Technical Knockout Graphics, Inc., In re

• Decision Date: 30 November 1987
• Docket Number: No. 87-5516,87-5516
• Citation: 833 F.2d 797
• Parties: -6084, 56 USLW 2337, 87-2 USTC P 9645, 17 Collier Bankr.Cas.2d 1246, Bankr. L. Rep. P 72,123 In re TECHNICAL KNOCKOUT GRAPHICS, INC., a California corporation, Debtor. UNITED STATES of America, Appellant, v. TECHNICAL KNOCKOUT GRAPHICS, INC., a California corporation, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 797

833 F.2d 797

60 A.F.T.R.2d 87-6084, 56 USLW 2337, 87-2

USTC P 9645,

17 Collier Bankr.Cas.2d 1246,

Bankr. L. Rep. P 72,123

In re TECHNICAL KNOCKOUT GRAPHICS, INC., a California corporation, Debtor UNITED STATES of America, Appellant, v. TECHNICAL KNOCKOUT GRAPHICS, INC., a California corporation, Appellee.

No. 87-5516.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Aug. 4, 1987.

Decided Nov. 30, 1987.

Gary D. Gray, Asst. Atty. Gen., Tax Div., Washington, D.C., for appellant.

Philip D. Dapeer, George & Dapeer, Los Angeles, Cal., for appellee.

Appeal from the Judgment of the Bankruptcy Appellate Panel for the Ninth Circuit.

Before WALLACE, HALL and LEAVY, Circuit Judges.

LEAVY, Circuit Judge:

The United States appeals from an order of the bankruptcy appellate panel, upholding a bankruptcy court decision that permitted the debtor to designate how any payments it made after filing a petition for reorganization under Chapter 11 of the Bankruptcy Code would be used to pay off various federal taxes it owed, 68 B.R. 463.

The question presented on appeal is whether a corporate debtor under a Chapter 11 reorganization can designate that tax payments made prior to confirmation of its reorganization plan shall be applied first to satisfy the corporation's trust fund liabilities, thereby protecting the corporation's principals from potential personal liability. Because we conclude that the debtor cannot designate allocation of such payments, we reverse the decision of the bankruptcy appellate panel.

I. Facts and Proceedings Below

Technical Knockout Graphics, Inc. (TKO) defaulted on the payment of corporate income, Social Security, unemployment, and income withholding taxes during 1982 and 1983. On May 3, 1984, it filed a petition for reorganization under Chapter 11 of the Bankruptcy Code. The government filed a proof of claim in that proceeding for $491,634 in delinquent taxes and interest, of which approximately $290,000 was for taxes withheld from the wages of TKO's employees and interest thereon.

The Internal Revenue Code (Code) provides that taxes required to be deducted by employers from the wages paid to employees under 26 U.S.C. Secs. 3102(a) and 3402(a), such as withholding and Social Security taxes, "shall be held to be a special fund in trust for the United States." 26 U.S.C. Sec. 7501(a). The withheld funds are commonly referred to as "trust fund" taxes. Slodov v. United States, 436 U.S. 238, 242-43, 98 S.Ct. 1778, 1782-83, 56 L.Ed.2d 251 (1978). "Non-trust fund" taxes are those not collected from employees' wages. Under the Code, the employer is responsible for collecting, and is personally liable for, the trust fund taxes. 26 U.S.C. Secs. 3102(a), (b), 3402, 3403, 6672.

If a corporation is unable to pay its trust fund taxes, the United States Treasury suffers the loss because the employees from whose wages the taxes are withheld are still credited with those amounts as if they had in fact been paid to the government. United States v. Huckabee Auto Co., 783 F.2d 1546, 1548 (11th Cir.1986); Sorenson v. United States, 521 F.2d 325, 328 (9th Cir.1975). Congress has imposed personal liability on any officer or employee of the employer responsible for 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 such tax or the payment thereof." 26 U.S.C. Sec. 6672. These officers and employees are termed the "responsible persons." This is not true for non-trust fund taxes. That the funds collected under Section 6672(a) are termed a penalty "does not alter their essential character as taxes." United States v. Sotelo, 436 U.S. 268, 275, 98 S.Ct. 1795, 1800, 56 L.Ed.2d 275 (1978). The Internal Revenue Service (IRS) collects the amount of the unpaid trust fund taxes only once, whether collected in part or in whole from each responsible person and/or the corporate employer. USLIFE Title Ins. Co. v. Harbison, 784 F.2d 1238, 1243 & n. 7 (5th Cir.1986).

It is the policy of the IRS that when a taxpayer submits a "voluntary" payment, the taxpayer may designate the tax liability to which the payment will be applied. Muntwyler v. United States, 703 F.2d 1030, 1032 (7th Cir.1983). However, where the payment is "involuntary," the IRS allocates the payments as it sees fit, applying the payment first to non-trust fund taxes. Id. Because the personal liability of the responsible persons offers an additional source for collection of trust fund taxes, this policy increases the government's opportunity to recover in full the taxes due.

Before proposing a reorganization plan, TKO filed a motion in the bankruptcy court asking that it be allowed to make payments to the IRS to reduce the trust fund portion of its pre-petition tax liability. The government opposed the motion. While the government had no objection to being paid, it objected to TKO's attempt to designate the application of payments to the trust fund portion of its liability.

The government contended that payments made by a debtor in Chapter 11 proceedings are involuntary, and thus the IRS is entitled to apply the payments as it sees fit. TKO argued that the proposed payments were voluntary, because TKO had no obligation to make any payments at all prior to filing a reorganization plan.

On March 18, 1986, the bankruptcy court granted TKO's motion, stating:

[The] debtor in possession is permitted to pay to the Internal Revenue Service for and on account of pre-filing employment taxes due and owing by debtor, such amounts in the discretion of debtor in possession by way of reduction of such pre-filing indebtedness and debtor in possession shall be permitted to designate such payment or payments ... as it so desires, by way of application to the trust fund portion of the employment taxes due, or any other portion of the employment taxes due. The Internal Revenue Service shall accept such payments made by debtor in possession ... and shall accept and be bound by the designation by debtor in possession as to how such payments are to be applied.

The government appealed this decision to the bankruptcy appellate panel. In a split decision, the panel affirmed the bankruptcy court. The majority stated that the issue was not whether the debtor could designate its payments to the IRS, but whether the bankruptcy court had the power to order such an allocation. The majority found that Section 505 of the Bankruptcy Code, which authorizes bankruptcy courts to determine the tax liability of the debtor, included the power to allocate repayment among various liabilities. 11 U.S.C. Sec. 505. The panel concluded that "the bankruptcy court ... determined that an equitable allocation would result from directing all of the payment to reduce the 'trust fund' portion of the tax liability."

The dissent rejected TKO's contention that pending confirmation of a reorganization plan, payments made in Chapter 11 proceedings are voluntary or may be designated at the debtor's discretion. The government timely appealed this decision.

By July 23, 1986, TKO had paid to the United States an amount equal to its trust fund liability, designating that it be applied to that liability. On September 16, 1986, the bankruptcy court confirmed TKO's reorganization plan. Under it, 100% of TKO's tax liability is to be repaid, with 11% interest, over six years.

II. Discussion

A. Appealability and Mootness

On July 24, 1987, this court, sua sponte, ordered the parties to file letter briefs discussing two issues: (1) whether the interlocutory order of the bankruptcy court was appealable, and (2) whether the confirmed reorganization plan renders this appeal moot.

1. Appealability

The court of appeals has jurisdiction over final orders, judgments, and decrees of the bankruptcy courts, whether on appeal from a district court or bankruptcy appellate panel. 28 U.S.C. Sec. 158(d); Mason v. Integrity Ins. Co. (In re Mason), 709 F.2d 1313, 1315 (9th Cir.1983).

In bankruptcy proceedings, this court has cautioned against applying with "blind adherence" the rules of finality developed under the general grant of appellate jurisdiction contained in 28 U.S.C. Sec. 1291. Id. at 1316. Instead, the court has adopted a pragmatic approach to deciding whether a bankruptcy court's order is final, recognizing that "certain proceedings in a bankruptcy case are so distinct and conclusive either to the rights of individual parties or the ultimate outcome of the case that final decisions as to them should be appealable as of right." Id. at 1317.

Thus, the court has " 'adopted a test that emphasizes the need for immediate review, rather than whether the order is technically interlocutory, in determining what is appealable as a final judgment in bankruptcy proceedings.' " Farber v. 405 N. Bedford Dr. Corp. (In re 405 N. Bedford Dr. Corp.), 778 F.2d 1374, 1377 (9th Cir.1985) (quoting White v. White (In re White), 727 F.2d 884, 885 (9th Cir.1984)). Bankruptcy orders that " 'may determine and seriously affect substantive rights' and 'cause irreparable harm to the losing party if he had to wait to appeal to the end of the bankruptcy case,' " Mason, 709 F.2d at 1316 (quoting R. Levin, Bankruptcy Appeals, 58 N.C.L.Rev. 967, 985-86 & n. 140 (1980)), are immediately appealable, if the orders "finally determine the discreet [sic] issue to which [they are] addressed." Four Seas Center, Ltd. v. Davres, Inc. (In re Four Seas Center, Ltd.), 754 F.2d 1416, 1418 (9th Cir.1985). However, if " 'further proceedings in the bankruptcy court will affect the scope of the order, the order is not subject to review' " by this court under 28 U.S.C. Sec. 158. In re 405 N. Bedford Dr. Corp., 778 F.2d at 1377 (quoting Four Seas, 754 F.2d at 1418).

We hold that the bankruptcy court's decision is appealable as a final judgment. The order finally determined the discrete issue of the debtor's right...