Opinion
CASE NO. 97-60969 Chapter 13, ADVERSARY NO. 97-6078
June, 2000
MEMORANDUM OPINION
NOW before the Court is the Plaintiff's First Amended Original Complaint filed by Billy W. Peden, the Debtor in this bankruptcy case. The Court considered the pleadings, the arguments of counsel, and the evidence adduced at trial. This opinion constitutes the Court's findings of fact and conclusions of law to the extent required by Fed.R.Bankr.Proc. 7052 and disposes of all issues before the Court.
FACTUAL AND PROCEDURAL BACKGROUND
On May 31, 1993, the Internal Revenue Service assessed a 100% Trust Fund Recovery Penalty against Billy Peden (hereinafter "Peden"), in the amount of $25,838.78 under 26 U.S.C. § 6672 for unpaid third and fourth quarter 1986 employment (941) taxes reported but not paid by Tri-State Transportation Company, Inc., ("Tri-State"). Tri-State was a trucking company that filed for bankruptcy protection under Chapter 11, Title 11 of the U.S. Code on December 31, 1986. Peden, who was an investor in Tri-State and field manager, had become an officer in December 1986. He signed Tri-State's voluntary petition seeking relief under Chapter 11 when Mr. M. E. Shelton, Tri-State's president, "disappeared". Among other debts, Tri-State owed employment taxes for the third and fourth quarters of 1986. Tri-State confirmed a Chapter 11 plan, consummated that plan and the Tri-State bankruptcy case was closed in 1991.
In connection with its 1993 assessment of the 100% penalty against Peden following the close of the Tri-State bankruptcy case, the IRS filed a tax lien against certain of Peden's real property located in Van Zandt County, Texas.
In 1997, Peden, individually, filed a petition for relief under Chapter 13. The IRS filed a proof of claim in the Chapter 13 proceeding for $34,813.50 consisting of 100% penalty plus interest. Peden objected to the proof of claim and filed the instant adversary seeking a determination of the amount of the claim, an adjustment of the amount due and cancellation of the lien filed by the IRS against his Van Zandt County property. The matter came on to be heard pursuant to a regular setting and, after trial, was taken under advisement.
Billy Peden also was a Chapter 7 debtor in Case No. 88-61820 in which he received a discharge.
Peden's Original Complaint also seeks reasonable attorneys' fees and costs of court, pre and post-judgment interest and such other and further relief at law or in equity, etc.
DISCUSSION
Under 26 U.S.C. § 6672(a):
[a]ny person required to collect, truthfully account for, and pay over any tax imposed by this title 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, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.
I.R.C. § 6672(a). Section 6672(a) of the Tax Code has been applied as a two pronged test. To be liable for the payroll taxes, the corporate officer must be found to be a "responsible person" and his failure to pay over the taxes must be shown to have been "willful." Wilkinson v. U.S., 3 Cl.Ct. 55, 59-60 (1983).
A responsible person is one who has "the power to control the decision making process by which the employer corporation allocates funds to other creditors in preference to its withholding tax obligations" Godfrey v. United States, 748 F.2d 1568, 1575 (Fed. Cir. 1984). "Willful" has been defined under the Internal Revenue Code and case law applicable to 26 U.S.C. § 6672 violations. Intentional preference for debts of other creditors over the liability to the United States by one under a duty to pay over payroll taxes constitutes a willful failure to collect and pay over the taxes within the meaning of 26 U.S.C. § 6672. Bolding v. United States, 565 F.2d 663, 215 Ct.Cl. 148 (1977). See also Wilkinson, Supra at 60 and Newsome v. United States, 431 F.2d 742, 26 A.F.T.R. 2d 70-5078, 27 A.F.T.R.2d 71-1248, 70-2 USTC p 9504, 70-2 USTC P 9597, (5th Cir.) reh. denied. A "responsible person" manifests personal fault amounting to a "willful" failure to collect and to pay over taxes by making "a deliberate choice voluntarily, consciously, and intentionally * * * to pay other creditors instead of paying the Government."[Michaud, Ibid at 23 citing to Godfrey, 748 F.2d at 1577 (citation omitted).] In lieu of this "deliberate choice" standard, the "willfulness" prong is satisfied "`if the responsible person acts with a reckless disregard of a known or obvious risk that trust funds may not be remitted to the Government, * * * such as by failing to investigate or to correct mismanagement after being notified that withholding taxes have not been duly remitted.'" Michaud, Ibid at 23 citing to Godfrey, 748 F.2d at 1578 [quoting Mazo v. United States, 591 F.2d 1151, 1154 (5th Cir.) cert. denied, 444 U.S. 842, 100S.Ct. 82, 62 L.Ed.2d 117 (1972)].
"Willful" means voluntary, conscious or intentional as opposed to accidental. Garsky v. United States, 600 F.2d 86,91 (7th Cir. 1979). A considered decision not to fulfill one's obligations to pay taxes owed, evidenced by payments made to other creditors in the knowledge that the taxes are due, is all that is required to establish willfulness. Feist v. United States, 607 F.2d 954,961 (Ct.Cl. 1979).
The dispute between the parties centers around the extent to which Peden can be responsible for withholdings that occurred before he became the responsible officer but were unpaid at the time he became a responsible officer. The evidence clearly indicates that Peden did not become the responsible person until December 31, 1986. Prior to December 31, 1986, M.E. Shelton was the responsible person and Peden asserts that Peden was neither a responsible person nor an individual liable for the failure to collect and pay over trust fund monies during the pre-bankruptcy period. The crux of the IRS' case is that the IRS imputes to Peden liability under 26 U.S.C. § 6672 for having been a responsible person during the entire third and fourth quarters. At trial and in its brief, the IRS was unable to present the Court with any precedent as a basis for imputing liability retroactive from Peden's becoming an officer beyond the fact that Peden filed Tri-State's payroll tax return for the fourth quarter of 1986. In this regard, the IRS grasps the correct result, but offers the wrong rationale.
Mr. Peden incorrectly assumes that if M.E. Shelton was the responsible officer, Peden is absolved from responsibility. There can be more than one responsible person [Michaud v.U.S., 40 Fed.Cl. 1, 80 A.F.T.R. 2d 97-8007, 97-2 U.S.T.C. P 50,972 (Fed.Cl., Nov.26, 1997) citing to Gephart v. United States, 818 F.2d 469, 473 (6th Cir. 1987)], however, the IRS cannot "double-dip". See Gens v. United States, 222 Ct.Cl. 407,415, 615 F.2d 1335, 1339 (1980) and Michaud v.U.S., Ibid at 14 n. 18. Accordingly, the IRS can continue collection against responsible persons for amounts not paid or discharged under a bankrupt business entity's (such as Tri-State's) Chapter 11 plan.
U.S.'s answer to Plaintiff's First Amended Original Complaint, para. IX. "If a person is liable for a portion of the quarter, then he is liable for the entire quarter."
The filing of the return is not significant in this case. Liability for payment over of withholding taxes arises at the time sums are withheld from employees' wages rather than at the later date when the employer's quarterly tax return is filed [Bolding v. U.S., 565 F.2d 663, 215 Ct. Cl. 148 (1977); U.S. v. DeBerandinis, 395 F. Supp. 944 (D.C. Conn. 1975), affirmed 538 F.2d 315;U.S./I.R.S. v. Lee, 184 B.R. 257 (W.D.Va. 1995)]; the duty is a continuing one which arises when federal income and social security taxes are withheld from employees' wages and does not end until such funds are paid over to the United States. Newsome v. U.S., 431 F.2d 742, 746 (C.A. Tex. 1970).
THE EXISTING FUNDS DOCTRINE
Retroactive liability under Section 6672 may be imposed under the "existing funds" doctrine. Under the "existing funds doctrine", where employer funds exist at the time a person becomes a "responsible person", that person may violate the pay over requirement of the penalty statute by willfully failing to pay over trust funds collected prior to his accession to control. Thus, even if a tax liability accrued before the officer became a "responsible person", he is still responsible in the amount of the corporation's funds and liquid assets at the time he assumed responsibility. Peterson v. United States, 758 F. Supp. 1209, 1217, 71A A.F.T.R.2d 93-3838, 90-2 USTC P 50,433, Unempl.Ins.Rep. (CCH) P 15640A.08 (1990) citing to Slodov, 436 U.S. 240, 259-260, 98 S.Ct. 1778, 1791 (1978); Purdy Co., 814 F.2d 1183, 1191 (7th Cir. 1987). The maximum amount to which a new responsible person can be liable is the balance of trust funds existing in the corporate coffers at the time the individual became a "responsible person". The willfulness prong of the [two-prong § 6672] test must still be met in order for a "responsible person" to be liable for the 100% penalty. Michaud v.U.S., 40 Fed.Cl. 1, 80 A.F.T.R. 2d 97-8007, 97-2 U.S.T.C. P 50,972 (Fed.Cl., Nov.26, 1997).
Accordingly, willful failure to pay over the funds can only be found if there were unencumbered funds available to Peden with which to pay the overdue third and fourth quarter 1986 taxes. The "existing funds" doctrine could be compared to a taxpayer "parachute" by means of which the errant taxpayer, who assumes duties after the tax liability arises, can reduce (if not eliminate) the impact of the 100% penalty and personal liability for unpaid corporate taxes. Here, Peden has the opportunity to limit his personal liability by demonstrating that unencumbered funds were not available. "[T]he person responsible for the collection, accounting and payment of withholding taxes does not violate the Code by willfully using employer funds for purposes other than satisfaction of tax claims when, at the time he assumed control, there were no funds with which to satisfy the tax obligations and funds thereafter generated were not directly traceable to the unpaid taxes". Slodov v. U.S., 436 U.S. 240, 98 S.Ct. 1778 (1978). A responsible person is liable for outstanding payroll tax liability accrued as of the time he undertakes the duties that make him a responsible person, to the extent of the corporation's liquid assets on that date. Ibid. at 259-260; Gutman v. United States, 79-2 USTC ¶ 9598, at 88177, aff'd per curiam 222 Ct.Cl. 537, 618 F.2d 125 (1979). A taxpayer seeking to limit the extent of his liability under [I.R.C. § 6672] has the burden of proof that the business did not have sufficient unencumbered funds to satisfy unpaid taxes after the date taxpayer acquires knowledge of deficiency. Solomonson v. United States, 41 F. Supp.2d 851, 858 (1998). See also Honey v. United States, 963 F.2d 1083,1090 (8th Cir. 1992).
Recall that the penalty extends only to the limit of unpaid or uncollected taxes. Peden or another taxpayer can reduce the extent of the liability by demonstrating that the taxes have been reduced or paid in full by Tri-State or other liable persons, for example, Mr. Shelton. The pleadings indicate that Peden may be entitled to a credit in the amount of $3,479.34 but this was not developed at trial. See United States' Answer To Original Complaint- Page 2, Para. VIII.
Peden did not present the existing funds defense. The Court's conclusions are drawn from the record and the evidence adduced at trial as to whether sufficient funds or liquid assets to pay the overdue taxes existed in Tri-State's coffers at the time Peden became President and responsible officer. According to Peden's testimony at trial, he became a "responsible person" under § 6672 in late December, 1986. Norris Farnell, III, Tri-State's CPA, testified at trial that Peden took control on or about December 25, 1986. He also testified that Peden was not a signatory on the payroll tax account until after December 29, 1986. On December 29, 1986, M.E. Shelton signed a check to pay IRS taxes. On December 30, 1986, Peden signed a check to the IRS in the amount of $4,675.00. Therefore, the Court finds that the evidence shows Peden became a responsible person on December 30, 1986. Exhibit D-MM admitted into evidence at trial is Tri-State's Schedules of Assets and Liabilities as of the date of filing of Tri- State's bankruptcy petition on December 31, 1986. The Summary of Schedules indicates that there was no cash on hand ("zero") and that deposits were — $35,730.00, a number that is somewhat deceptive. Otherwise, there were no liquid assets scheduled. Further inquiry into the negative $35,730.00 amount reflected on the Debtor's Summary of Schedules reveals that it is derived from amounts in three depository accounts. The first entry scheduled is for First National Bank New Boston; it shows that that account held $136.00 on the date of filing. The second, an account at Texas American Bank of Longview, is scheduled in the amount of -$75,000.00. The third account, an account at Oak Lawn Bank of Texas, reveals that there was a positive balance of $39,134.00 on hand as of the date of filing. See the Debtor's Schedule B. No statement of account from Oak Lawn Bank was submitted into evidence, hence the Court must rely upon the sworn Schedules with respect to the amount in the Oak Lawn Bank of Texas account. Absent evidence to the contrary, the Court must assume that funds existed in the amount of $39,270.00 (the combined funds in both accounts with positive balances) with which Peden could have paid the amounts due to the IRS as of the date he became a responsible person. Accordingly, as of December 30, 1986, Billy Peden was a responsible person as that term is defined with respect to § 6672 liability and $39,270.00 was available to him to pay the overdue taxes. No evidence presented to this court indicates that the funds in First National Bank of Boston, Tri-State's payroll account, or those in Oak Lawn Bank were encumbered by any entity other than the Federal Government. Indeed, Peden testified that Gifford-Hill, one of Tri-State's clients, depended on Tri-State, so, sometime after "the middle of December", Peden continued operations and deposited the revenue stream into the Oak Lawn Bank to continue operations. He testified that employees were paid from that revenue stream. Peden's testimony directly ties the funds received from Gifford-Hill to the payroll paid to the employees in December, 1986 such that there is no viable tracing defense with respect to the funds in the Oak Lawn Bank account. Therefore, Peden's liability under I.R.C. § 6672 is limited to an amount no greater than $39,270.00 if failure to pay over such funds was willful as that term is defined for purposes of § 6672 liability. Given that the IRS' claim is for a lesser amount, the "existing funds" doctrine provides no relief for the Debtor.
However, the Statement of Account for that bank account submitted into evidence indicates a negative balance of$1,097.66. The $75,000 figure appears to correspond to Texas American Bank's security interest in accounts receivable. See Peden's Exhibit 5 or the IRS' Exhibit D-E.
The IRS presented unrebutted evidence that funds available in the Tri-State accounts during the fourth quarter of 1986 were paid to other creditors preferring them over the IRS. See Defendant's Exhibits B and E. Moreover, Peden himself testified at trial that he paid employees out of the Oak Lawn Bank account in December, 1986, from revenue Tri-State received from Gifford-Hill. The Fifth Circuit has held that as used in 26 U.S.C. § 6672, the term "willfully" "does not require a criminal or other bad motive on the part of the responsible person, but simply a voluntary failure to collect, truthfully account for, and pay over the taxes withheld from the employees." Newsome, Ibid at 745. See also Wood v. United States, 808 F.2d 411, 415 (5th Cir. 1987). By preferring other creditors to the I.R.S., the taxpayer acts to make the Government "an unwilling joint venturer to its corporate enterprise." Bowen v. United States, 836 F.2d 965, 967 (5th Cir. 1988) citing to Mazo v. United States, 591 F.2d 1151, 1154 (5th Cir.) cert. denied, 444 U.S. 842, 100S.Ct. 82, 62 L.Ed.2d 117 (1972). Accordingly, this Court must find that Peden willfully failed to pay over the taxes. However, in rare circumstances, a finding of willfulness may be negated.
REASONABLE CAUSE
Failure to remit taxes under section 6672 is not willful if the taxpayer can produce a "reasonable cause" for this failure. The reasonable cause exception is quite limited in scope. Howard v. United States, 711 F.2d 729, 736 (5th Cir. 1983) citing toNewsome. In defining the term `willfully' the 5th Cir. Court, although other courts have held to the contrary, has held that `reasonable cause' is part of the civil test in determining whether the failure to collect, account for, and pay over was willful. Newsome, Ibid at 746. In Bowen v. United States, 836 F.2d 965, 968 (5th Cir. 1988), the Court, citing to Mazo [mere delegation of responsibility to another does not constitute "reasonable cause"] and Newsome, said that "although we have recognized conceptually that a reasonable cause may militate against a finding of willfulness, no taxpayer has yet carried that pail up the hill." The Bowens unsuccessfully plead as "reasonable cause" that they expected to have sufficient funds at a later date. In the Wood case, Supra, the taxpayer argued that making the deposits throughout the quarter without paying them over negates willfulness. The Court disagreed. (One other factor that distinguishes the Wood case from the facts in this case is that the taxpayer was the responsible person both before and after the obligations accrued.) The Howard Court ruled that an order from a superior not to pay withholding taxes is insufficient "reasonable cause". Advice from a banking officer to refrain from payment of withholding taxes is not "reasonable cause" according to the Bowen Court and advice from a senior official of the IRS acting in a non-official capacity is not reasonable cause according to the Howard Court. The District Court in Newsome v. United States held that reliance upon the advice of regularly employed accountants and attorneys constituted "reasonable cause" sufficient to negate a finding of willfulness only to have that ruling reversed and remanded on appeal to the 5th Circuit.Newsome, Ibid 747-748. In Cash v. Campbell, 346 F.2d 670, 15 A.F.T.R.2d 1057, 65-1 USTC P 9428 (5th Cir.(Tex.), May 20, 1965) (NO. 21231) the 5th Circuit ruled that taxpayer's reliance upon the government to collect taxes from a fund in the registry of the Federal Court upon which the government had a lien, but for which it did not file a claim, did not constitute "reasonable cause" where the I.R.S. at no time assured the taxpayer it would do so. The burden rests with Peden to negate willfulness or to show "reasonable cause". Peden did not plead or support "reasonable cause" as a defense. There is no evidence before this Court that would compel a finding of "reasonable cause".
A search in Westlaw of the database of cases reported from the Fifth Circuit containing the terms "6672" and "reasonable cause" reveals 8 pertinent matches. The earliest is the case of Frazier v. United States, 304 F.2d 528, 9 A.F.T.R. 2d 1743, 62-2 USTC P 9535 (5th Cir. (Tex.)June 11, 1962) (No. 19426). Frazier paid his employees their net wages when he knew the corporation had insufficient assets to pay the withholding taxes and subsequently preferred other creditors over the I.R.S. when funds and assets were available. The case predates the "existing funds" doctrine and might be decided differently in light of the 1978 Slodov decision. Regardless, the Frazier Court cites to Kellums v. United States, 97 F. Supp. 681 (Conn. 1951) and to Gray Line Co. v. Grandquist, 237 F.2d 390, 395 (Ninth Cir. 1956) holding that "where the failure to pay was conscious and intentional, but motivated by reasonable cause, the penalty will not lie."_Frazier, Ibid at 529-530. "Reasonable cause" in the Gray Line case, in contrast to that of the Newsome case, was reliance on the advice from an attorney that the taxes were not due. However, in Newsome, Newsome paid checks to both creditors and himself after he was aware the payroll taxes were overdue and there were insufficient funds on hand with which to cover them. Moreover, the Court noted that the character of the attorney's advice to Newsome was not that he was justified in using withheld funds, only that he remit his Form 941 without payment if he was certain there were insufficient funds to cover the check!
The Court has the authority to liberally construe the pleadings. Even a liberal construction will not salvage the foundering, albeit construed, "reasonable cause" defense absent some evidence. According to the Plaintiff's First Amended Original Complaint "a payroll tax audit conducted by W. R. Jones, an I.R.S. Collection Officer in Texarkana, showed no payroll tax owed by Tri-State." Complaint at Paragraph VIII. The IRS denied the assertion of Paragraph VIII in its Answer. Mr. Jones was not subpoenaed by Plaintiff and so there is no testimony to this effect. No records were submitted into evidence at the trial to support the statement in the Complaint. In support of his averment, Peden has shown the Court that he believed the taxes had been satisfied because of two payments to the IRS: the $40,000 payment dated December 29, 1986 by a check signed by Mr. Shelton and the $4,675.00 payment signed by Peden himself on December 30, 1986. Absent a designation on the check ensuring its application to the pre-petition payroll taxes for the third and fourth quarter of 1986, the IRS was under no obligation to apply such payments to a specific tax or period. Ultimately, the sole person responsible for ensuring that the taxes would be applied to the pre-petition unpaid payroll tax obligations was Billy Peden and the sole person with the power to insulate himself from § 6672 liability for failure to pay over the payroll taxes was Billy Peden. Reliance upon the advise of attorneys, accountants or other agents is not sufficient to insulate Peden from liability.
CONCLUSION
As of December 30, 1986 at the latest, Billy Peden was a responsible person as that term is defined with respect to IRC § 6672 liability. He possessed check writing authority as of December 30, 1986. As of the date of filing of the bankruptcy petition, $39,270.00 was available to him to pay the overdue taxes. There is no evidence that the funds were encumbered. Under the existing funds doctrine, Billy Peden's liability predates December 30, 1986 to the extent of the funds available as of the date he became a responsible person. Failure to pay over the available funds to the I.R.S. was willful insofar as Peden preferred other creditors over the IRS regardless of evil motive or intent to defraud the government. No evidence of reasonable cause negating willfulness has been proven. Therefore, Peden's liability under IRC § 6672 is limited to an amount no greater than $39,270.00. The IRS has filed a claim in the amount of $34,813.50 for such taxes which shall be allowed. An order will be entered accordingly.