Ribs-R-Us, Inc., Matter of

• Decision Date: 09 September 1987
• Docket Number: INC,RIBS-R-U,No. 86-5774,86-5774
• Citation: 828 F.2d 199
• Parties: -5601, 87-2 USTC P 9528, 17 Collier Bankr.Cas.2d 1098, Bankr. L. Rep. P 71,987 In the Matter of, a corporation of the State of New Jersey. Appeal of UNITED STATES of America, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 199

828 F.2d 199

60 A.F.T.R.2d 87-5601, 87-2 USTC P 9528,

17 Collier Bankr.Cas.2d 1098,

Bankr. L. Rep. P 71,987

In the Matter of RIBS-R-US, INC., a corporation of the State of New Jersey Appeal of UNITED STATES of America, Appellant.

No. 86-5774.

United States Court of Appeals Third Circuit.

Argued May 21, 1987.

Decided Sept. 9, 1987.

Roger M. Olson, Asst. Atty. Gen., James H. Love, Wynette J. Hewett (argued), Michael L. Paup, Tax Div., Dept. of Justice, Washington, D.C., (Thomas W. Greelish, U.S. Atty., of counsel), for appellant.

Paul R. DeFilippo (argued), Robert K. Malone, Crummy, Del Deo, Dolan, Griffinger & Vecchione, Newark, N.J., for appellee.

Before SLOVITER, BECKER and GARTH, Circuit Judges.

OPINION OF THE COURT

SLOVITER, Circuit Judge.

The question presented by this appeal is whether a corporate debtor under reorganization pursuant to Chapter 11 of the Bankruptcy Code can specify in its plan of reorganization that federal tax payments shall be applied first to satisfy the corporation's trust fund liabilities, thereby protecting the corporation's principals from potential personal liability in the event that the reorganization is unsuccessful. Because we conclude that payments on pre-petition federal tax liabilities by a debtor pursuant to a plan of reorganization under Chapter 11 are involuntary under the federal tax law, we hold that the debtor cannot direct the allocation of such payments between the trust fund and non-trust fund portions of the debtor's tax liabilities and that the bankruptcy court erred as a matter of law in approving the plan with such a designation.

I. FACTS

On July 29, 1985 the debtor, Ribs-R-Us, Inc., filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of New Jersey. The United States subsequently filed a proof of claim for back taxes, including trust fund taxes, consisting of withholding and Social Security taxes deducted from the debtor's employees for which the debtor's principals, as responsible persons, are personally liable under 26 U.S.C. Sec. 6672. Ribs-R-Us, which prior to the filing of its bankruptcy petition operated a restaurant in Verona, New Jersey, has remained at all times a Ribs-R-Us filed a Plan of Reorganization on October 23, 1985. Under the plan, repayment of priority claims would be funded by the proceeds from the sublease of a Ribs-R-Us restaurant and the sale of its liquor license. General unsecured creditors were to recover 25 cents on the dollar from funds contributed by two principals of Ribs-R-Us, Mitchell Mekles and Mitchell Levy, who in turn would receive all the stock in the reorganized Ribs-R-Us.

debtor in possession pursuant to 11 U.S.C. Sec. 1107, no trustee having been appointed.

The plan provided that priority tax claims under 11 U.S.C. Sec. 507(a)(7), including the United States' tax claims, were to be paid in full with interest ¹ in equal monthly installments over the six-year maximum period permitted by the Bankruptcy Code. The plan further provided that "[a]ll payments to any member of this class shall first be applied, or shall be deemed applied, to reduce the 'trust fund' portion of the creditor's claim, if any." App. at 71.

The United States filed an Objection to Confirmation of Debtor's Plan of Reorganization contending, inter alia, that the payments of priority tax claims made pursuant to the bankruptcy proceedings were involuntary payments, and therefore could be applied as the Internal Revenue Service saw fit without designation by the debtor. The bankruptcy court denied the United States' objection on the ground that the debtor's payments of priority tax claims under the plan were voluntary and therefore Ribs-R-Us was entitled to direct that payments to the IRS be applied first to reduce the trust fund portion of Ribs-R-Us' federal tax liability. The bankruptcy court thus confirmed the plan, including the provision directing the application of payments, authorized Ribs-R-Us to designate payments to be applied first to the trust fund portion of its liability, and ordered the United States to apply the payments as designated by Ribs-R-Us. The United States appealed to the district court, which affirmed. This appeal followed.

II. LIABILITY OF RESPONSIBLE PERSONS FOR TRUST FUND TAXES

The applicable provision of the Internal Revenue Code provides that taxes such as withholding and Social Security taxes required to be deducted by employers from the wages paid to employees under 26 U.S.C. Secs. 3102(a), 3402(a) "shall be held to be a special fund in trust for the United States." 26 U.S.C. Sec. 7501(a). The withheld sums are commonly referred to as "trust fund taxes." See Slodov v. United States, 436 U.S. 238, 243, 98 S.Ct. 1778, 1783, 56 L.Ed.2d 251 (1978). Where withholding and Social Security taxes are deducted by an employer from wages paid, such taxes "are credited to the employee regardless of whether they are paid by the employer." Id.

As the Supreme Court recognized, taxes collected by a corporate employer on behalf of employees "can be a tempting source of ready cash to a failing corporation beleaguered by its creditors." Id. Although a corporation's federal tax liabilities are not dischargeable in bankruptcy, see 11 U.S.C. Sec. 523(a)(1)(A), corporate dissolution frequently "has 'the practical effect of discharging all debts including taxes,' regardless of statutory declarations of nondischargeability." United States v. Sotelo, 436 U.S. 268, 278, 98 S.Ct. 1795, 1801, 56 L.Ed.2d 275 (1978) (citation omitted).

In order that the United States avoid bearing the loss of taxes withheld but not paid over, Congress has imposed personal liability on any officer or employee of the employer responsible for effectuating the collection and payment of trust fund taxes who "willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof." 26 U.S.C. Sec. 6672(a). Although the liability under section 6672 is termed a "penalty", such liability "shall be assessed and collected in the same manner as taxes." 26 U.S.C. Sec. 6671(a). See also United States v. Sotelo, 436 U.S. at 275, 98 It is the government's position that the plan provision directing the application of tax payments initially to the trust fund portion of Ribs-R-Us' tax liability was intended to shield from potential personal liability principals of Ribs-R-Us, including Mekles and Levy, who continued as the sole shareholders of the reorganized corporation, and that because this is in derogation of the purpose of section 6672 it is impermissible.

                S.Ct. at 1800.  The IRS need not attempt to collect from the employer before assessing a responsible person under section 6672.   Datlof v. United States, 370 F.2d 655, 656 (3d Cir.1966).  Moreover, personal liability under section 6672 is not dischargeable and survives the bankruptcy of the responsible persons.  11 U.S.C. Sec. 523(a)(1)(A);  see also United States v. Sotelo, 436 U.S. at 277, 98 S.Ct. at 1801
                

III. VALIDITY OF DESIGNATION PROVISION

It has consistently been the policy of the IRS that where a taxpayer submits a voluntary payment, the taxpayer may designate the tax liability to which the payment will be applied. See Rev.Rul. 79-284, 1979-2 C.B. 83, modifying Rev.Rul. 73-305, 1973-2 C.B. 43, superseding Rev.Rul. 58-239, 1958-1 C.B. 94. On the other hand, where the payment is not voluntary, it is the policy of the IRS to apply the payment first to non-trust fund taxes due. IRS Policy Statement P-5-60, IRS Manual (May 30, 1984); see also Slodov v. United States, 436 U.S. at 252 n. 15, 98 S.Ct. at 1788, n. 15. Because the personal liability of the responsible person offers an additional source of collection of trust fund taxes, this allocation increases the United States' opportunity to recover taxes due it in full.

Ribs-R-Us does not challenge the proposition that its entitlement to designate application of payments depends on whether we view the payments as voluntary. See, e.g., In re Avildsen Tools & Machine, Inc., 794 F.2d 1248, 1251-52 (7th Cir.1986); O'Dell v. United States, 326 F.2d 451, 456 (10th Cir.1964); Amos v. Commissioner, 47 T.C. 65, 69-70 (1966). This dispute between the parties is limited to whether a payment of taxes pursuant to a Chapter 11 reorganization is "voluntary". The district courts and bankruptcy courts have divided on this issue. ²

In Amos v. Commissioner, 47 T.C. 65, 69 (1966), the Tax Court defined involuntary payment as follows:

An involuntary payment of Federal taxes means any payment received by agents of the United States as a result of distraint or levy or from a legal proceeding in which the Government is seeking to collect its delinquent taxes or file a claim therefor.;

(emphasis added). Using this definition, the Seventh Circuit in Muntwyler v. United States, 703 F.2d 1030 (7th Cir.1983), held that payments to the IRS made by the trustee of an assignment for the benefit of creditors were voluntary because the only action by the IRS was the filing of a claim with the trustee and that therefore payments could be directed by the debtor to its trust fund liabilities. In reaching its conclusion, the court distinguished the assignment for the benefit of creditors from payments made in bankruptcy, viewing the latter situation as one in which "court action is involved." Id. at 1033. The court stated that "[t]he government might have been correct in its claim if the corporation had been in bankruptcy which it was not." Id. at 1034 n. 2.

The issue arose before the Seventh Circuit again in In re Avildsen Tools & Machine After briefing and argument in the present case, the Eleventh Circuit, considering the same issue as that before us, "decline[d] to accept the argument of the IRS that all payments made under a Chapter 11 reorganization are involuntary and thus properly...