Otte v. United States 8212 375

• Decision Date: 19 November 1974
• Docket Number: No. 73,73
• Citation: 419 U.S. 43,95 S.Ct. 247,42 L.Ed.2d 212
• Parties: William OTTE, Trustee in Bankruptcy of Freedomland, Inc., Petitioner, v. UNITED STATES and the City of New York. —375
• Court: U.S. Supreme Court

42 L.Ed.2d 212

95 S.Ct. 247

419 U.S. 43

William OTTE, Trustee in Bankruptcy of Freedomland, Inc., Petitioner,

v UNITED STATES and the City of New York.

No. 73—375.

Argued Oct. 15, 1974.

Decided Nov. 19, 1974.

Syllabus[

1. A trustee in bankruptcy for an employer is required by the withholding provisions of the Internal Revenue Code of 1954 (IRC) and similar provisions of the New York City Administrative Code to withhold taxes from the payment of priority claims for wages earned by employees prior to the employer's bankruptcy, but unpaid at the inception of the bankruptcy proceeding. The payment of the wage claims is 'payment of wages' under IRC § 3402(a) requiring withholding of income taxes, and is wages under IRC § 3102(a) requiring withholding of social security taxes, and an 'employer,' defined by IRC § 3401(d)(1) to include 'the person having control of the payment' of wages, is present under § 3402(a). The same rationale applies to the withholding of city income taxes under the similar City Code provisions. Pp. 48—52.

2. From the obligation to withhold it follows that the trustee is also required to prepare and submit to the wage claimants and to the taxing authorities the reports and returns required of employers under IRC §§ 6051(a), 6001, and 6011 and similar provisions of the City Code, P. 52.

3. Requiring the trustee to withhold, report, and file returns does not unduly burden the administration of bankrupt estates so as to contravene the spirit of the Bankruptcy Act, for the burden is the same as any employer, or receiver, arrangement debtor, or other fiduciary, with a like number of employees must bear; moreover, both the IRC and the City Code allow the trustee to withhold taxes at a flat rate, thus facilitating the tax computation. Pp. 52—54.

4. Proofs of claim by the United States and New York City with respect to the withholding taxes on the priority wage claims are not required. Since tax liability accrues only when the wage is paid, and since the wages subject to the wage claims here, although earned before bankruptcy, were not paid prior thereto, so that the bankrupt employer's tax liability came into being only during bankruptcy, the taxes are not like debts of the bankrupt for which proofs of claims must be filed. Pp. 54—55.

5. The federal and city withholding taxes are entitled, as are the priority wage claims from which they emerge, to second priority of payment under § 64a(2) of the Bankruptcy Act. Such taxes are not within the fourth priority under § 64a(4), since they did not become due and owing by the bankrupt until after the wage claims were paid following bankruptcy. Nor are such taxes entitled to first priority under § 64a(1), since they are not costs or expenses of administration of the bankrupt estate, but are part of the wage claims themselves and are carved out of the payment of those claims. Pp. 55—58.

2 Cir., 480 F.2d 184, affirmed.

BLACKMUN, J., delivered the opinion for a unanimous Court.

Howard Karasik, New York City, for petitioner.

Keith A. Jones, Washington, D.C., for respondent United States.

Samuel J. Warms, New York City, for respondent.

Mr. Justice BLACKMUN delivered the opinion of the Court.

This bankruptcy case raises issues (a) as to whether priority claims for wages earned by employees prior to an employer's bankruptcy, but unpaid at the inception of the bankruptcy proceeding, are subject to withholding taxes, and, if so, (b) as to whether the taxing entities must file proofs of claim, and (c) as to which priority of payment, if any, the withholding taxes enjoy under 64a of the Bankruptcy Act (the Act), 11 U.S.C. § 104(a).¹

I

On September 15, 1964, Freedomland, Inc., a New York corporation, filed a petition with the United States District Court for the Southern District of New York for an arrangement under Chapter XI of the Act, 11 U.S.C. §§ 701—799. The arrangement failed, and on August 30, 1965, Freedomland was adjudicated a bankrupt. Petitioner, William Otte, was appointed and qualified as the trustee.

During the statutorily prescribed six-month period for the filing of proofs of claim against the estate, see §§ 57 and 63 of the Act, 11 U.S.C. §§ 93 and 103, 413 former employees of Freedomland filed proofs for unpaid wages (each claim in the amount of $600 or less and all the claims aggregating approximately $80,000) that had been earned within three months preceding the filing of the Chapter XI petition. These wage claims concededly were entitled to a second priority of payment under § 64a(2). No proofs for any federal income or Federal Insurance Contributions Act taxes on these wage claims, withholdable under Chapters 24 and 21, respectively, of the Internal Revenue Code of 1954, 26 U.S.C. §§ 3401—3404 and 3101—3126, were filed by the United States, and no proofs for any New York City personal income tax, withholdable under Chapter 46, Titles T and U, of the New York City Administrative Code, were filed by the city.

In November 1969 the trustee filed a motion for an order directing distribution to the 413 priority wage claimants without deduction for any federal, state, or city withholding taxes. He also asked that the referee declare that the trustee was not required to withhold or pay any such tax or to file any report or return relative thereto with the respective taxing authorities. The State of New York, although served, filed no response to the trustee's motion. The United States and the city did respond. The referee issued an order granting the trustee the relief he requested. App. 48a—50a. In a supporting memorandum decision, the referee stated that the withholding and reporting requirements of the federal and city statutes 'would impose a further burden on the administration of these estates which is entirely inconsistent with the objective of efficient expeditious economic administration of bankrupt estates,' and that 'compliance with withholding and reporting requirements . . . is utterly inconsistent with the spirit and the letter of the Bankruptcy Act.' Id. at 36a, 37a.

The United States and the city filed petitions with the United States District Court to review the referee's order and decision. After a hearing, the District Court reversed the order and decision insofar as they pertained to federal taxes. It directed the withholding of federal taxes on the priority wage claims, and also concluded that the amounts to be withheld were 'taxes which became legally due and owing by the bankrupt,' within the language of § 64a(4), and, therefore, were to be paid as tax claims of the fourth priority. The court observed that little more than a simple bookkeeping effort would be involved in withholding 25% of the wage distributions. 2 It held that proofs of claim were not required because the employees' proofs gave notice to the trustee and other creditors of the total amounts distributable on account of the claims. The District Court, however, ruled against the city on the ground that the city's personal income tax did not become effective until 1966, and thus no city tax was due and owing by the bankrupt in 1964 when the Chapter XI petition was filed. In re Freedomland, Inc., 341 F.Supp. 647 (1972).

The trustee, the—United States, and the city all appealed. The United States Court of Appeals for the Second Circuit affirmed in part and reversed in part. It held that the trustee was obligated to withhold, to report, and to pay over the withholding taxes on the wage claims, and that the taxing entities were not required to file proofs of claim. It further held, however—and thus to this extent disagreed with the District Court—that both the United States and the city were entitled to be paid as second priority claimants under § 64a(2). In re Freedomland, Inc., 480 F.2d 184 (1973).

We granted the trustee's petition for certiorari (unopposed by the United States) primarily because the circuits are in disarray as to the priority to be accorded to withholding taxes on prebankruptcy wage claims.³ 414 U.S. 1156, 94 S.Ct. 912, 39 L.Ed.2d 108 (1974). No cross-petition was filed by either the United States or the city of New York.

II Withholding, Reports, and Returns

Every Court of Appeals which has faced the issue, including the Second Circuit in the present case, has held, contrary to the ruling of the referee, that the withholding provisions of the Internal Revenue Code, and of state or municipal tax statutes, require that a trustee in bankruptcy withhold income and social security taxes from payments of wage claims, and that he prepare and submit to the wage claimants, and to the taxing authorities the reports and returns statutorily required of employers. United States v. Fogarty, 164 F.2d 26, 30—33 (CA8 1947); United States v. Curtis, 178 F.2d 268, 269 (CA6 1949), cert. denied, 339 U.S. 965, 70 S.Ct. 1001, 94 L.Ed. 1374 (1950); Lines v. California Dept. of Employment, 242 F.2d 201, 202, reh. den., 246 F.2d 70 (CA9), cert. denied, 355 U.S. 857, 78 S.Ct. 86, 2 L.Ed.2d 64 (1957); In re Connecticut Motor Lines, Inc., 336 F.2d 96 (CA3 1964). To the same effect is In re Daigle, 111 F.Supp. 109, 111 (Me.1953).

A. The requirement of withholding. Section 3402(a) of the Internal Revenue Code, 26 U.S.C. § 3402(a), requires '(e)very employer making payment of wages' to 'deduct and withhold upon such wages . . . a tax determined . . ..' Section 3401(a) defines 'wages' for withholding purposes to mean, with certain exceptions, 'all remuneration . . . for services performed by an employee for his employer,' and § 3401(d) defines 'employer' as 'the person for whom an individual performs or performed any service, of whatever nature, as the employee of such person.' The latter section makes an exception where 'the person for whom the individual performs or performed the services does not have control of the payment of the wages for such services'; in that case, 'employer' means 'the person having control of the payment of such wages.' Sections...