U.S. v. Schroeder, 89-1240

• Decision Date: 27 April 1990
• Docket Number: No. 89-1240,89-1240
• Citation: 900 F.2d 1144
• Parties: -998, 90-1 USTC P 50,250, Unempl.Ins.Rep. CCH 15393A UNITED STATES of America, Plaintiff-Appellant, v. Walter H. SCHROEDER, Josephine J. Schroeder, and Louis Brodnan, Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1144

900 F.2d 1144

65 A.F.T.R.2d 90-998, 90-1 USTC P 50,250,

Unempl.Ins.Rep. CCH 15393A

UNITED STATES of America, Plaintiff-Appellant, v. Walter H. SCHROEDER, Josephine J. Schroeder, and Louis Brodnan, Defendants-Appellees.

No. 89-1240.

United States Court of Appeals Seventh Circuit.

Argued Feb. 13, 1990.

Decided April 27, 1990.

Richard M. Prendergast, Dept. of Justice, Tax Div., Washington, D.C., Eileen M. Marutzky, Asst. U.S. Atty., Chicago, Ill., Gary R. Allen, Ann Belanger Durney, David M. Moore, Dept. of Justice, Tax Div., Appellate Section, Washington, D.C., for plaintiff-appellant.

Lowell Komie, Michele Reilly, Arnold H. Landis, Chicago, Ill., John D. Kightlinger, Robert F. Meersman, Kathleen T. Meersman, Meersman & Meersman, Mount Prospect, Ill., for defendants-appellees.

Before WOOD, Jr. and COFFEY, Circuit Judges, and ESCHBACH, Senior Circuit Judge.

ESCHBACH, Senior Circuit Judge.

Arlington Plating Company, Inc. ("APC") withheld $131,428.72 in personal income and social security taxes from its employees' wages but it did not remit these "trust-fund" taxes as required to the United States. APC's officers, among whom were included Walter Schroeder and Louis Brodnan, chose instead to give the money to APC's creditors in an attempt to prevent the corporation's insolvency. The attempt failed. APC entered bankruptcy on July 16, 1976.

After the misappropriation of the trust fund taxes APC, and later the trustee in bankruptcy ("TIB"), made various payments to the United States in an attempt to settle APC's liability. This liability consisted, among other things, of amounts due for the errant trust fund taxes and amounts due for "non-trust fund" taxes, which included corporate income taxes and employer's social security tax. In June of 1976 APC paid the United States $11,446.82. The United States, through the Internal Revenue Service, allocated $11,267.04 of this amount to satisfy APC's non-trust fund tax liability. The remaining portion, $179.78, was used to reduce APC's liability for trust-fund taxes from $131,428.72 to $131,248.94. This allocation was made according to the IRS's standard policy, in which involuntary or undesignated corporate payments are allocated to satisfy non-trust fund tax liabilities first, trust fund tax liabilities second. In September of 1978 the TIB paid the United States $30,000. Of this, $23,651.81 was allocated by the IRS towards satisfaction of non-trust fund tax liabilities (amounts of which arose anew over time). The remaining amount of $6348.19 was applied towards partial satisfaction of the corporation's trust fund tax liability, reducing the principal amount of this liability to $124,900.75. Once again, the IRS followed standard policy in apportioning the payment.

On February 25, 1980 the IRS assessed Schroeder and Brodnan with a penalty based on APC's unsatisfied trust fund tax liability. The IRS did so pursuant to I.R.C. Sec. 6672, which makes those responsible for a business's failure to pay trust fund taxes liable for a penalty that equals 100% of the amount not properly paid. 26 U.S.C. Sec. 6672. See also Garsky v. United States, 600 F.2d 86, 89 (7th Cir.1979). Section 6672, in effect, gives the United States the ability to collect wayward trust fund taxes not only from an erring business, but also from those individuals responsible for guarding against such an error. See, e.g., Purdy Co. of Ill. v. United States, 814 F.2d 1183, 1186 (7th Cir.1987); Monday v. United States, 421 F.2d 1210, 1218 (7th Cir.), cert. denied, 400 U.S. 821, 91 S.Ct. 38, 27 L.Ed.2d 48 (1970). It "casts the net of liability over 'any person required to collect, truthfully account for, and pay over' withholding taxes--any 'responsible person' in tax jargon." Wright v. United States, 809 F.2d 425, 427 (7th Cir.1987). There is no question here that Schroeder and Brodnan were responsible for APC's willing failure to pay its trust fund taxes and, consequently, that they were liable under Sec. 6672. Thus, the IRS could pursue for satisfaction of the trust fund tax liability not only APC, but Schroeder and Brodnan as well.

When the IRS assessed Schroeder and Brodnan it made a mistake. The assessment against these individuals was for $131,248.94. At the time it was made, however, APC's trust fund tax liability was only $124,900.75. In light of IRS policy to collect delinquent trust fund taxes only once, ¹ the assessment should have been for $124,900.75 instead of for $131,248.94. In making the assessment the IRS apparently overlooked the $6348.19 previously allocated in September 1978 towards satisfaction of APC's trust fund tax liability.

After the assessment, more money related to APC's tax liabilities reached the IRS. On March 14, 1984 the TIB sent a check for $96,537.03. As before, the IRS first allocated these funds to satisfy APC's outstanding non-trust fund tax liability. The amount was small, however, only $2370.58. The remaining amount of $94,166.45 was allocated to reduce the trust fund tax liability. The TIB sent the IRS another check on March 22, 1984. The entire amount of $6730 was allocated by the IRS towards satisfaction of APC's current non-trust fund tax liability. The Sec. 6672 individuals also sent some money. Throughout the time period of 1980-85, the IRS received payments from them totalling $22,031.59. All of this, of course, went towards reducing their Sec. 6672 liability.

By 1985, the IRS had received trust fund allocated payments from the TIB and the Sec. 6672 individuals that substantially reduced the principal balance owed to the United States: from the 1980 assessed amount of $131,248.94 to a current amount of $15,050.90 ($8712.71 ² if considering the $6348.19 allocated from the "forgotten" payment). Since the 1980 assessment, however, statutory interest had accrued on the Sec. 6672 individuals' outstanding balances. The amount of that interest was well over $100,000. To recover this amount and the principal then due, the United States sued the Sec. 6672 individuals. Most of them settled. Brodnan and Schroeder ("the defendants") did not.

Their case went to trial in June of 1988. The trial was bifurcated into jury and bench portions. The first portion was before a jury to determine if under 26 U.S.C. Sec. 6672 the defendants were persons responsible for APC's willful failure to pay its trust fund tax liability. The jury found that they were. The second portion was to be a bench trial to determine the amount of the penalty owed the United States.

A pre-trial conference was held one week before the bench trial was scheduled to begin. At this conference the United States admitted, for the first time, that the assessment of February 25, 1980 upon which it was suing was in error because of the forgotten $30,000 payment. The district court was none too pleased with this development. Throughout the course of pre-trial discovery the defendants specifically and repeatedly asked the United States about the $30,000 payment, and the government specifically and repeatedly denied any knowledge of it. This information evasion was not isolated either. The United States had denied knowledge of the March 1984 TIB payments at one time, too, only belatedly acknowledging its receipt of that money. The sum total of these and other mishaps on the part of the government raised a question about the propriety of the government's litigation tactics.

At the pre-trial conference the United States stated its intention to seek from the defendants only a lower and correct principal amount of $8712.71, plus statutory accrued interest. When the bench trial began it put on various witnesses to establish that amount, one of whom was a former IRS special agent. The witness explained how the 1980 assessment was calculated, and how the corporate payments were allocated according to the IRS's policy. He conceded that the 1980 assessment had not accounted for the September, 1978 payment of $30,000. But he had revised calculations taking that payment into account, calculations showing the principal amount now owed by the defendants. The witness did not know how much interest they owed, however, as the interest calculation he had was based on old, erroneous figures. He could only guess that it was for an amount approximating $100,000. The defendants put on witnesses as well, including an "expert" accountant who believed that the IRS should have allocated APC's pre-1984 payments differently, based on a 75% trust fund/25% non-trust fund split. Assuming such a split, and various other things, the expert opined that the defendants owed the United States nothing, and, in fact, that they had overpaid. At the conclusion of the trial the defendants moved for dismissal of the action and for an award of attorney's fees under 26 U.S.C. Sec. 7430. The court took these motions under advisement.

In a written memorandum and order entered December 8, 1988, the court entered judgment for the defendants. The court noted that although an IRS assessment generally is presumed valid, the presumption may be overcome by a showing "that the assessment is without rational foundation, or is arbitrary and erroneous" or by a showing that the assessment "was computed in an improper manner." It also noted that a supplemental assessment must be made within the limitations period for an original assessment. The court found that the assessment of February, 1980 was "incorrect"; that it should have been "abated by $6348.19 to reflect a credit given for the $30,000 payment in 1978." It also found that the IRS's allocation of APC's payments towards satisfaction of its non-trust fund and trust fund tax liabilities was arbitrary. It concluded from this that the February 1980 assessment was "arbitrary and erroneous" and "invalid," and that "the defendants are technically entitled to a new assessment." The court further concluded that the United States's "attempt ... to credit the defendants with a portion of the $30,000...