In re Paulson, Bankruptcy No. 83-0219 JLC

• Decision Date: 15 December 1992
• Docket Number: Adv. No. 92-153.,Bankruptcy No. 83-0219 JLC
• Parties: In re Larry M. PAULSON, Debtor. Larry M. PAULSON, Plaintiff, v. UNITED STATES of America, INTERNAL REVENUE SERVICE, Defendant.
• Court: United States Bankruptcy Courts. Third Circuit. U.S. Bankruptcy Court — Western District of Pennsylvania

152 B.R. 46 (1992)

In re Larry M. PAULSON, Debtor.

Larry M. PAULSON, Plaintiff, v. UNITED STATES of America, INTERNAL REVENUE SERVICE, Defendant.

Bankruptcy No. 83-0219 JLC, Adv. No. 92-153.

United States Bankruptcy Court, W.D. Pennsylvania.

December 15, 1992.

John P. Vetica, Jr., Pittsburgh, PA, for debtor.

Donna J. Pankowski, Pittsburgh, PA, Richard I. Miller, Tax Div., U.S. Dept. of Justice, Washington, DC, for the I.R.S.

Thomas W. Corbett, Jr., Robert L. Eberhardt, Pittsburgh, PA, U.S. Attorney's Office.

MEMORANDUM OPINION

JOSEPH L. COSETTI, Chief Judge.

The matter before this court is Larry M. Paulson's ("Debtor") liability to the Internal Revenue Service ("IRS") for assessed tax liabilities, penalties, and post-petition interest.

I. FACTS

On November 10, 1983, the Debtor filed a voluntary petition under Chapter 11 of the Bankruptcy Code. The case was converted to Chapter 7 on October 3, 1984. On May 4, 1990, the Debtor was granted a discharge.

The IRS made assessments against the Debtor for unpaid employment and withholding tax liabilities ("Form 941") for the following pre-petition tax periods: second, third and fourth quarters of 1979; fourth quarter of 1980; first, second, and third quarters of 1981; all four quarters in 1982; and the first quarter of 1983. In addition, the IRS assessed a Form 941 liability against the Debtor for the fourth quarter of 1983, which quarter was partially pre-petition and partially post-petition. The Form 941 liabilities for each quarter can be segregated into two types of tax liabilities: "trust fund" and "non-trust fund." "Trust fund" liabilities refer to those taxes that are collected or withheld by the employer on behalf of the employee.¹ "Non-trust fund" liabilities are those taxes directly attributable to the employer.²

As of May 7, 1992, the IRS also made a total of $26,243.16 in assessments against the Debtor for unpaid federal unemployment taxes ("Form 940") for the following pre-petition periods: 1980, 1981, 1982, and 1983. (A small portion of the 1983 liability accrued post-petition.)

In addition to the underlying tax assessments, the IRS has assessed against the Debtor a claim for pre-petition interest and penalties regarding all of the liabilities listed above. Further, the IRS asserts that additional interest has accrued on all of these accounts, both during and after the bankruptcy, although that interest has not yet been assessed against the Debtor.

The bulk of the base tax liabilities of the Debtor, principally Forms 941 for the last quarter of 1980, the first, second and third quarters of 1981, all four quarters in 1982, and the first and second quarters of 1983, and the Forms 940 for the tax periods 1980, 1981, 1982 and 1983 were all due to be filed within three years prior to the filing of the bankruptcy petition.

The IRS concedes that the liabilities of the Debtor for the non-trust fund taxes due on the Form 941 liabilities for the second, third, and fourth quarters of 1979, and the applicable interest thereon, were discharged on May 4, 1990, because those liabilities were not priority taxes under 11 U.S.C. § 507(a)(7)(D). The IRS further concedes that the penalties attributable to the Form 941 liabilities for the second, third, and fourth quarters of 1979 were also discharged on May 4, 1990. Finally, the IRS acknowledges that its tax claim was unsecured during the bankruptcy proceeding. Liens were entered subsequent to the entry of the discharge order.

II. ANALYSIS

1. Were all "non-trust fund" portions of the Debtor's Form 941 liabilities discharged?

The Debtor contends that all "non-trust fund" portions of the Form 941 liabilities were discharged pursuant to his May 4, 1990 discharge. The Debtor argues that 11 U.S.C. § 507(a)(7)(C) controls the dischargeability of the non-trust fund portions. He further asserts that although § 507(a)(7)(C) provides exception from discharge for those taxes "required to be collected or withheld," his "non-trust fund" liabilities do not fall within this exception. The Debtor believes that "non-trust fund" taxes, by their definition, are not collected or withheld by the employer, and thus fall outside of the scope of the § 507(a)(7)(A) discharge exception.

Section 727(b) of the Bankruptcy Code excepts from the effect of discharge those items enumerated in 11 U.S.C. § 523. Section 523(a)(1)(A) provides that a discharge under section 727 does not discharge taxes "of the kind and for the periods specified in section . . . 507(a)(7)." While the Debtor is correct in his assertion that the "non-trust fund" portions of the liability do not fall within the scope of the section 507(a)(7)(C) exception, the Debtor fails to consider § 507(a)(7)(A), which states as follows:

§ 507. Priorities.

(a) The following expenses and claims have priority in the following order:

(7) Seventh, allowed unsecured claims of governmental units, only to the extent that such claims are for—

(A) an employment tax on a wage, salary, or commission of a kind specified in paragraph (3) of this subsection earned from the debtor before the date of the filing of the petition, whether or not actually paid before such date, for which a return is last due, under applicable law or under any extension, after three years before the date of the filing of the petition;

In accordance with § 523(a)(1)(A), employment taxes on wages, salaries or commissions are not dischargeable.

In the case of In re Ndosi, 116 B.R. 687, 690 (Bkrtcy.D.Minn.1990), the bankruptcy court ruled that § 507(a)(7)(D) applies exclusively to employment taxes on wages, salaries and commissions earned from the debtor. Because the "non-trust fund" portions of the Debtor's Form 941 liabilities are based on wages earned from the Debtor, this court holds that the Debtor remains liable to the IRS for those Form 941 liabilities that were based on returns due within three years prior to the filing of the petition. See, Matter of Pierce, 935 F.2d 709 (C.A. 5 1991).

2. Were the penalties assessed against Debtor for the Form 940 and 941 liabilities discharged?

The Debtor contends that the tax penalties assessed against him in regard to the Form 940 and 941 liabilities were discharged. The Debtor relies on 11 U.S.C. § 507(a)(7)(G) (as referenced indirectly in § 523(a)(1)(A)) which grants priority to penalties "related to a claim of a kind specified in this paragraph and in compensation for actual pecuniary loss." The Debtor further asserts that the penalties in the instant case are punitive³ and thus fall outside of the § 507(a)(7)(G) priority status. The Debtor concludes that, because the penalties never received priority status, they were discharged.

As previously stated, § 523(a)(1)(A) specifically provides "exceptions to discharge . . . for a tax or a customs duty of the kind and for the periods specified in § 507(a)(2) or § 507(a)(7). . . ." Section 507(a)(7)(G) provides priority status for "pecuniary" taxes. Therefore, the Debtor is correct in asserting that a punitive penalty does not receive priority treatment. The court in In re Healis held:

Inasmuch as the IRS has assessed interest and penalties against the debtors in this case, we can only presume without evidence to the contrary that those penalties are intended to be punitive in nature. As such, no requirement for priority payment exists for these penalties.

In re Healis, 49 B.R. 939, 942 (Bkrtcy. M.D.Pa.1985).

Nevertheless, the lack of a priority of a tax penalty under § 507(a) does not necessarily cause such penalty to be discharged, unless an exemption from discharge is found somewhere else in the Bankruptcy Code. The court in In re New England Carpet Co., Inc., 26 B.R. 934 (Bkrtcy.D.C.Vt.1983), after determining that a punitive penalty lacked priority status under § 507(a)(7)(B)⁴ held that "the lack of priority however, does not alter the propriety of the penalty. As such, the court has determined pursuant to section 505(a)(1) that the penalties as assessed by the City of Winooski are assessed in the proper amounts." Id. at 937.

Under the Bankruptcy Code, the nondischargeability of tax penalties is explained in § 523(a)(7), which states:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

(7) to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty—

(A) relating to a tax of a kind not specified in paragraph (1) of this subsection; or

(B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition;

Under § 523(a)(7), those tax penalties assessed against the Debtor in the instant case which were due after November 10, 1980 are nondischargeable because they satisfy all three of the § 523(a)(7) requirements for nondischargeability:

(1) they are not compensation for actual pecuniary loss⁵ (see McKay v. U.S., 957 F.2d 689, 693 (C.A. 9 1991).

(2) they are related to taxes specified in § 523(a)(1), specifically those enumerated in § 507(a)(7)(C) and (D), or taxes which are otherwise nondischargeable (see In re Burns, 887 F.2d 1541, 1544 (C.A. 11 1989); and

(3) they were imposed with respect to a transaction that occurred within three years before the date of the filing of the petition (see McKay, supra; In re Burns, supra; In re Roberts, 906 F.2d 1440 (C.A. 10 1990).

Thus, it is determined that the Debtor is liable to the IRS for all Form 940 and 941 tax penalties assessed on tax returns due after November 10, 1980.

3. Is the IRS entitled to post-petition interest on its claim?

The most contested issue in this case is whether the IRS is entitled to post-petition interest. In the Supreme Court decision, Bruning v. United States, 376 U.S. 358, 84 S.Ct. 906, 11 L.Ed.2d 772 (1964), the court considered the same issue presented here;...