987)). By order dated, August 15, 1988, the district court affirmed the decision of the bankruptcy court. This appeal followed.

II.

As we have noted, we must decide whether Sec. 547(b) of the Bankruptcy Code allows a bankruptcy trustee to avoid as preferential transfers, payments of non-segregated funds transferred from the debtor's general operating account to the IRS during the pre-bankruptcy petition period on account of the debtor's tax withholding obligations. Whether withheld taxes paid pre-petition to the IRS from non-segregated funds commingled with other funds of the debtor are avoidable preferences depends on whether the funds are considered to be property of the debtor's estate or held to be in trust for the IRS. The IRS argues that withheld taxes, paid pre-petition, are deemed to have been held in trust for the government under Sec. 7501 of the Internal Revenue Code. The trustee responds that because the withheld taxes were commingled with the other funds rather than placed in a separate account, they may not be designated as trust funds and may be recovered.

A.

Section 547(b) of the Bankruptcy Code allows the trustee in bankruptcy to recover payments on account of antecedent debts made by the debtor immediately prior to the filing of a bankruptcy petition:

Sec. 547. Preferences

* * *

* * *

(b) Except as provided in subsection (c) of this section,

the trustee may avoid any transfer of property of the debtor--

(1) to or for the benefit of a creditor;

(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;

(3) made while the debtor was insolvent;

(4) made--

(A) on or within 90 days before the date of the filing of the petition; or

(B) between 90 days and one year before the date of the filing of the petition, if such creditor, at the time of such transfer--

(i) was an insider; and (ii) had reasonable cause to believe the debtor was insolvent at the time of such transfer; and

(5) that enables such creditor to receive more than such creditor would receive if--

(A) the case were a case under chapter 7 of this title;

(B) the transfer had not been made; and

(C) such creditor received payment of such debt to the extent provided by the provisions of this title.

11 U.S.C. Sec. 547(b) (1982). ³ Section 547(c) of the Bankruptcy Code provides a transferee creditor with defenses to a preference action brought by the trustee. 11 U.S.C. Sec. 547(c). ⁴ Thus, to prevail in a preference action, the trustee must prove that a transfer of "property of the debtor" took place and that the transfer met the criteria listed in Sec. 547(b). In addition, the trustee must overcome any Sec. 547(c) defenses raised by the transferee. Funds held in trust do not constitute "property of the debtor," and therefore are not recoverable as a preference under Sec. 547(b). See 11 U.S.C. Sec. 541(d). ⁵

Here, the IRS does not contest that the trustee meets the criteria listed in Section 547(b); rather, it argues that the payments were not "transfer[s] of property of the debtor" because the payments represent money held in trust for the IRS pursuant to Section 7501, and as such, are simply not subject to Section 547(b). Section 7501(a) provides:

Sec. 7501. Liability for taxes withheld or collected

(a) General rule.--Whenever any person is required to collect or withhold any internal revenue tax from any other person and to pay over such tax to the United States, the amount of tax so collected or withheld shall be held to be a special fund in trust for the United States. The amount of such fund shall be assessed, collected, and paid in the same manner and subject to the same provisions and limitations (including penalties) as are applicable with respect to the taxes from which such fund arose.

I.R.C. Sec. 7501. ⁶ If a person required to collect or withhold any internal revenue tax from any other person under I.R.C. Sec. 7501 fails to collect, account for, or pay over such tax, the IRS may require that person to collect the tax and deposit the amount in a separate bank account. I.R.C. Sec. 7512. Thus, Sec. 7501 itself does not require segregation of withholding taxes, unless the IRS, finding the employer delinquent in paying over the taxes, demands that the funds be placed in a separate account.

B.

Because of the complicated legislative history and statutory authority in this case, we believe it would be helpful to track the development of the status of withholding tax payments in bankruptcy. Prior to the passage of the 1978 Bankruptcy Act, the seminal case addressing the status of withholding taxes in bankruptcy was United States v. Randall, 401 U.S. 513, 91 S.Ct. 991, 28 L.Ed.2d 273 (1971). In Randall, the IRS sought to collect withholding taxes in possession of the...