In re Vermont Fiberglass, Inc.

Decision Date10 August 1987
Docket NumberBankruptcy No. 83-155.
Citation76 BR 358
CourtU.S. Bankruptcy Court — District of Vermont
PartiesIn re VERMONT FIBERGLASS, INC., d/b/a Pettit Pools of Rutland, Debtor.

M. Butterfield, Candon & Butterfield, Rutland, Vt., for debtor.

D. Stefanik, U.S. Dept. of Justice, Washington, D.C., for the I.R.S.


FRANCIS G. CONRAD, Bankruptcy Judge.

The debtor moves this Court for an Order directing the IRS to allocate mortgage proceeds and dividends received by the IRS from the debtor, and from debtor's trustee to debtor's "Trust Fund Taxes," and not to its interest and penalty tax liability to the IRS.1 Because we find that debtor sufficiently directed the allocation of mortgage proceeds and the IRS did not; and because we find the IRS has failed to produce evidence to require us to exercise our discretion in its favor and against the debtor, we sustain debtor's motion to allocate proceeds and dividends received by the IRS to debtor's "Trust Fund Taxes."


Prior to bankruptcy debtor disclosed to the IRS the existence of a mortgage and promissory note due debtor from the Church of Attunement and offered this asset in partial satisfaction of the debtor's withholding tax liability as inferentially memorialized in a letter dated July 18, 1982 from debtor's counsel to an Internal Revenue officer.2

At the June 3, 1987 hearing, Internal Revenue officer Nolan (presently retired) testified that debtor's counsel voluntarily disclosed the Church of Attunement's mortgage, prior to the debtor's July 18, 1982 letter and the subsequent IRS's notice of levy. The officer also testified that the debtor fully cooperated with the IRS in its disclosures and even produced financial statements for the IRS's inspection. Because of this disclosure, the officer testified that the IRS never issued a collection summons or needed to subpoena the debtor to determine the mortgage's existence. He did not, however, adequately explain away the logical inference that debtor's pre-levy disclosures was an offer to the IRS for an assignment of debtor's receivable collection, and he produced no evidence that the IRS would have discovered this receivable without the debtor's voluntary disclosure.

An IRS "Notice of Levy", dated February 16, 1983, was served by the IRS on the Church of Attunement. Debtor was never served with this "notice of levy"; however, debtor's counsel conceded that he had received a courtesy copy.

On August 5, 1983, debtor filed its voluntary petition under Chapter 11 of Title 11 of the United States Code.

During December of 1983, proceeds from the Church of Attunement mortgage and promissory note were received by debtor's attorney. The cashiers check dated December 9, 1983 was made payable to "Vermont Fiberglass Corp. & Internal Revenue Ser." and in the amount of $8,794.34.

On February 2, 1984, IRS filed its proof of claim for taxes and sought: $84,889.02 for secured claims; $29,675.86 for unsecured priority claims; and, unsecured general claims of $2,524.61 for penalty. The IRS filed an amendment to their proof of claim on August 20, 1984, and sought: $78,898.43 for secured claims; unsecured priority claims of $31,261.39; and unsecured general claims for penalty of $2,031.81.

On March 8, 1984, debtor's case was converted to a Chapter 7 proceeding and, after an April 5, 1984 hearing, this Court dismissed debtor's motion to reconsider the conversion.

On March 19, 1984, debtor's counsel sent the IRS the December 9, 1983 cashier's check from the mortgagee, together with a letter stating, inter alia:

"This check is being turned over to the Internal Revenue Service without prejudice to Vermont Fiberglass\'s rights to contest the manner in which the funds are being applied and to which accounts the funds are being applied."

When questioned about the delay in forwarding the proceeds, Debtor's counsel was unable to satisfactorily explain why the cashier's check was not tendered to the IRS while the debtor was in a Chapter 11 proceeding.

On May 4, 1984, this Court entered an Order appointing a trustee, and on May 24, 1984, the trustee was authorized, by an Order of even date, to conduct the debtor's business. The trustee's Report and Account approved without objection, after notice and hearing, the IRS's allowed claim of $108,857.12. A first and final pro rata dividend of $29,071.99 as a tax priority pursuant to 11 U.S.C. § 507(a)(7) was allowed. Order For Disbursements And Dividend Sheet, Francis G. Conrad, B.J., July 1, 1986, at page 3. After the July 1, 1986 Order for Disbursements and Dividend Sheet, and at the close of the Chapter 7 proceeding, the trustee made a payment of $29,071.99 to the IRS for federal employment taxes.

At hearing, the IRS produced no evidence on how it had allocated either the mortgage proceeds or the trustee's distribution to the debtor's tax liabilities.

The debtor's principal officer, at an earlier hearing, testified that one of his goals, and those of the debtor in filing the original voluntary bankruptcy petition, was to make full payment to the IRS of all debtor's back taxes.3


The crucial factual determination is the voluntariness of the debtor's pre and postpetition actions, and whether the debtor, the IRS, or this Court may direct to which accounts, ie. "Trust Fund Tax," interest, and/or penalty, the IRS must credit proceeds derived from the offered mortgage or the trustee's Chapter 7 distribution. As we understand it, the basic rule for the application of payment is: in the absence of a creditor's enforced collection measure, the debtor may direct the payments application; if he fails to do so, the right devolves upon the creditor; if the creditor fails to allocate in a timely manner, the Court will make the application according to its own notion of justice. See National Bank of the Commonwealth, of New York City v. Mechanics' National Bank, 94 U.S. (4 Otto) 437, 439, 24 L.Ed. 176 (1877).

A. Trust Fund Doctrine

"Trust Fund Taxes" are those taxes withheld by employers from employees' wages that are required to be held in trust for the United States Treasury pursuant to 26 U.S.C. § 7501.4 When making payments of wages to employees, 26 U.S.C. § 3402 requires employers to deduct and withhold income taxes.5 Liability for payment of the tax required to be deducted and withheld is placed upon the employer under 26 U.S.C. § 34036. An employee receives credit for the withheld taxes regardless of whether the employer actually remits the "Trust Fund Taxes" to the government. Slodov v. United States, 436 U.S. 238, 243, 98 S.Ct 1778, 1783, 56 L.Ed.2d 251, 259 (1978).

If the employer fails to remit the taxes, then the government may look to a "responsible person" for the willful nonpayment for recourse. Uslife Title Ins. Co. of Dallas v. Harbison, 784 F.2d 1238, 1243 (5th Cir.1986). Congress has provided the IRS with a powerful tool for recourse to prevent a presumed loss to the Treasury, 26 U.S.C. § 6672.7 Section 6672 imposes personal liability upon: "Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect . . . shall, in addition to other penalties provided by law, be liable to a penalty to the total amount of the tax . . . not collected . . . and paid over." Id.

A "person" is statutorily defined by 26 U.S.C. § 6671(b),8 however, for § 6672 liability purposes, case law developed this statutory definition into the term of art, "responsible person." Slodov v. United States, 436 U.S. 238, 245 n. 7, 98 S.Ct 1778, 1784 n. 7, 56 L.Ed.2d 251, 260-61 n. 7 (1978). A "responsible person" is one who has the power, duty, and control over the collection and remittance of "trust fund" taxes. Monday v. United States, 421 F.2d 1210, 1214 (7th Cir.1970), cert. denied, 400 U.S. 821, 91 S.Ct 38, 27 L.Ed.2d 48 (1970); Werner v. United States, 374 F.Supp. 558, 562 (D.Conn.1974) affirmed per curiam 512 F.2d 1381, 1382 (2d Cir.1975). Liability of a "responsible person" is both joint and severable from the corporate employer, United States v. Huckabee Auto Co., 783 F.2d 1546, 1548-49 (11th Cir.1986), since a Section 6672 action is:

"Not one against a transferee of assets of the corporation, or one of a derivative character. . . . it is quite plain from the terms of the statute that the Congress intended that funds collected for these taxes be treated as a trust fund and that persons responsible for their paying over should be individually liable, as well as the corporation, for their diversion."

Spivak v. United States, 370 F.2d 612, 615 (2d Cir.1967), cert. denied 387 U.S. 908, 87 S.Ct 1690, 18 L.Ed.2d 625 (1967) (citations omitted). While the IRS need not exhaust its collection efforts on the corporate employer prior to assessing a "responsible person", Datlof v. United States, 370 F.2d 655, 656 (3d Cir.1966), cert. denied 387 U.S. 906, 87 S.Ct 1688, 18 L.Ed.2d 624 (1967), "There certainly must first be a liability running from the employer for such taxes." In re Turchon, 62 B.R. 461, 465, 14 CBC.2d 1370 (Bkrtcy.E.D.N.Y.1986).

Although plainly termed a "penalty" by Congress, the liability imposed under 26 U.S.C. § 6672 has not been literally applied by the Courts, for Bankruptcy Code purposes, to mean a penalty, but rather "penalty" is considered as a mere revenue collection device, United States v. Sotelo, 436 U.S. 268, 275, 98 S.Ct 1795, 1800, 56 L.Ed.2d 275 (1978); United States v. Huckabee Auto Co., 783 F.2d 1546, 1548 (11th Cir.1986); Monday v. United States, 421 F.2d 1210, 1216 (7th Cir.1970), cert. denied, 400 U.S. 821, 91 S.Ct 38, 27 L.Ed.2d 48 (1970), to accomplish the Congressional purpose of protecting it's tax. Spivak v. United States, 370 F.2d 612, 616 (2d Cir. 1967), cert. denied 387 U.S. 908, 87 S.Ct 1690, 18 L.Ed.2d 625 (1967). Thus, a § 6672 "penalty" is a tax for Bankruptcy...

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