Brandt-Airflex Corp., In re

• Decision Date: 30 March 1988
• Docket Number: BRANDT-AIRFLEX,D,No. 666,666
• Citation: 843 F.2d 90
• Parties: , 63 A.F.T.R.2d 89-748, 88-1 USTC P 9258, 17 Bankr.Ct.Dec. 712, Bankr. L. Rep. P 72,252, Unempl.Ins.Rep. CCH 3 In reCORPORATION, Debtor. CORPORATION, Debtor-in-Possession, Plaintiff-Appellant, v. LONG ISLAND TRUST COMPANY, N.A., New York State Tax Commission, and the United States of America, Defendants-Appellees. ocket 87-5034.
• Court: U.S. Court of Appeals — Second Circuit

Page 90

843 F.2d 90

97 A.L.R.Fed. 147, 63 A.F.T.R.2d 89-748,

88-1 USTC P 9258,

17 Bankr.Ct.Dec. 712, Bankr. L. Rep. P 72,252,

Unempl.Ins.Rep. CCH 3

In re BRANDT-AIRFLEX CORPORATION, Debtor.

BRANDT-AIRFLEX CORPORATION, Debtor-in-Possession, Plaintiff-Appellant, v. LONG ISLAND TRUST COMPANY, N.A., New York State Tax

Commission, and the United States of America,

Defendants-Appellees.

No. 666, Docket 87-5034.

United States Court of Appeals, Second Circuit.

Argued Feb. 4, 1988.

Decided March 30, 1988.

Michael I. Saltzman, New York City (Saltzman & Holloran, of counsel), for plaintiff-appellant.

C. Gayden Wren, Garden City, N.Y. (Cullen and Dykman, of counsel), for defendant-appellee Long Island Trust Co.

Robert K. Drinan, Mineola, N.Y., Asst. Atty. Gen. of State of N.Y. (Robert Abrams, Atty. Gen. of State of N.Y.) for defendant-appellee New York State Tax Comn.

Murray S. Horwitz, Atty., Dept. of Justice, Washington, D.C. (William S. Rose, Jr., Asst. Atty. Gen., Gary R. Allen and Wynette J. Hewett, Attys., Dept. of Justice, Andrew J. Maloney, U.S. Atty. for E.D.N.Y., of counsel), for defendant-appellee U.S.

Before TIMBERS, WINTER and ALTIMARI, Circuit Judges.

ALTIMARI, Circuit Judge:

The plaintiff appeals from an order of the United States District Court for the Eastern District of New York, Thomas C. Platt, Judge, reversing a grant of summary

                judgment in favor of plaintiff entered by the United States Bankruptcy Court for the Eastern District of New York, C. Albert Parente, Bankruptcy Judge.    Plaintiff claimed entitlement to tax credits pursuant to 26 U.S.C. Sec. 3505 and N.Y. Tax Law Sec. 678.  The district court held that plaintiff did not have any right to relief under either of these code sections, and accordingly dismissed plaintiff's complaint for lack of jurisdiction.  We agree that the bankruptcy court did not have jurisdiction to hear this case, and we affirm the decision of the district court
                

BACKGROUND

Brandt-Airflex Corporation ("Brandt") is in the business of metal fabrication and finishing. Its principal place of business is East Farmingdale, New York, where it employs approximately 60 people. In 1979, Brandt entered into a secured lending agreement with the Long Island Trust Company ("LITC"). According to Brandt, its deteriorating financial condition led it to renegotiate the lending agreement in 1983. Under this new agreement, the "Overdraft Financing Agreement," LITC would honor preapproved checks issued by Brandt.

During 1983, 1984, and the first quarter of 1985, LITC advanced funds to Brandt for the payment of employee wages. LITC did not, however, provide funds for the federal and state withholding taxes which Brandt was obligated to pay to the taxing authorities.

On February 13, 1985, Brandt filed a petition for reorganization under Chapter Eleven of the Bankruptcy Code. The Internal Revenue Service and the New York State Tax Commission both filed claims against the bankrupt estate for unpaid taxes. These unpaid taxes included federal income and social security taxes which Brandt was obligated to withhold from employees' wages pursuant to 26 U.S.C. Secs. 3102(a) and 3402(a), as well as state income taxes required to be withheld under N.Y. Tax Law Sec. 675 (McKinney 1987).

On April 30, 1986, Brandt commenced the instant adversary proceeding in bankruptcy court. Brandt contended that it was not liable for the unpaid taxes, because I.R.C. Sec. 3505(b) and its state-law counterpart, N.Y. Tax Law Sec. 678(b) had the effect of shifting liability for the withholding taxes to LITC. These two statutes impose liability for withholding taxes, under certain circumstances, upon a lender which "supplies funds to or for the account of an employer for the specific purpose of paying wages of the employees of such employer." Id.

In its complaint, Brandt sought a declaration of its tax liability pursuant to section 505(a)(1) of the Bankruptcy Code. More specifically, Brandt requested a declaration that it was entitled to a tax credit in the amount of LITC's alleged liability, and a declaration that the taxing authorities' claims against Brandt's estate be reduced by such amount. Brandt also requested that the bankruptcy court "order the IRS and the Tax Commission to collect from LITC for all of the employment tax liabilities which are now, allegedly to be due and owing by Brandt."

All the defendants filed motions to dismiss on various grounds, including lack of jurisdiction. The bankruptcy court converted these motions sua sponte into motions for summary judgment. On February 6, 1987, the bankruptcy court entered summary judgment in favor of Brandt. See In re Brandt-Airflex Corp., 69 B.R. 701 (Bankr.E.D.N.Y.1987). The court concluded that:

1. LITC was a direct cause of the tax accrual.

2. The Overdraft Agreement rendered the plaintiff financially impotent and unable to meet the tax obligation.

3. LITC was the employer in fact and primarily liable for the delinquent taxes.

4. The taxing authorities will not be prejudiced by proceeding to collect the taxes from LITC.

Id. at 710.

Defendants were apparently confused about the import of the bankruptcy court's holding: after the decision was rendered, LITC moved for reargument and relief from the judgment; the New York State The bankruptcy court granted reargument but denied LITC's motion for relief from judgment. The motions for clarification were denied as "unnecessary" because, the court held, its decision was "self-explanatory." In denying the United States' motion, the court emphasized, however, that its earlier ruling had not relieved Brandt of liability, and that the claims of the taxing authorities against Brandt's estate were still valid.

Tax Commission moved for clarification of the decision; and the United States moved to alter or amend the judgment, in order to clarify the issue of Brandt's liability.

Defendants appealed to the District Court for the Eastern District of New York. On September 18, 1987, the district court reversed the bankruptcy court's decision on the ground that plaintiff failed to state a claim for relief under either 26 U.S.C. Sec. 3505 or N.Y. Tax Law Sec. 678. The district court accordingly dismissed the complaint with prejudice, for lack of jurisdiction. See In re Brandt-Airflex Corp., 78 B.R. 10 (E.D.N.Y.1987).

DISCUSSION

I. Liability for withholding taxes under 26 U.S.C. Sec. 3505

Employers are required to pay over to the taxing authorities that portion of the income and social security taxes which is withheld from employees' wages. See 26 U.S.C. Secs. 3102(a) and 3402(a); N.Y. Tax Law Sec. 675. These withheld funds are deemed to be held in trust by the employer for the benefit of the taxing authorities. See 26 U.S.C. Sec. 7501(a); N.Y. Tax Law Sec. 675.

Sometimes, as in the present case, a party other than the actual employer will pay the employees' wages, or will advance funds to the employer for the purpose of financing the employer's payroll.

Prior to the enactment of I.R.C. Sec. 3505 and its state-law counterpart, N.Y. Tax Law Sec. 678, collection problems arose when a third party funded an employer's net payroll, but neither the third party nor the employer paid the required withholding taxes. The government is required to credit employees for the withheld taxes whether or not the employer actually pays them, see e.g., Slodov v. United States, 436 U.S. 238, 243, 98 S.Ct. 1778, 1783, 56 L.Ed.2d 251 (1978); if, however, the employer lacked the funds to pay its overdue withholding taxes, the government was without any effective recourse against the employer. Nor could the government proceed against the third-party supplier of funds, because only "employers" were liable for the withholding taxes, and the payroll financer was not considered to be an "employer." See S.Rep. No. 1708, 89th Cong., 2d Sess., reprinted in 1966 U.S.Code Cong. & Admin.News 3722, 3742.

Section 3505 was therefore enacted to provide the government with an alternate source for the collection of unpaid withholding taxes. Section 3505(a) imposes personal liability for withholding taxes on a party other than the employer which pays wages directly to the employer's employees. Section 3505(b), under which Brandt claims entitlement to relief, imposes liability under limited circumstances on a party supplying funds to the employer which are earmarked for the payment of wages. That section provides:

If a lender, surety, or other person supplies funds to or for the account of an employer for the specific purpose of paying wages of the employees of such employer, with actual notice or knowledge ... that such employer does not intend to or will not be able to make timely payment or deposit of the amounts of tax required by this subtitle to be deducted and withheld by such employer from such wages, such lender, surety, or other person shall be liable in his own person and estate to the United States in a sum equal to the taxes (together with interest) which are not paid over to the United States by such employer with respect to such wages. However, the liability of such lender, surety, or other person shall be limited to an amount equal to 25 percent of the amount so supplied to or for the account of such employer for such purpose.

Section 3505(c) provides that "[a]ny amounts paid to the United States pursuant to this section shall be credited against the liability of the employer."

N.Y. Tax Law Sec. 678 is essentially identical to 26 U.S.C. Sec. 3505, and was enacted in order to bring the state tax code into conformity with the federal. For ease of discussion, we will focus on the federal provision, but all that we say is equally applicable to the state tax law.

Section 3505 was enacted for the benefit of the government, to facilitate its collection of withholding taxes. See S.Rep. No. 1708, U.S.Code Cong. & Admin.News at 3742-44. It is completely within the discretion of the taxing authority whether or not to initiate collection...