Internal Revenue Service v. Kaplan ( 1997 )

Opinions of the United
1997 Decisions States Court of Appeals
for the Third Circuit
1-17-1997
In Re Michael Kaplan
Precedential or Non-Precedential:
Docket 95-5409,96-5180
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
___________
Nos. 95-5409 and 96-5180
___________
IN RE: MICHAEL KAPLAN; MORRIS KAPLAN
Debtors
THE INTERNAL REVENUE SERVICE
vs.
MICHAEL KAPLAN; MORRIS KAPLAN,
Appellants in No. 95-5409
(D.C. Civ. No. 94-cv-05656)
IN RE: KAPLAN BUILDING SYSTEMS, INC.
Debtor
1
INTERNAL REVENUE SERVICE
vs.
KAPLAN BUILDING SYSTEMS, INC.,
Appellant in No. 96-5180
(D.C. Civ. No. 95-cv-04331)
___________
Appeal from the United States District Court
for the District of New Jersey
___________
Argued
December 10, 1996
Before: BECKER, MANSMANN and GREENBERG, Circuit Judges.
(Filed January 17, 1997)
___________
Robert A. Baime, Esquire (ARGUED)
Dechert, Price & Rhoads
Princeton Pike Corporate Center
P.O. Box 5218
Princeton, N.J. 08563
2
Joel H. Levitin
Debra D. O'Gorman
Dechert, Price & Rhoads
477 Madison Avenue
New York, NY 10022
COUNSEL FOR APPELLANTS
Loretta C. Argrett
Assistant Attorney General
Thomas Linguanti, Esquire (ARGUED)
Gary R. Allen, Esquire
David English Carmack, Esquire
Linda E. Mosakowski, Esquire
United States Department of Justice
Tax Division
P.O. Box 502
Washington, DC 20044
COUNSEL FOR APPELLEE
Faith S. Hochberg
United States Attorney
OF COUNSEL FOR APPELLEE
3
___________
OPINION OF THE COURT
__________
MANSMANN, Circuit Judge.
In this appeal, we are presented with two decisions of
the district court dated May 18, 1995, and February 20, 1996,
which reversed the orders of the bankruptcy court on two related
bankruptcy cases. We are asked to decide whether the district
court erred in determining that the bankruptcy court was not
authorized to compel the Internal Revenue Service to reallocate
tax payments first to trust fund taxes. We find that neither 11
U.S.C. § 105 nor the Supreme Court's decision in United States v.
Energy Resources Co., Inc., 495 U.S. 545 (1990), authorized the
bankruptcy court to order the Internal Revenue Service to
reallocate tax payments under the particular facts here.
Accordingly, we will affirm the decisions of the district court.
I.
We feel compelled to set forth the facts in detail
because these bankruptcy cases are so heavily fact-intensive.
This consolidated appeal arises from two separate but
related Chapter 11 bankruptcy petitions filed by Michael and
Morris Kaplan and Kaplan Building Systems, Inc. ("KBS"). KBS
is a Pennsylvania corporation formed for the sole purpose of
acquiring and operating a modular home manufacturing business.
4
Two brothers, Michael and Morris Kaplan, organized KBS and, at
all relevant times, were its sole owners. During 1990, KBS made
only one payment of employment taxes in the approximate amount of
$200,000. That payment was not accompanied by a quarterly
return. For the four quarters of 1990, KBS failed to file timely
returns and to pay to the United States approximately $2 million
in federal employment taxes. Of this amount, $1,564,468 were
"trust fund" taxes.1
On February 11, 1991, Michael and Morris Kaplan filed
two separate Chapter 11 petitions with the United States
Bankruptcy Court for the District of New Jersey, which were later
consolidated. KBS did not file for bankruptcy at that time.
Although the Kaplans owned or were partners in approximately 89
entities including KBS, they wanted to avoid preparing petitions
and paying filing fees with respect to each of the entities. The
Kaplans thus sought an injunction under 11 U.S.C. § 105 to enjoin
specific creditors from instituting civil actions against the
"non-filing" Kaplan businesses. Although a number of KBS's other
creditors were named in the injunctions, the IRS was not one of
the defendant-creditors named in the orders, nor did the IRS
participate in the matter.2 Invoking its powers under section
1. Trust fund taxes refer to the employees' share of FICA
and FUTA taxes required to be withheld by the employer and held
in trust for the federal government pursuant to 26 U.S.C. §
7501(a). Under I.R.C. § 6672, the IRS may collect unpaid trust
fund taxes directly from the employer's officers or employees who
are responsible for collecting the tax. These individuals are
commonly referred to as "responsible persons."
2. In their Brief in Support of Debtors' Motion to Compel
the Internal Revenue Service to Reallocate Certain Payments, the
Kaplans indicated that, at some later time but prior to June 15,
5
105, the bankruptcy court enjoined all of the named defendant-
creditors from proceeding to litigate claims against the non-
filing Kaplan entities. The injunction dissolved ninety days
after the effective date of the Kaplans' plan of reorganization.
In March of 1991, KBS filed its employment tax returns
for the four quarters of 1990 and the corresponding taxes were
assessed against KBS. In lieu of instituting formal collection
proceedings against KBS, the revenue officer determined that KBS
could make installment payments to satisfy the debts, provided
the Kaplans executed Forms 2751--Proposed Assessment of 100
Percent Penalty--and consented to the assessment and collection
of a responsible person's penalty in connection with KBS's unpaid
trust fund taxes for 1990. The Kaplans executed the necessary
forms, thereby agreeing that the responsible person penalty could
be assessed against them on or before December 31, 1995.
KBS and the IRS entered into two installment
agreements. The first installment agreement provided that KBS
would pay the IRS $30,000 per month from October, 1991 through
December, 1991; $35,000 per month from January, 1992, through
March, 1992; $40,000 per month from April through June, 1992; and
$50,000 from July, 1992, until December, 1994, when the balance
would be paid in full. Although the installment agreement
contained several conditions, it did not address the allocation
(..continued)
1993, the IRS filed a proof of claim asserting an unliquidated
KBS tax liability against the Kaplans in their individual
bankruptcies. The Kaplans filed a motion to expunge the IRS's
claim, giving actual notice to the IRS; the IRS did not oppose.
Consequently, the bankruptcy court entered an order on June 15,
1993, expunging the IRS's claim.
6
of payments. By the end of 1993, KBS defaulted on the first
installment agreement.
A second installment agreement was drawn up in May,
1994, which required KBS to make monthly payments of $60,000 from
July of 1994 to March of 1995, and $100,000 from April of 1995
until the debt was paid in full. The installment agreement form,
which had been revised in January, 1993, provided as one of the
conditions that "[a]ll payments will be applied in the best
interest of the United States." On May 27, 1994, the general
counsel for the Kaplan companies wrote to the revenue officer
advising him that before executing the installment agreement, KBS
deleted the language on the form providing that payments will be
applied in the best interest of the United States. The revenue
officer informed KBS's counsel that the agreement could not be
accepted by the IRS with the deletion of this condition. KBS
reversed the deletion, but reserved its right to further contest
this allocation. The IRS executed the second installment
agreement on July 6, 1994 and KBS made payments through at least
September of 1994. The Kaplans claim they have personally funded
KBS's tax liability payments in an amount in excess of $1
million.
On January 29, 1993, the bankruptcy court confirmed the
Kaplans' first amended plan of reorganization. The confirmed
plan dealt with some debts against the non-filing Kaplan
entities. With respect to tax claims against KBS, the plan
provided:
Notwithstanding anything in this Plan to the contrary,
Tax Claims against Kaplan Building Systems,
7
Inc. shall be paid in accordance with and
pursuant to installment agreements with
Internal Revenue Service.3
On July 29, 1994, the Kaplans filed a motion in their
individual bankruptcy cases to compel the IRS to reallocate the
tax payments made by KBS (but funded by the Kaplans) to trust
fund obligations.4 Without such reallocation, the Kaplans remain
liable for 100% of KBs's unpaid trust fund taxes. The bankruptcy
court held a hearing at which the Kaplans argued that because
reallocating the payments to KBS's trust fund liabilities would
"enhance the probability the Kaplans will fully consummate their
confirmed Plan which requires payments to be made to creditors
over time," the bankruptcy court has the authority to and should
compel the IRS to change the allocation of KBS's payments that
had been funded by the Kaplans, based on the Supreme Court's
holding in United States v. Energy Resources Co., Inc., 495 U.S.
545 (1990). The government opposed the motion, asserting that
Energy Resources was inapposite here because the corporation was
not a debtor in the Kaplans' bankruptcy proceedings and whatever
the effect on KBS, the allocation of tax payments would not
affect the reorganization of the Kaplans, who were the only
debtors in the case. The bankruptcy court concluded that this
case was completely analogous to Energy Resources, even though
3. Article III, Section 3.1(B)(ii) of Debtors' First
Amended Joint Plan of Reorganization.
4. The KBS tax payments were made prior to the execution
of the first installment agreement; these payments were also made
pursuant to the first and second installment agreement s. Thus,
the time period involved runs from 1990 to September, 1994.
8
the structure here was not a textbook structure. Because it
found that the reallocation of KBS's taxes was necessary for the
Kaplans' reorganization, the bankruptcy court entered an order
directing the IRS to reallocate the prior payments to trust fund
taxes.
The IRS appealed the bankruptcy court's order to the
district court. On May 18, 1995, the district court issued an
order reversing the decision of the bankruptcy court, finding
that because KBS was not a debtor in bankruptcy, the bankruptcy
court was not authorized to order the IRS to reallocate payments
made by KBS. The district court noted that unlike Energy
Resources, the bankruptcy court here lacked jurisdiction over KBS
and, therefore, was without the power to order reallocation of
the tax payments under 11 U.S.C. §§ 1123, 1129 and 105, as those
sections were not applicable. The district court further held
that the bankruptcy court could order retroactive allocation of
tax payments.5 In dicta, the district court commented that KBS
could file its own Chapter 11 petition, thereby subjecting itself
to the bankruptcy court's jurisdiction. The Kaplans filed a
timely appeal to this court, which was stayed on September 12,
1995, pending the district court's ruling on the same issue in
the KBS bankruptcy case.
5. In support of this holding, the district court cited In
re Deer Park, Inc., 10 F.3d 1478 (9th Cir. 1993); In re Flo-
Lizer, Inc., 164 B.R. 79 (Bankr. S.D. Ohio 1993), aff'd, 164 B.R.
749 (S.D. Ohio 1994); and In re M.C. Tooling Consultants, 165
B.R. 590 (Bankr. D.S.C. 1993).
9
On June 2, 1995, KBS filed its own bankruptcy petition
under Chapter 11 of the Bankruptcy Code. On that same date, KBS
filed several motions with the bankruptcy court, one of which
asked the court to compel the IRS to reallocate the tax payments
funded by the Kaplans on behalf of KBS to trust fund taxes. KBS
argued that reallocation of the tax payments was necessary for
its successful reorganization, in that it would induce the
Kaplans to provide KBS with new emergency funding necessary for
the continued operation of KBS. The IRS opposed the motion on
the basis that the bankruptcy court lacked authority to
reallocate, arguing that all of the payments at issue had been
made pre-petition and that the debtor had failed to designate the
manner in which they were to be applied. The IRS applied the
payments in accordance with IRS written policy, which requires
that payments received be applied in a manner consistent with the
best interests of the government, unless otherwise designated.
Having determined that it had jurisdiction over KBS,
the bankruptcy court considered whether it had the authority to
compel the IRS to reallocate the tax payments under Energy
Resources. Concluding that the reallocation was necessary to
KBS's successful reorganization, the bankruptcy court entered an
order, with retroactive effect, directing the IRS to reallocate
the tax payments made by KBS to trust fund taxes.
The IRS appealed that order to the district court. In
reversing the decision of the bankruptcy court, the district
court held that the Supreme Court's holding in Energy Resources
did not displace the rule of law that the IRS may designate
10
voluntary payments in its best interests when the debtor fails to
make a designation. Having found that KBS never designated the
manner in which its tax payments would be allocated, the district
court found that the IRS was free to apply the tax payments
towards KBS's outstanding corporate income tax.
On March 20, 1996, KBS filed a notice of appeal of the
district court's order and moved to consolidate the KBS appeal,
No. 96-5180, with the appeal in the Kaplans' bankruptcies, No.
95-5409. We granted that motion and consolidated the cases on
June 10, 1996. We have jurisdiction over these consolidated
appeals pursuant to 28 U.S.C. §§ 158(d) and 1291.
11
II.
At the core of the district court's ruling in the
Kaplans' bankruptcy cases stands its finding that the bankruptcy
court lacked jurisdiction over KBS. Thus, we turn initially to
the issue of whether the bankruptcy court had jurisdiction over
KBS in the Kaplans' bankruptcy cases. We begin our analysis by
examining 28 U.S.C. § 1334.
Section 1334(b) provides in relevant part that "the
district courts shall have original but not exclusive
jurisdiction of all civil proceedings arising under title 11, or
arising in or related to cases under title 11." 28 U.S.C. §
1334(b) (1990). The bankruptcy courts, in turn, obtain
jurisdiction by operation of 28 U.S.C. § 157, which allows the
district courts to refer, to the bankruptcy courts, cases over
which the district courts have jurisdiction pursuant to section
1334. Quattrone Accountants, Inc. v. Internal Revenue Service,
895 F.2d 921, 926 n.3 (3d Cir. 1990).
We have held that in a case involving non-debtors, the
bankruptcy court's jurisdiction is to be determined solely by 28
U.S.C. § 1334(b). Id. at 926. The Sixth Circuit has agreed with
our conclusion. In re Wolverine Radio Co., 930 F.2d 1132, 1140
(6th Cir. 1991). But cf. United States v. Huckabee Auto Co., 783
F.2d 1546, 1549 (11th Cir. 1986).6 The dispute at issue here
6. In United States v. Huckabee Auto Co., 783 F.2d 1546,
1549 (11th Cir. 1986), the court of appeals refused to extend the
jurisdiction of the bankruptcy court to the section 6672
liabilities of the taxpayers who were not debtors under the
Bankruptcy Code. The court found that because the liability
imposed under section 6672 was separate and distinct from that
levied on the employer under sections 3102 and 3402 of the
12
arose between KBS and the IRS, two non-debtors, which the Kaplans
are attempting to bring within the jurisdiction of the bankruptcy
court as a proceeding7 related to their Chapter 11 bankruptcy
case. Thus, we must turn to the meaning of the terms, "related
to," in light of our explanation in Quattrone Accountants and
Pacor, Inc. v. Higgins, 743 F.2d 984 (3d Cir. 1984).
In Quattrone Accountants, we were asked to decide
whether, inter alia, the bankruptcy court had jurisdiction
pursuant to 28 U.S.C. § 1334 and 11 U.S.C. § 5058 to determine a
(..continued)
Internal Revenue Code, it was irrelevant that the section 6672
liability, if assessed against the responsible persons, would
adversely affect the corporate debtor's reorganization. Id. at
1548-49 (citations omitted).
In Huckabee Auto, the corporation was the debtor and
taxpayer; here, the situation is reversed: the responsible
persons, i.e., the Kaplans, are the debtors and the corporation,
a non-debtor, is the taxpayer. In addition, the court of appeals
in Huckabee Auto failed to consider the bankruptcy court's
jurisdiction under 28 U.S.C. § 1334(b).
7. The dispute between the IRS and KBS constitutes a civil
"proceeding" as that term is used in 28 U.S.C. § 1334.
Proceeding "is used in a broad sense, referring to ``[a]nything
that occurs within a case,' including contested and uncontested
matters." Melodie Freeman-Barney, Notes and Comments,
Jurisdiction Under the Bankruptcy Amendments of 1984: Summing Up
the Factors, 22 Tulsa L.J. 167, 180 (1986) (citing Collier on
Bankruptcy (MB ¶ 3.01[1][c][ii] (15th ed. 1986)). The
legislative history to the Bankruptcy Reform Act of 1978 confirms
that the term "proceeding" should be broadly interpreted. H.R.
Rep. No. 598, 95th Cong., 2d Sess. (1978), reprinted in 1978
U.S.C.C.A.N. 5963, 6400-6401.
8. Section 505(a)(1) provides in relevant part:
. . . the court may determine the amount or legality of
any tax, any fine or penalty relating to a
tax, or any addition to tax, whether or not
previously assessed, whether or not paid, and
whether or not contested before and
adjudicated by a judicial or administrative
tribunal of competent jurisdiction.
13
non-debtor's tax liability under section 6672 of the Internal
Revenue Code. Concluding that section 505 did not address a
situation involving non-debtors9 and, therefore, neither limited
nor granted jurisdiction, we turned to section 1334 to resolve
the issue of the bankruptcy court's jurisdiction. 895 F.2d at
925-26.
We examined the "related to" language of section 1334
by looking at our previous explanation of those terms in Pacor,
Inc. v. Higgins, supra.10 In Pacor, we explained that under
section 1334, a civil matter is "related to" a bankruptcy
proceeding when "the outcome of that proceeding could conceivably
have any effect on the estate being administered in bankruptcy."
743 F.2d at 994 (citations omitted). We then stated that "[a]n
action is related to bankruptcy if the outcome could alter the
debtor's rights, liabilities, options, or freedom of action
(either positively or negatively) and which in any way impacts
upon the handling and administration of the bankrupt estate."
Id. Our analysis of the "related to" language of section 1334(b)
9. The IRS assessed a section 6672 responsible person
penalty against the debtor, Quattrone Accountants, for failing to
pay withholding taxes on behalf of its client, United Dairy
Farmers Cooperative Association (UDF). Philip Quattrone, part
owner and principal officer of the debtor, filed a complaint
requesting the bankruptcy court to determine his section 6672 tax
liability, as well as that of the debtor.
10. In Pacor, we held that a personal injury suit in which
the defendant filed a third party claim seeking indemnification
against the debtor, JohnsManville, was not related to the
JohnsManville bankruptcy, reasoning that the outcome of the
original personal injury action would not bind JohnsManville
until a third party action was actually brought and tried. 743
F.2d at 995.
14
was followed by the Supreme Court in Celotex Corp. v. Edwards,
___ U.S. ___, 115 S. Ct. 1493, 1498-99 (1995).
Applying these decisions to the facts of this case, we
conclude that the dispute between the IRS and KBS is related to
the Kaplans' bankruptcy proceeding. Here the debtors, Michael
and Morris Kaplan, agreed to section 6672 responsible person
liability, in effect guaranteeing that KBS's trust fund taxes
would be paid in full. By virtue of their agreement with the
IRS, if KBS failed to pay its trust fund taxes in full, the
Kaplans would automatically be liable for the shortfall. If the
IRS is allowed to allocate the pre-petition tax payments it
received to non-trust fund taxes, there is no effect on the
Kaplans -- they are still 100% liable for the shortfall. If,
however, the IRS is not permitted to designate how the payments
will be applied, and the bankruptcy court is allowed to order the
IRS to allocate the pre-petition payments to trust fund taxes
first, then the Kaplans' responsible persons liability is reduced
to the extent that the trust fund tax liability of KBS is
likewise reduced. Thus, the outcome of the dispute between KBS
and the IRS could conceivably affect, in a positive manner, the
Kaplans' estate in bankruptcy.
We find, therefore, that the bankruptcy court had
jurisdiction over the dispute between KBS and the IRS.
III.
Although we have determined that the bankruptcy court
had jurisdiction over the non-debtors pursuant to section 1334,
15
our inquiry does not end there.11 Notwithstanding the bankruptcy
court's jurisdiction, we must examine whether the bankruptcy
court was authorized to issue the order to compel allocation of
tax payments under the broad grant of equitable powers in 11
U.S.C. § 105.12
Section 105(a) states in pertinent part:
The court may issue any order, process, or
judgment that is necessary or appropriate to
carry out the provisions of this title.13
That the bankruptcy court has the power under section 105 to
enjoin creditors from proceeding in a state court against third
parties where failure to enjoin would affect the bankruptcy
estate has been recognized by numerous bankruptcy courts and two
courts of appeals.14 Moreover, the Supreme Court in Energy
11. We note that while the district court found incorrectly
that the bankruptcy court lacked jurisdiction over KBS in the
Kaplans' bankruptcy, this error is not fatal to its decision.
12. In In re Cardinal Industries, Inc., 109 B.R. 748, 752
(Bankr. S.D. Oh. 1989), the bankruptcy court held that
jurisdiction under section 1334 was not sufficient by itself to
determine whether an injunction should issue; but rather, the
court must examine, under 11 U.S.C. § 105(a), whether the usual
standards for injunctive relief are met.
13. The legislative history to section 105 is sparse. The
House Report states merely that section 105 is similar in effect
to the All Writs Statute, 28 U.S.C. § 1651. H.R. Rep. 595, 95th
Cong., 2d Sess. (1978), reprinted in 1978 U.S.C.C.A.N. 6273. The
legislative history further provides that section 105 authorizes
a court of the United States to stay a state court action. Id.
at 6274.
14. In re Monroe Well Service, Inc., 67 B.R. 746, 750-51
(Bankr. E.D.Pa. 1986); In re Otero Mills, 25 B.R. 1018, 1021-1022
(D.N.M. 1982); A.H. Robins Co. v. Piccinin, 788 F.2d 994, 1002
(4th Cir.), cert. den., 479 U.S. 876 (1986). See also, National
Labor Relations Board v. Superior Forwarding, Inc., 762 F.2d 695,
698 (8th Cir. 1985) (Bankruptcy court is empowered under section
105 to enjoin federal regulatory proceedings when those
proceedings would threaten the assets of the debtor's estate).
16
Resources found the Bankruptcy Code implicitly authorized the
bankruptcy courts to approve reorganization plans designating tax
payments as either trust fund or non-trust fund, based on the
bankruptcy courts' residual authority to approve reorganization
plans under section 1123(b)(5) and 1129 of the Bankruptcy Code,
and on the statutory directive of section 105. 495 U.S. at 549.
Energy Resources involved two corporations which filed
petitions for reorganization under Chapter 11 of the Bankruptcy
Code: Newport Offshore, Ltd. (Newport) and Energy Resources Co.,
Inc. (Energy Resources). In the Newport bankruptcy, the IRS
objected unsuccessfully to a provision in the reorganization plan
which stated that Newport's tax payments would be applied to
extinguish all trust fund tax liabilities prior to paying the
non-trust fund portion of the tax liability. The IRS appealed to
the district court, which reversed the decision of the bankruptcy
court. The debtor appealed to the Court of Appeals for the First
Circuit.
In the Energy Resources bankruptcy case, the bankruptcy
court approved a reorganization plan which created a special
trust to fund the corporation's federal tax liability. When the
IRS refused to apply a tax payment out of the special trust to
Energy Resources' trust fund taxes, the trustee successfully
petitioned the bankruptcy court to order the IRS to allocate the
payment to trust fund taxes. The IRS appealed this order to the
district court, which affirmed the bankruptcy court. The IRS
then filed an appeal to the Court of Appeals for the First
17
Circuit. The Newport and Energy Resources cases were
consolidated on appeal.
The court of appeals reversed in In re Newport Offshore
Ltd. and affirmed in In re Energy Resources Co.15 Initially, the
court of appeals examined the characterization of tax payments
made pursuant to a Chapter 11 reorganization plan as "voluntary"
or "involuntary."16 Although the court of appeals concluded that
the payments were involuntary, deferring to the IRS's
interpretation of its own rules, it held that the "Bankruptcy
Courts nevertheless had the authority to order the IRS to apply
an ``involuntary' payment made by a Chapter 11 debtor to trust
fund tax liabilities if the Bankruptcy Court concluded that this
designation was necessary to ensure the success of the
reorganization." 871 F.2d at 230-34.
The Supreme Court affirmed the judgment of the court of
appeals, holding that regardless of whether the payments are
properly characterized as "involuntary", a bankruptcy court has
the authority to order the IRS to apply tax payments made by
Chapter 11 debtor corporations to trust fund liabilities if the
15. In re Energy Resources Co., Inc., 871 F.2d 223 (1st
Cir. 1989).
16. IRS policy allows taxpayers who "voluntarily" pay their
tax liability to designate the manner in which the tax payments
will be applied. Energy Resources, 495 U.S. at 548 (citations
omitted). Traditionally, a tax payment has been considered
"involuntary" when it is made to "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." United States v. Pepperman, 976 F.2d 123, 127
(3d Cir. 1992) (citing Amos V. Commissioner, 47 T.C. 65, 69
(1966)).
18
bankruptcy court determines that this designation is necessary to
the success of a reorganization plan. 495 U.S. at 548-49. To
find such authority for the bankruptcy court, the Court looked to
sections 1123, 1129, and 105 of the Bankruptcy Code. Under
sections 1123(b)(5) and 1129, the Court found that the Code
"grant[ed] the bankruptcy courts residual authority to approve
reorganization plans including ``any . . . appropriate provision
not inconsistent with the applicable provisions of this title.'"
Id. at 549. Turning to section 105, the Court noted that the
Code also provides that bankruptcy courts may "``issue any order,
process, or judgment that is necessary or appropriate to carry
out the provisions' of the Code." Id. (citing 11 U.S.C. §
105(a)). The Court further noted that these "statutory
directives are consistent with the traditional understanding that
bankruptcy courts, as courts of equity, have broad authority to
modify creditor-debtor relationships." Id. (citations omitted).
The Court rejected the government's argument that
bankruptcy court orders directing allocation to trust fund taxes
conflict with sections 507(a)(7), 523(a)(1)(A), 1129(a)(11), and
1129(a)(9)(C) of the Bankruptcy Code, provisions which protect
the government's ability to collect delinquent taxes. The Court
found that the restrictions in those sections of the Code do not
address the bankruptcy court's ability to designate whether tax
payments are to be applied to trust fund or non-trust fund tax
liabilities and, thus, did not preclude the court from issuing
the type of orders involved here. Id. at 550.
19
The Court found equally unpersuasive the government's
argument that it stands in a better position to have all of its
debt discharged if the debtor corporation's tax payments are
first applied to non-trust fund taxes because the debt that is
not guaranteed will be paid off first. The Court stated that
while from the government's viewpoint this result is more
desirable, it is an added protection not provided for in the Code
itself. Id. Finally, the government contended that the
bankruptcy court's orders contravened section 6672 of the
Internal Revenue Code, which permits the IRS to collect unpaid
trust fund taxes directly from the "responsible" individuals.
The government reasoned that if the IRS cannot designate a debtor
corporation's tax payments as non-trust fund, the debtor might
only be able to pay the guaranteed debt, leaving the government
at risk for non-trust fund taxes. Discarding this argument as
well, the Supreme Court found that section 6672, by its terms,
does not protect against this eventuality. Id. at 551.
Despite the Supreme Court's finding that the residual
authority of the bankruptcy court under sections 1123, 1129 and
105(a) authorized the reallocation of tax payments, Energy
Resources does not change the result here. The facts in the
Kaplans' bankruptcy cases simply do not provide the bankruptcy
court with the authority to grant the relief sought by the
Kaplans. First and foremost, KBS, the taxpayer, was not the
debtor. Indeed, we agree with the IRS that Energy Resources does
not reach the situation where a third party might benefit: the
Kaplans could not be deemed necessary to the success of KBS's
20
plan because at the time the payments were made, KBS did not have
a reorganization plan.17 In addition, as KBS was not a debtor
prior to June 1995, the IRS was not afforded the usual
protections in a Chapter 11 reorganization: a priority for
specified tax claims, including trust fund taxes, and a provision
making these tax debts nondischargeable, 11 U.S.C. §§ 507(a)(7),
523(a)(1)(A); the requirement that the bankruptcy court assure
itself that the reorganization will succeed, 11 U.S.C. §
1129(a)(11), making it more likely that the IRS will collect the
tax liability; and a provision that the tax debt must be paid off
within six years, 11 U.S.C. § 1129(a)(9)(C).
As we stated in Pepperman, "the Court in Energy
Resources consistently linked its holding with the fact of
reorganization and the debtor's need for rehabilitation." 976
F.2d at 130. Because KBS had not filed its own Chapter 11
petition, the bankruptcy court did not have before it all of the
17. Although KBS and some of its creditors were being
reorganized under the Kaplans' bankruptcies, the IRS was not
listed as a creditor of KBS in the schedule of defendants in the
section 105 stay litigation. Moreover, the Kaplans'
reorganization plan provided that the tax claims against KBS
would be paid in accordance with the installment agreements with
the IRS. We note, however, that these installment agreements
were voluntary agreements which KBS could, and eventually did,
default on. The fact that the Kaplans never sought the
bankruptcy court's intervention with regard to the IRS's tax
claims against KBS and, indeed, specifically provided in their
plan that the normal rule pertaining to payment of allowed tax
claims (i.e., allowed tax claims must be paid in full within
fifteen days after the effective date of the plan or, pursuant to
11 U.S.C. § 1129(a)(9)(C), paid in full over six years from the
earlier of the assessment date or plan effective date), did not
apply to the IRS's tax claims against KBS, mandates the
conclusion that the bankruptcy court lacked authority to order
the reallocation of KBS's tax payments.
21
claims and, therefore, could not have made an appropriate
determination as to whether the KBS reorganization was likely to
succeed. Since this determination is a prerequisite to the
Court's holding in Energy Resources, the bankruptcy court lacked
the authority to order the IRS to reallocate tax payments in the
Kaplans' bankruptcies. We observed in Pepperman that "section
105 does not ``give the court the power to create substantive
rights that would otherwise be unavailable under the Code,'"
noting that Energy Resources does nothing to undermine this
observation. 976 F.2d at 131 (citations omitted). Further,
"``[t]he fact that a [bankruptcy] proceeding is equitable does not
give the judge a free-floating discretion to redistribute rights
in accordance with his [or her] personal views of justice and
fairness, however enlightened those views may be.'" Id. (quoting
Matter of Chicago, Milwaukee, St. Paul & Pac. R.R., 791 F.2d 524,
528 (7th Cir. 1986)).
Because KBS, the taxpayer, was not a debtor under the
facts here,18 the bankruptcy court was precluded from making an
appropriate determination regarding the likelihood of KBS's
successful reorganization as required by Energy Resources. We
hold, therefore, that the bankruptcy court lacked authority under
section 105 to order the IRS to allocate KBS's tax payments in
the Kaplans' bankruptcy.
18. The IRS did not file a proof of claim against KBS in
the Kaplans' bankruptcies. KBS was organized as a corporation,
not a partnership. As a separate legal entity, KBS, in order to
avail itself of the full protections and powers of the bankruptcy
court, must itself be a debtor. See, In re FTL, Inc., 152 B.R.
61 (Bankr. E.D. Va. 1993). The tax payments at issue were pre-
petition and not made pursuant to a reorganization plan.
22
IV.
Likewise in KBS's bankruptcy, we are compelled to find
that the bankruptcy court lacked authority under section 105 to
order the IRS to reallocate tax payments to trust fund taxes
first. The broad powers granted to the bankruptcy court under
section 105 are insufficient alone to authorize a retroactive
allocation of pre-petition tax payments. Pepperman, 976 F.2d at
131 ("section 105 does not ``give the court the power to create
substantive rights that would otherwise be unavailable under the
Code.'") (citations omitted). The bankruptcy court's equitable
powers under section 105 are not triggered where, like the
situation before us, the requirements of Energy Resources have
not been met.19 Indeed, since a reorganization plan was not
filed in the KBS bankruptcy, the bankruptcy court had no basis
upon which to exercise its equitable authority under section
105.20
We agree with the following inquiry set forth by the
Court of Appeals for the First Circuit to be made by the
19. When the bankruptcy court here determined that
reallocation was necessary to the successful reorganization of
KBS, it did not have before it a plan of reorganization. In
Energy Resources, a reorganization plan existed under 11 U.S.C.
§§ 1123 and 1129. In that situation, the bankruptcy court has
the authority to oversee the reorganization and, under § 105, has
the equitable power to do what is necessary to get the plan
confirmed.
20. Thus, the bankruptcy court could not have assured
itself, as it was required to do under 11 U.S.C. § 1129(a)(11),
that the reorganization plan would succeed; and that the debtor
would take no more than six years within which to structure the
tax payments, 11 U.S.C. § 1129(a)(9)(C).
23
bankruptcy court when assessing whether reallocation for tax
payments is necessary to the successful reorganization of the
debtor:
upon consideration of the reorganization plan as a
whole, in so far as the particular structure
or allocation of payments increases the risk
that the IRS may not collect the total tax
debt, is that risk nonetheless justified by
an offsetting increased likelihood of
rehabilitation, i.e., increased likelihood of
payment to creditors who might otherwise lose
their money?
In re Energy Resources Co., Inc., 871 F.2d at 234. It is clear
from the record that the bankruptcy court in KBS's case did not
undertake to perform this analysis. Thus, the holding by the
Supreme Court in Energy Resources, which clearly took into
consideration the existence of a reorganization plan, does not
control the resolution of this case.21
We further note that all of the cases cited by KBS in
support of retroactive allocation are factually distinguishable
as they involved post-petition, post-confirmation tax payments.22
Appellants do not cite any authority which would support a
retroactive allocation involving pre-petition payments not made
21. The fact that the IRS had not challenged the bankruptcy
court's determination that reallocation was necessary for a
successful reorganization is not dispositive here, as that
determination was prematurely reached.
22. In addition to Energy Resources, the appellants rely on
In re Deer Park, Inc., 10 F.3d 1478 (9th Cir. 1993), and In re
Flo-Lizer, Inc., 164 B.R. 79 (Bankr. S.D. Ohio 1993),
to support their contention that the allocation order may be
applied retroactively. In all three of these cases, the tax
payments at issue were made post-petition, pursuant to an
approved plan of reorganization.
24
pursuant to a reorganization plan. Moreover, in asking us to
approve the retroactive allocation of pre-petition tax payments,
KBS is, in effect, asking us to extend the time applicable to
preferential transfers under 11 U.S.C. § 547 well beyond that
allowed by the Bankruptcy Code. We find no basis in the
Bankruptcy Code or other legal authority which would justify this
treatment. Accordingly, we find that retroactive allocation of
pre-petition tax payments is not permitted.23
Because we find that Energy Resources does not
apply here, we must turn to the common law regarding voluntary
payments. The parties have agreed that the tax payments at issue
were made voluntarily. "IRS policy has long permitted a taxpayer
who ``voluntarily' submits a payment to the IRS to designate the
tax liability . . . to which the payment will apply." In re
Energy Resources Co., Inc., 871 F.2d at 227 (citing Rev. Rul. 79-
284, 1979-2 C.B. 83; Slodov v. United States, 436 U.S. 238
(1978)) (other citations omitted); Pepperman, 976 F.2d at 127.
This policy reflects the generally recognized common law rule
between debtors and creditors that "the debtor may indicate which
debt it intends to pay when it voluntarily submits a payment to a
creditor, but may not dictate the application of funds that the
creditor involuntarily collects from it." Pepperman, 976 F.2d at
127 (citing O'Dell v. United States, 326 F.2d 451, 456 (10th Cir.
1964)) (citation omitted).
23. To the extent that the district court in the Kaplans'
bankruptcy cases ruled that retroactive allocation was allowed,
that conclusion constitutes legal error.
25
The long-standing policy of the IRS with regard to
voluntary payments is reflected in IRS Policy Statement P-5-60,
which provides:
In determining the amount of the 100 percent penalty to
be assessed in connection with employment
taxes, any payment made on the corporate
account involved is deemed to represent
payment of the employer portion of the
liability (including assessed and accrued
penalty and interest) unless there was some
specific designation to the contrary by the
taxpayer. The taxpayer, of course, has no
right of designation in the case of
collections resulting from enforced
collection measures. To the extent partial
payments exceed the employer portion of the
tax liability, they are considered as being
applied against the trust fund portion of the
assessment.
1 Administration, CCH Internal Revenue Manual at 1305-15 (Mar.
1981). Rev. Rul. 79-284, 1979-2 C.B. 83, was promulgated in
agreement with this policy. Kinnie v. United States, 771 F. Supp.
842, 853 (E.D. Mich. 1991), aff'd, 994 F.2d 279 (6th Cir. 1993).
Rev. Rul. 79-284, modifying Rev. Rul. 73-305,24 1973-2 C.B.43,
states that a taxpayer must provide specific written instructions
24. Rev. Rul. 73-305, which provides that where no specific
instructions are given by the taxpayer as to the application of a
partial tax payment, the amount of the payment will be applied to
tax, penalty, and interest, in that order, did not apply to
withheld employment taxes. Rev. Rul. 79-284 made Rev. Rul. 73-
305 applicable to withheld employment taxes by providing:
Rev. Rule 73-305 applies to withheld employment taxes .
. . where the taxpayer provides specific
written instructions for the application of a
voluntary partial payment. If no designation
is made by the taxpayer, the Internal Revenue
Service will allocate partial payments of
withheld employment taxes . . . in a manner
serving its best interest.
26
for the application of a voluntary partial payment of withheld
employment taxes.
Revenue rulings are entitled to great deference, but
courts may disregard them if they conflict with the statute they
purport to interpret or its legislative history, or if they are
otherwise unreasonable. Geisinger Health Plan v. C.I.R., 985
F.2d 1210, 1216 (3d Cir. 1993) (citations omitted); Kinnie v.
United States, 994 F.2d 279, 286 (6th Cir. 1993); Amato v.
Western Union Intern, Inc., 773 F.2d 1402, 1411 (2d Cir. 1985);
Certified Stainless Services, Inc. v. United States, 736 F.2d
1383, 1386 (9th Cir. 1984). The Court of Appeals for the Sixth
Circuit in Kinnie specifically found that the IRS's
interpretation of Rev. Rul. 79-284 was not unreasonable, nor did
it conflict with any specific statute. 994 F.2d at 287. The
court of appeals further found that requiring the designation to
be in writing serves an important purpose: it prevents
litigation over various oral statements and understandings. Id.
Accordingly, the court upheld the IRS's application of voluntary
tax payments in the best interest of the government absent a
written instruction from the taxpayer. Id. See also, Slodov v.
United States, 436 U.S. 238, 252 n. 15 (1978) (acknowledging IRS
Policy Statement P-5-60 prevails unless the government is
notified in writing that taxes are to be applied in a different
manner).
The crucial issue before us is what constitutes an
effective designation where voluntary payments are involved. KBS
would have us find that it effectively designated its payments to
27
be applied first to trust fund taxes because it had an
"understanding" with the IRS that payments were to be applied in
that manner and because the IRS failed to notify them to the
contrary. KBS further argues that to be effective, the
designation need not be in writing. The weight of authority,
however, goes against this argument. In addition, the cases
cited by KBS to support their argument that the designation need
not be in writing are factually distinguishable.25
We also reject KBS's contention that the language of
the first installment agreement is consistent with its belief
that payments were being applied to trust fund taxes first.
While it is true that the first installment agreement does not
contain any provisions contrary to the Kaplans' and KBS's beliefs
that the payments would be applied first to trust fund taxes,
this fact alone does not obviate the requirement that the
taxpayers provide a written designation contemporaneously with
their payment.
25. Freck v. I.R.S., 37 F.3d 986, 994 (3d Cir. 1994)
(Taxpayer did not have an opportunity to designate because tax
payments were made by a third party); McKenzie v. United States,
536 F.2d 726, 730 (7th Cir. 1976) (Bankruptcy Court found
evidence established IRS agent told taxpayer he would apply
payments first to trust fund taxes and, therefore, it was not
necessary for taxpayer to give specific instructions or
directions); In re Mallory, 32 B.R. 73, 74 (Bankr. D. Colo. 1983)
(Even though government admitted that designation under Rev. Rul.
73-305 can be oral if the designation is made when the payment is
tendered, bankruptcy court found no "specific directions" were
given with the tender of payment); In re T.M. Products, 118 B.R.
131, 134 (Bankr. S.D. Fla. 1990) (where IRS's efforts and the
court orders were specifically directed to the payment of trust
fund taxes, the bankruptcy court found that the taxpayer was
entitled to designate and, thus, the IRS could not apply payments
to non-trust fund taxes after it learned that reorganization was
no longer possible).
28
In our view, the record clearly establishes that a
designation, written or otherwise, was not made with respect to
any of the payments at issue. Undeniably, at the September 26,
1994, hearing before the bankruptcy court, counsel for the
Kaplans clarified that there was no written agreement to allocate
tax payments to trust fund liabilities first, nor was there a
binding oral agreement. In addition, the evidence suggests that
a tax return was not filed with the 1990 payment,26 and that a
designation did not accompany either the payments made before the
first installment agreement, or those made pursuant to the
installment agreements.
In order to prevail in the absence of a written
designation, KBS must show that the IRS assured it that the
payments would be allocated to trust fund taxes first, thereby
equitably estopping the IRS from changing the allocation at this
late date. The evidence of record, however, does not suggest
that the IRS agreed to apply KBS's payments to trust fund taxes
first, nor does it show that the Kaplans were led to believe the
IRS was not contesting designation requests. Other than the
statements of the Kaplans, there is no evidence to suggest that
the designation requests were, in fact, made.
In support of its equitable estoppel argument, KBS
cites In re Jones, 181 B.R. 538, 543-44 (D. Kansas 1995). That
26. A tax return accompanying a payment is considered a
written designation to apply the payment as shown on the return;
a payment received without a return is considered undesignated
and is applied first to the employer's non-trust fund taxes.
Internal Revenue Manual 56(18)3.1 (11-21-89).
29
case is distinguishable inasmuch as the Chapter 13 debtor had an
oral agreement with a specifically identified IRS agent. The
district court found that there was a running dialogue between
the agent and the debtor in which the agent made it clear to the
debtor that the IRS was interested in initially collecting the
payroll withholding taxes and provided the debtor with an
incentive to make these payments. The district court further
found that the actions of the IRS gave the debtor strong reason
to believe that his payment would be applied to his withholding
taxes. The district court held that the debtor, having shown
that the elements of equitable estoppel were met,27 was entitled
to have his payment credited to his withholding tax liability.
Unlike In re Jones, the taxpayers here have not
produced any evidence to suggest that the IRS engaged in conduct
which could have led the Kaplans and KBS to believe that their
tax payments were being applied to trust fund taxes first. KBS's
equitable estoppel argument, therefore, fails.
Accordingly, we find that KBS failed to designate that
its payments be applied to trust fund taxes first. The IRS was
allowed, therefore, to apply the tax payments in the best
interests of the government.
27. The traditional elements of equitable estoppel are:
"(1) the party to be estopped must have known the facts; (2) the
party to be estopped must intend that his conduct will be acted
upon or must so act that the party asserting the estoppel has the
right to believe it was so intended; (3) the party asserting
estoppel must be ignorant of the true facts; and (4) the party
asserting estoppel must rely on the other party's conduct to his
injury. In re Jones, 181 B.R. 538, 543 (D. Kansas 1995) (citing
Penny v. Giuffrida, 897 F.2d 1543, 1545-46 (10th Cir. 1990).
30
V.
For the reasons set forth above, we will affirm the
decisions of the district court.
31