Trust Fund Taxes, Including Collected State Sales Taxes, Are Not Dischargeable in Bankruptcy (7/21/12)

In In re: Calabrese, ___ F.3d ___, 2012 U.S. App. LEXIS 14897 (3d Cir. 2012), here, the Third Circuit held that state sales taxes that a seller collects from purchasers is a trust fund tax that is not dischargeable in bankruptcy.  The bankruptcy statute exempts from discharge "trust fund" taxes.  

The issue as posited by the Court was:

We must decide whether the sales taxes held by Calabrese are "trust fund" or "excise" taxes under 11 U.S.C. § 507(a)(8). Excise taxes receive priority, and are non-dischargeable, if they are less than three years old, as measured from the date of the bankruptcy petition. See 11 U.S.C. § 507(a)(8)(E) (priority); 11 U.S.C. § 523(a)(1)(A) ("A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt . . . for a tax or a customs duty . . . of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed . . . ."). Trust fund taxes are always prioritized and are never dischargeable irrespective of the age of the debt. See 11 U.S.C. §§ 507(a)(8)(C), 523(a)(1)(A). 

Three of our sister courts of appeals have considered the question presented here. In each case, the court determined that the statutory text of § 507(a)(8) does not resolve the dispute. See Shank v. Wash. State Dep't of Revenue, Excise Tax Div. (In re Shank), 792 F.2d 829, 832 (9th Cir. 1986); DeChiaro v. N.Y. State Tax Comm'n, 760 F.2d 432, 435 (2d Cir. 1985); Rosenow v. State of Ill., Dep't of Revenue (In re Rosenow), 715 F.2d 277, 279 (7th Cir. 1983). Proceeding to analyze the legislative history, all three concluded that a sales tax paid by a third party is a trust fund tax within the meaning of subsection (C), and not an excise tax under subsection (E).

The Third Circuit panel then reviewed the statute and legislative history.  Finding the statute inconclusive on the issue, the panel proceeded, reluctantly it says, "to wade into the murky waters of legislative history."  The panel also found the legislative history inconclusive.  Said the panel (footnote omitted):

Faced with an ambiguous statute and an indefinite legislative history, we turn to public policy. As noted by Judge Reinhardt, these considerations cut both ways. See id. at 836. On the one hand, two broad purposes of the bankruptcy scheme enacted by Congress are to give the debtor a new financial start and to keep creditors on an equal playing field.4 See BFP v. Resolution Trust Corp., 511 U.S. 531, 563 (1994)  [*23] (Souter, J., dissenting) ("[A] maximum and equitable distribution for creditors and ensuring a 'fresh start' for individual debtors[] [are] often said [to be] at the core of federal bankruptcy law."). On the other hand, the incentives for a potential debtor like Calabrese would be quite perverse if, when he sees his business take a turn for the worse, he knows he might obtain a discharge of his debt if he refuses to turn over to the state sales taxes collected from third parties. See Shank, 792 F.2d at 832. On balance, we think the second consideration weighs more heavily. 

We also find significant the fact that third-party sales taxes resemble trust fund taxes more than other sales taxes even though the source of taxation is a sales transaction. After all, such taxes are owed not by the debtor, but are merely held by the debtor on behalf of the party that owes the tax to be transferred to the taxing authority at a later time. Using similar reasoning, the Supreme Court in Begier, considering the interactions of various statutes from the Bankruptcy and Internal Revenue Codes, concluded that taxes required to be withheld by an employer under the Federal Insurance Contributions Act, 26 U.S.C. § 3102(a), are held in trust for the IRS even when those taxes are improperly comingled (sic) with the employer's general operating funds. 496 U.S. at 55-67. "Because the debtor does not own an equitable interest in property he holds in trust for another, that interest is not 'property of the estate[,]' [n]or is [it] 'property of the debtor' . . . ." Id. at 59 (quoting 11 U.S.C. §§ 541, 547). The analogy to Begier is not a perfect one, but the underlying principle—that the debtor is responsible for money in which he never had an equitable interest—is just as applicable here. 

Finally, our decision is consistent with New Jersey's own treatment of its sales tax. Under New Jersey law, "the vendor collects the tax from its customers, and holds it in trust until it is reported and turned over to the State. This is not a tax imposed on the vendor but on the vendor's customer, and as such is what is commonly called a 'trust fund' tax." Yilmaz, Inc. v. Dir., Div. of Taxation, 22 N.J. Tax 204, 231 (2005) (citation omitted) (citing Cooperstein v. State of N.J., Div. of Taxation, 13 N.J. Tax 68, 78 n.4 (1993)), aff'd, 915 A.2d 1069, 1072 & n.3 (N.J. Super. Ct. App. Div. 2007); accord N.J. Stat. Ann. § 54:32B-12(a) ("The [sales] tax shall be paid to the person required to collect it as trustee for and on account of the State."). That the Tax Court of New Jersey has recognized its sales tax is a trust fund tax when held by a business owner for the customer validates our common-sense construction of § 507(a)(8). 

In sum, we believe public policy concerns weigh against Calabrese, primarily because sales taxes collected by a retailer never become the property of the retailer; ab initio, it retains those funds in trust for the state. Accordingly, we hold that Calabrese's sales-tax obligation is subject to § 507(a)(8)(C) and is not dischargeable. We will affirm the order of the District Court.

For tax procedure students, note the following:

• Trust fund taxes are not dischargeable.  The principal trust fund tax we deal with in federal tax procedure is the tax (income tax and employee's share of FICA) withheld from an employee and the potential resulting Trust Fund Recovery Penalty (often acronymed to TFRP) in § 6672, here.  The TFRP is a significant practice for the tax controversy practitioner and, hence, we spend considerable time with the TFRP in the book (see pp. 453 ff of the nonfootnoted version).
• Trust fund taxes may be commingled.  Trust fund taxes do not require that the funds be kept separately in trust, but may be commingled funds.  Hence there is no requirement of a separate trust corpus in order for there to be a trust fund tax.  The employment trust fund taxes are illustrative.  At least in most cases, the employer will not have a separate account to separate trust fund tax from general operating deposits.  That does not mean that the trust fund concept fails for lack of a corpus.
• Statutory Interpretation.  The statutory interpretation dynamics are important to understand, although this case will not be a leading case.  Notice what the court did.  It's job is to apply an exception to discharge that is solely statutory.  Yet, the statute is inconclusive.  The court has to answer the question, therefore so it must find some other way to get the answer.  Particularly in the tax context, the use of legislative history, although scorned by some jurists like Justice Scalito, is pretty much standard fare where the statute is inconclusive.  (In other areas, where the agency directed to manage the statutory scheme has spoken via authorititive pronouncement such as regulation, a Chevron modality of interpretation might apply, but that was not the context here where no regulatory agency had spoken; hence the use of legislative history is standard.)  Then, however, finding the legislative history inconclusive, the court had to answer the question on policy grounds by extrapolating from knowns (such as the TFRP) to unknowns such as the state sales tax in question.