Slobodian v. United States of America Internal Revenue Service

PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
___________
No. 15-2833
___________
IN RE: NET PAY SOLUTIONS, INC.,
d/b/a NET PAY PAYROLL SERVICES,
Debtor
MARKIAN R. SLOBODIAN,
Appellant
v.
UNITED STATES OF AMERICA INTERNAL REVENUE
SERVICE
__________
On Appeal from the United States District Court
for the Middle District of Pennsylvania
(D.C. No. 1:13-cv-02677)
District Judge: Honorable Christopher C. Conner
___________
Argued March 2, 2016
Before: SMITH and HARDIMAN, Circuit Judges.*
(Filed: May 10, 2016)
*
The Honorable Dolores K. Sloviter assumed inactive
status on April 4, 2016, after the argument and conference in
this case, but before filing of the opinion. This opinion is filed
by a quorum of the panel pursuant to 28 U.S.C. § 46(d) and
Third Circuit I.O.P. Chapter 12.
Markian R. Slobodian (Argued)
801 North Second Street
Harrisburg, PA 17108
Attorney for Appellant
Ivan C. Dale (Argued)
Michael J. Haungs
U.S. Department of Justice
Tax Division
950 Pennsylvania Ave., N.W.
Washington, D.C. 20044
Attorneys for Appellee
Ari D. Kunofsky, Esq.
United States Department of Justice
Tax Division
P.O. Box 227
Ben Franklin Station
Washington, DC 20044
Attorney for Appellee
____________
OPINION OF THE COURT
____________
HARDIMAN, Circuit Judge.
Markian Slobodian, in his capacity as trustee of debtor
Net Pay Services, Inc., appeals the District Court’s summary
judgment in favor of the Internal Revenue Service. The
District Court denied Slobodian’s motion to avoid five
alleged preferential transfers under 11 U.S.C. § 547(b) of the
Bankruptcy Code. The District Court held that four of the five
payments were not avoidable because of their minimal value.
And although the fifth payment was sufficiently large to
constitute a preference, it was not avoidable because the
funds were not property of Net Pay’s estate. For the reasons
that follow, we will affirm.
I
The facts of this case are straightforward. Before it
filed for protection under Chapter 7 of the Bankruptcy Code,
2
Net Pay managed its clients’ payrolls and handled their
employment taxes pursuant to a form contract called a
“Payroll Services Agreement,” which required clients to
provide their employee payroll information so Net Pay could
determine the taxes and wages they owed. The Agreement
gave clients the option of authorizing Net Pay to transfer
funds from their bank accounts into Net Pay’s account and to
remit those funds to the clients’ employees, the IRS, and
other taxing authorities. The Agreement also established an
independent contractor relationship between Net Pay and its
clients, disclaiming “any relationship of employment, agency,
joint venture, partnership, or any other fiduciary relationship
of any kind.” App. 189.
At issue in this appeal are five transfers Net Pay made
on behalf of its clients to the Internal Revenue Service on
May 5, 2011—almost three months before it filed its Chapter
7 petition. These transfers included: (1) $32,297 on behalf of
Altus Capital Partners, Inc.; (2) $5,338 on behalf of
HealthCare Systems Connections, Inc.; (3) $1,143 on behalf
of Project Services, LLC; (4) $352.84 for an unknown client;
and (5) $281.13 for another unknown client. The day after
these transfers were made, Net Pay informed its clients that it
was “ceasing business operations including all payroll
processing.” App. 267.
As trustee for Net Pay, Slobodian sought to recover the
monies represented by these five payments, arguing that they
were avoidable preferential transfers.1 Slobodian and the IRS
1
The Bankruptcy Code allows trustees to “avoid any
transfer of an interest of the debtor in property (1) to or for
the benefit of a creditor; (2) for or on account of an
antecedent debt owed by the debtor before such transfer was
made; (3) made while the debtor was insolvent; (4) made . . .
on or within 90 days before the date of the filing of the
petition . . . (5) that enables such creditor to receive more than
such creditor would receive” in the debtor’s bankruptcy
proceedings. 11 U.S.C. § 547(b).
3
filed cross-motions for summary judgment. The District
Court granted the IRS judgment as a matter of law.2
The District Court concluded that four of the five
transfers were not subject to recovery as preference payments
because they were less than the minimum amount established
by law ($5,850). 11 U.S.C. § 547(c)(9) (2013). Recognizing
that four of the payments were beneath that threshold, the
Trustee argued that because the payments exceeded $5,850 in
the aggregate, the statutory threshold did not apply. The
District Court disagreed, reasoning that distinct transfers may
be aggregated for purposes of defeating the threshold only if
they are “‘transactionally related’ to the same debt.”
Slobodian v. U.S. ex rel. Comm’r, 533 B.R. 126, 132–133
(M.D. Pa. 2015). Because the payments of $5,338, $1,143,
$353, and $281 were “separate and unrelated transactions in
satisfaction of independent antecedent debts” to different
creditors, the Court held that they could not be aggregated to
satisfy the statutory minimum. Id. at 133.
As for the $32,297 payment Net Pay made on behalf of
Altus, which plainly exceeded the statutory minimum, the
question remained whether it was a “transfer of an interest of
the debtor in property.” 11 U.S.C. § 547(b) (emphasis added).
To evaluate that question, the District Court noted that
section 7501(a) of the Internal Revenue Code creates a
special statutory trust in favor of the United States for taxes
withheld from employee paychecks (otherwise known as
“trust fund” taxes). Informed by the Supreme Court’s opinion
interpreting that provision in Begier v. Commissioner, 496
U.S. 53 (1990), the District Court held that Net Pay lacked an
interest in the transferred funds because they were held in
trust under § 7501(a) at the moment they were withheld.
Notwithstanding this evidence, the Trustee emphasized
that $6,527.90 of the Altus payment was designated for
employer, non-trust-fund tax obligations unaffected by
§ 7501(a). The District Court saw the evidence differently,
finding that the payroll summary offered by Net Pay in
support of this assertion failed to “identify what portion of
2
The District Court had withdrawn the reference from
the bankruptcy court pursuant to 28 U.S.C. § 157(d).
4
Altus’s non-trust fund and trust fund tax obligations were
outstanding at the time.” Id. at 137 (emphasis added).
Because there was unrefuted evidence that the IRS applied
the entire $32,297 toward Altus’s trust fund tax obligations,
the Court held that the payment was not avoidable as a
preference.
This timely appeal followed.3
II
We begin with the Trustee’s argument that the four
smaller value transfers may be aggregated to exceed the
Bankruptcy Code’s minimum threshold for the avoidance of
preferential transfers.4 We have not had occasion to examine
this provision, which states that the “trustee may not avoid
. . . a transfer . . . if, in a case filed by a debtor whose debts
are not primarily consumer debts, the aggregate value of all
3
The District Court had jurisdiction pursuant to 28
U.S.C. § 157 and 28 U.S.C. § 1334. We have jurisdiction
under 28 U.S.C. § 1291. We review the District Court’s
summary judgment de novo, applying the same standard as
the District Court. Viera v. Life Ins. Co. of N. Am., 642 F.3d
407, 413 (3d Cir. 2011). Summary judgment is proper “if the
movant shows that there is no genuine dispute as to any
material fact and the movant is entitled to judgment as a
matter of law.” Fed. R. Civ. P. 56(a). “In conducting our
review, we view the record in the light most favorable to the
non-moving party and draw all reasonable inferences in that
party’s favor.” Aleynikov v. Goldman Sachs Grp., 765 F.3d
350, 358 (3d Cir. 2014).
4
Assuming the Government’s interpretation of the
§ 7501(a) trust provision is correct, it would not affect the
four smaller transfers, which related to non-trust-fund taxes
not covered by § 7501(a). On the other hand, if Net Pay’s
arrangements with its clients created a trust relationship under
state or federal law, Net Pay would not have an interest in any
of the property transferred to the IRS. See infra at 19–21 n.13.
5
property that constitutes or is affected by such transfer is less
than $5,850.”5 11 U.S.C. § 547(c)(9).
A
Although section 547(c)(9) is less than pellucid, it is
clear that the “aggregate value” of “all property” that
“constitutes or is affected by” a debtor’s “transfer to or for the
benefit of a creditor” must be at least $5,850 to be avoidable
as a preference. 11 U.S.C. § 547(b)(1), (c)(9). But this leaves
unanswered the question whether small-value transfers for the
benefit of different creditors and based on distinct debts can
be aggregated and avoided as preferential. Citing an
interpretive rule—“the singular includes the plural,” 11
U.S.C. § 102(7)—the Trustee reads the Bankruptcy Code to
allow the aggregation of transfers that individually fall below
the threshold, as long as they were all to the same transferee.
We reject the Trustee’s reading. As we shall explain, when
read in context, § 547(c)(9) precludes aggregation of multiple
preferential transfers for the benefit of different creditors on
distinct debts.
1
A “central policy” of the Bankruptcy Code is
“[e]quality of distribution among creditors.” Begier, 496 U.S.
at 58. “According to that policy, creditors of equal priority
should receive pro rata shares of the debtor’s property.” Id.
The power of bankruptcy trustees to avoid preferential
transfers that benefit certain creditors over others is critical to
this system. “This mechanism prevents the debtor from
favoring one creditor over others by transferring property
shortly before filing for bankruptcy.” Id. The fear is that “[i]f
preference law fails to preserve absolute equality in
5
This dollar amount has since been increased, but the
old amount controls. See Revision of Certain Dollar Amounts
in the Bankruptcy Code Prescribed Under Section 104(A) of
the Code, 75 Fed. Reg. 8747, 8748 (Feb. 21, 2013); 11 U.S.C.
§ 104(c). The IRS has the burden of proving the
unavoidability of a transfer under § 547(c)(9). J.P. Fyfe, Inc.
of Fla. v. Bradco Supply Corp., 891 F.2d 66, 71 (3d Cir.
1989); 11 U.S.C. § 547(g).
6
liquidation, those creditors who are aware of this failure will
compete for position during insolvency rather than
cooperating fully in an attempt to maximize the value of the
firm.” Note, Preferential Transfers and the Value of the
Insolvent Firm, 87 Yale L.J. 1449, 1455 (1978); see also In re
Molded Acoustical Prods., Inc., 18 F.3d 217, 219 (3d Cir.
1994) (“[T]he preference rule aims to ensure that creditors are
treated equitably, both by deterring the failing debtor from
treating preferentially its most obstreperous or demanding
creditors in an effort to stave off a hard ride into bankruptcy,
and by discouraging the creditors from racing to dismember
the debtor.”).
The Bankruptcy Code includes certain exceptions to
the general preference rules. For example, a trustee may not
avoid a transfer made “in the ordinary course of business,” 11
U.S.C. § 547(c)(2), “because it does not detract from the
general policy of the preference section to discourage unusual
action by either the debtor or his creditors during the debtor’s
slide into bankruptcy.” Union Bank v. Wolas, 502 U.S. 151,
160 (1991) (internal quotation marks omitted). Indeed, it
furthers bankruptcy policies by “encourage[ing] creditors to
continue dealing with distressed debtors on normal business
terms” and “promot[ing] equality of distribution by ensuring
that creditors are treated equitably.” In re Pillowtex Corp.,
427 B.R. 301, 306 (Bankr. D. Del. 2010) (citing In re Molded
Acoustical Prods., Inc., 18 F.3d 217, 219 (3d Cir. 1994)).
The § 547(c)(9) minimum threshold is a relatively new
addition to the Code.6 See Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005, Pub. L. 109–8, 119 Stat.
23 (April 20, 2005). This provision was intended to benefit
creditors who had to decide whether small-value preference
actions were worth defending. See Kevin C. Driscoll Jr.,
Bankruptcy 2005: New Landscape for Preference
Proceedings, Am. Bankr. Inst. J., June 2005, at 1, 56. Given
6
A longer standing, nearly identical provision set a
lower threshold for consumer cases: “The trustee may not
avoid . . . a transfer . . . if, in a case filed by an individual
debtor whose debts are primarily consumer debts, the
aggregate value of all property that constitutes or is affected
by such transfer is less than $600.” 11 U.S.C. § 547(c)(8).
7
that “spending $10,000 in legal fees to defeat a $5,000
preference is a Pyrrhic victory,” many “defendants in these
smaller preferences chose to settle otherwise defendable
claims.” Id. Accordingly, as one court has observed, the
essential function of the minimum threshold is to
“discourage[] litigation over relatively insignificant transfer
amounts” in order to “promote commercial and judicial
efficiency, not only by reducing litigation over nominal
amounts, but also by preventing creditors with smaller claims
from waiving otherwise meritorious defenses simply because
the costs associated with defending against trustees’
avoidance actions exceed any anticipated benefits.” In re Bay
Area Glass, Inc., 454 B.R. 86, 90 (B.A.P. 9th Cir. 2011).
2
In view of this statutory scheme, the Trustee’s
argument makes little sense. An individual creditor’s ability
to invoke the minimum threshold as a defense would depend
not only upon whether the transfer from which it benefitted
was less than $5,850, but also on whether the debtor had
made any transfers (large or small) for the benefit of other
creditors, and whether all transfers taken together exceed the
statutory threshold. As the following hypothetical
demonstrates, this cannot be the law.
Assume a debtor has 1,000 creditors to whom it paid
$5,000 each during the preference period. If we accepted the
Trustee’s argument, the debtor’s estate would be able to
recover this $5,000,000 and none of those creditors would be
able to invoke the $5,850 minimum threshold as a defense.
This would render § 547(c)(9) ineffective. In fact, the
statute’s only effect would be to apply in the very few
bankruptcies where creditors were paid, in the aggregate, less
than $5,850 during the preference period. Because this
construction would render the minimum threshold an “empty
promise,”7 King v. Burwell, 135 S. Ct. 2480, 2495 (2015), we
must reject it.
7
The Trustee’s suggestion at oral argument that
aggregation should be liberally permitted when a number of
transfers for the benefit of independent creditors are made to
a single transferee might limit these concerns to some extent,
8
The Supreme Court has recognized that “[a] provision
that may seem ambiguous in isolation is often clarified by the
remainder of the statutory scheme . . . because only one of the
permissible meanings produces a substantive effect that is
compatible with the rest of the law.” United Sav. Ass’n of
Tex. v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365,
371 (1988) (internal citation omitted). Section 547(c)(9) is
such a provision. And close inspection of the statutory
scheme reveals that an interpretation of the minimum
threshold that fails to distinguish between creditors is
incompatible with the preference regime.
B
Unlike the Trustee’s argument, the District Court’s
reading of § 547(c)(9) is faithful both to the text of the statute
and the law as a whole. To reiterate, the defense provides that
a debtor’s “transfer to or for the benefit of a creditor” may not
be avoided if the “aggregate value” of “all property” that
“constitutes or is affected by such transfer” is “less than
$5,850.” 11 U.S.C. § 547(b)(1), (c)(9). In context, this
language requires that creditors be considered independently.
Hence, a creditor who has received the benefit of a prepetition
transfer less than that threshold may invoke the defense
regardless of what other creditors have received. This
comports with section 547’s text, which speaks to transfers
“to or for the benefit of a creditor.” 11 U.S.C. § 547(b)(1). It
also accords with the interpretation reached by a number of
bankruptcy courts. See, e.g., In re Pickens, 2007 WL
1650140, at *4 (Bankr. N.D. Iowa June 4, 2007) (“Trustee
cannot aggregate the total transfers of both [creditors] in this
action to reach the $5,000 limit. Since the parties agree that
[one creditor] received more than $5,000 in payments during
the preference period, she is barred from asserting § 547(c)(9)
as an affirmative defense as to those payments.”); In re
Nelson, 419 B.R. 338, 341 (Bankr. W.D. Ky. 2009)
but it has no basis in the text of the statute, which speaks in
terms of debtors and creditors, not of transferees. Net Pay
conceded as much. See Net Pay Reply Br. 4 (“The statute
does not focus on the identity of the recipient of the
transfer.”).
9
(“[Creditors] are to be considered individually when applying
§ 547(c)(8).”).
The text and context of § 547(c)(9) also demonstrate
that the minimum threshold contemplates a transfer-by-
transfer analysis. In this respect, the Trustee is wrong to
describe the threshold as internally inconsistent. See Net Pay
Br. 15 (“The language of [§ 547(c)(9)] is internally
contradictory or at best ambiguous because the term
‘aggregate’ implies a summation of various transfers, while
the language ‘such transfer’ implies the defense should be
applied on a payment by payment basis.”) (quoting In re
Carter, 506 B.R. 83, 87 (Bankr. D. Ariz. 2014)). In fact, the
provision anticipates that a single transfer might be composed
of more than one type of property and instructs that “all
property that constitutes or is affected by” that transfer should
be aggregated for purposes of determining whether the
threshold is met. 11 U.S.C. § 547(c)(9) (emphases added).8
This does not mean, of course, that courts must apply
the minimum threshold in a mindless way that would permit
wily debtors to thwart the law by structuring multiple
transfers in amounts less than the threshold. Although
§ 547(c)(9) envisions creditor-by-creditor and transfer-by-
transfer analyses, both the statutory scheme and the rule that
the singular includes the plural require that ostensibly distinct
transfers may nevertheless be aggregated if they are, in effect,
a single transfer on account of the same debt. See 4 Norton
Bankr. L. & Prac. 3d § 66:33 (“Courts look behind the form
of multiple transfers to avoid [strategic separation of transfers
on the same underlying obligation]. When a number of less
8
One bankruptcy court reached this conclusion in a
preference action against a debtor’s prepetition transfer of
both cash and a security interest in property to each of two
different creditors, wherein the cash and security interest
independently fell below the minimum threshold but
collectively exceeded it. See Pickens, 2007 WL 1650140, at
*3–4. There, the court held that the trustee could not
“aggregate the total transfers of both [creditors]” and that the
property transferred to each creditor—cash and the security
interest—could only be aggregated with respect to each
creditor if they were “transactionally related.” Id. at *5.
10
than [$5,850] transfers occur between two parties, it is
appropriate to treat the transfers as one transaction if they are,
in fact, conducted pursuant to a single, common plan.”);
Commercial Bankruptcy Litigation § 11:20 n.3 (“Multiple
transfers to a single creditor may be aggregated where the
underlying facts and circumstances indicate the transfers were
part of a common plan.”) (emphasis added); Andrea Coles-
Bjerre, Bankruptcy Theory and the Acceptance of Ambiguity,
80 Am. Bankr. L.J. 327, 354 n.85 (2006) (recognizing that
“aggregation within a transfer—whatever those bounds may
be—is different from aggregation across transfers”).
In sum, the Trustee’s reliance on § 102(7) (“the
singular includes the plural”) cannot bear the weight he has
placed upon it. As the District Court observed, if that
provision had the effect of allowing the debtor to aggregate
any and all transfers, “inclusion of the word ‘aggregate’ in the
provision would be entirely superfluous.” Slobodian, 533
B.R. at 133; see also Bennett v. Spear, 520 U.S. 154, 173
(1997) (“It is the cardinal principle of statutory construction
. . . to give effect, if possible, to every clause and word of a
statute.”) (internal quotation marks omitted); Corley v. United
States, 556 U.S. 303, 314 (2009) (explaining that “one of the
most basic interpretive canons” is that “[a] statute should be
construed so that effect is given to all its provisions, so that
no part will be inoperative or superfluous, void or
insignificant”) (internal quotation marks omitted). As the
foregoing explanation demonstrates, the fact that the singular
includes the plural simply means that (1) a creditor may
invoke the defense for multiple, independently qualifying
transfers (i.e., it’s not a “one-and-done” defense) and (2) a
party may defeat the defense where the challenged transfers
are strategically divided yet transactionally related.9
9
The authorities relied on by the Trustee are consistent
with this approach. Although each decision invokes § 102(7)
in allowing aggregation of multiple preferences, the critical
distinction is that the challenged payments in each case were
made for the benefit of a single creditor on account of a single
debt. See In re Hailes, 77 F.3d 873, 874–75 (5th Cir. 1996)
(several transfers to a single creditor on account of a single
judgment debt); In re Carter, 506 B.R. at 85–86 (multiple
11
* * *
In light of our interpretation of § 547(c)(9), we hold
that Net Pay’s four small-value transfers may not be
aggregated to exceed the minimum threshold for avoidable
preferences. Each payment involved a different creditor (i.e.,
a different Net Pay client), unrelated antecedent debts, and
distinct tax liabilities. Accordingly, the District Court did not
err when it held that the payments of $5,338, $1,143, $353,
and $281 to the IRS are not avoidable preferences.
III
We now consider Net Pay’s $32,297 payment to the
IRS on behalf of Altus, which obviously is not subject to the
minimum threshold defense of § 547(c)(9). The question
presented with respect to this payment is whether it was “an
interest of the debtor in property.” 11 U.S.C. § 547(b). The
District Court held that because Altus’s funds were held by
Net Pay in a special statutory trust pursuant to 26 U.S.C.
§ 7501(a), Net Pay had no interest in them. We agree.
A
The Internal Revenue Code provides that “[w]henever
any person is required to collect or withhold any internal
revenue tax from any other person and to pay over such tax to
the United States, the amount of tax so collected or withheld
shall be held to be a special fund in trust for the United
States.” 26 U.S.C. § 7501(a). This “any person”/“any other
person” language is a vague way of saying that the provision
payments but just one creditor and one debt); In re Transcon.
Refrigerated Lines, Inc., 438 B.R. 520, 521 (Bankr. M.D. Pa.
2010) (permitting aggregation of three separate transfers to a
single creditor in satisfaction of a single debt); In re Bunner,
145 B.R. 266, 267 (Bankr. C.D. Ill. 1992) (same, with respect
to separate garnishment payments); In re Alarcon, 186 B.R.
135, 137 (Bankr. D.N.M. 1995) (same); see also Pickens,
2007 WL 1650140, at *4 (“Cases arising under the consumer
small preference exception are not helpful as they, almost
without exception, consider multiple small payments to a
single creditor on a single debt, with the majority of the cases
considering wage garnishment.”) (emphases added).
12
applies to federal taxes that Congress requires employers to
withhold from their employees’ paychecks, otherwise known
as “trust fund taxes.” Begier, 496 U.S. at 54; In re Calabrese,
689 F.3d 312, 316 (3d Cir. 2012).
The Supreme Court interpreted § 7501(a) in Begier,
which involved an airline that declared bankruptcy after
paying certain withholding taxes to the IRS. 496 U.S. at 55–
56. The airline had commingled some of the trust fund taxes
that it withheld from its employees with money in its general
operating account, and then transferred funds to the IRS in
satisfaction of its trust fund tax obligations from both the
commingled general account and a segregated tax-fund-only
account. Id. When the airline tried to avoid all these payments
as preferential transfers, the IRS countered that the airline
never had an interest in the funds because of § 7501(a). Id. at
56–57.
The Court began its analysis by defining “interest of
the debtor in property.” Noting that “the purpose of the
avoidance provision is to preserve the property includable
within the bankruptcy estate,” the Court reasoned that
“‘property of the debtor’ subject to the preferential transfer
provision is best understood as that property that would have
been part of the estate had it not been transferred before the
commencement of bankruptcy proceedings.” Id. at 58. The
Court then turned to the Code’s definition of “property of the
estate,” which includes “all legal or equitable interests of the
debtor in property as of the commencement of the case” but
excludes property in which the debtor holds “only legal title
and not an equitable interest.” Id. at 59 (quoting 11 U.S.C.
§ 541(a), (d)). Because a debtor “does not own an equitable
interest in property he holds in trust for another,” the Court
concluded that such property is not subject to § 547(b). Id.
Having established the legal framework, the Court
articulated a two-pronged inquiry for deciding whether a
prepetition transfer from a debtor to the IRS is unavoidable
under § 7501(a): (1) whether a special statutory trust was
created with respect to a certain dollar amount in the first
place; and (2) if so, whether the assets used to pay the IRS
were assets belonging to that trust. Id. at 57–67. On the first
question, the airline argued that even though § 7501(a)
13
creates a statutory trust extending to “the amount of tax .
. . collected or withheld,” a trust fund tax is not “collected or
withheld” until specific funds are either sent to the IRS with
the relevant return or placed in a segregated fund. Id. at 60.
The Supreme Court disagreed, holding that the trust was
created at the moment the relevant taxes were withheld, and
that “[w]ithholding . . . occurs at the time of payment to the
employee of his net wages.” Id. at 60–61. It followed that the
airline created a special trust for the benefit of the United
States once it withheld the funds from its employees’
paychecks. Id. at 60–62.
The Court then considered the second prong of the
trust inquiry: whether the assets the airline used to pay the
IRS belonged to that trust. Id at 57–67. Absent statutory
guidance on this tracing question, the Court first considered
the common law. Id. at 62. But the Court found that unhelpful
because, “[u]nder common law principles, a trust is created in
property; a trust therefore does not come into existence until
the settler identifies an ascertainable interest in property to be
the trust res.” Id. (emphasis added). The statute’s approach is
“radically different.” Id. It provides that “the amount of [trust-
fund] tax . . . collected or withheld shall be held to be a
special fund in trust for the United States.” Id. (quoting
§ 7501(a)) (alteration in original). Hence, rather than
envisioning a particular property to be the trust res, § 7501(a)
“creates a trust in an abstract ‘amount’—a dollar figure not
tied to any particular assets—rather than in the actual dollars
withheld.”10 Id. It therefore made no sense for the Court to
apply common law tracing rules to the particular dollars
10
Some have called into question the propriety of
using trust law when applying § 7501(a). See In re Catholic
Diocese of Wilmington, Inc., 432 B.R. 135, 156 (Bankr. D.
Del. 2010) (“Not only does the ‘§ 7501 trust’ at issue in
Begier not fit ‘the common law paradigm,’ it is not even a
‘trust’ as that term is used under the law. You simply cannot
have a trust without trust property. The ‘amount of tax’ is not
property. Rather, it is the value of the property.”); Begier, 496
U.S. at 68 (Scalia, J., concurring) (“One ‘traces’ a fund only
after one identifies the fund in the first place. The problem
here is not ‘following the res’ of the tax trust, but identifying
the res to begin with.”).
14
withheld and the particular dollars paid to the IRS. Id. at 62–
63.
Having rejected the strict tracing rule of the common
law, the Court was faced with a dilemma. “Congress,” the
Court surmised, “expected that the IRS would have to show
some connection between the § 7501 trust and the assets
sought to be applied to a debtor’s trust-fund tax obligations.”
Id. at 65–66. The question was how much of a connection?
Relying on legislative history as “persuasive evidence of
Congressional intent,” 11 the Court held that courts should
allow the IRS to apply “reasonable assumptions” to govern
the tracing of withheld funds. Id. at 64–66 & n.5. One such
assumption identified by the Court is “that any voluntary
prepetition payment of trust-fund taxes out of the debtor’s
assets is not a transfer of the debtor’s property.” Id. at 67.
Hence, “the debtor’s act of voluntarily paying its trust-fund
tax obligation . . . is alone sufficient to establish the required
nexus between the ‘amount’ held in trust and the funds paid.”
Id. at 66–67. In other words, “the bankruptcy trustee could
not avoid any voluntary prepetition payment of trust-fund
taxes, regardless of the source of the funds.” Id. at 66.
Because the airline had voluntarily paid its trust fund tax
obligation out of its assets, the Court held that the transferred
amount had merely been held in trust by the airline and thus
could not be avoided as a preference. Id. at 67.
B
Our rather detailed exposition on Begier is necessary
here because there is only one meaningful difference between
that case and this appeal: here, the debtor is an intermediary
that withheld and paid taxes on behalf of its client-employers.
11
The Court likely would have arrived at the same
conclusion even without its reliance on legislative history. See
Begier, 496 U.S. at 70 (Scalia, J., concurring) (“If the Court
had applied to the text of the statute the standard tools of legal
reasoning, instead of scouring the legislative history for some
scrap that is on point (and therefore ipso facto relevant, no
matter how unlikely a source of congressional reliance or
attention), it would have reached the same result it does
today.”).
15
According to the Trustee, this distinction makes all the
difference because the “obvious meaning of the statute is that
in order for a trust to be created, a person who is required to
collect the tax must actually withhold the tax.” Net Pay Br.
11. Because Net Pay’s clients, not Net Pay itself, were
required to withhold the taxes at issue, the Trustee suggests
that those withholdings escape the statute. Id. at 11–12. We
are not persuaded.
Section 7501(a) provides that “[w]henever any person
is required to collect or withhold any internal revenue tax
from any other person and to pay over such tax to the United
States, the amount of tax so collected or withheld shall be
held to be a special fund in trust for the United States.” 26
U.S.C. § 7501(a). Net Pay’s clients indisputably were persons
“required to collect or withhold any internal revenue tax from
[their employees] and to pay over such tax to the United
States.” 26 U.S.C. § 7501(a). And the provision does not say
that clients themselves must be the only ones involved in the
withholding process in order for trust principles to be
implicated. It simply says that whenever an employer is
required to withhold employee taxes, the “amount of tax” that
is “so collected or withheld shall be held to be a special fund
in trust for the United States.” 26 U.S.C. § 7501(a). Nothing
there suggests that an employer may avoid the fact that an
amount required by law is being held in trust for the United
States merely by outsourcing payroll processing to a third
party. In fact, reading the statute that way would contravene
Begier, which instructs that “[n]othing in § 7501 indicates . . .
that Congress wanted the IRS to be protected only insofar as
dictated by the debtor’s whim.” 496 U.S. at 61. In effect, Net
Pay’s construction amends the statute to read: Whenever any
person is required to collect or withhold any internal revenue
tax from any other person and to pay over such tax to the
United States, the amount of tax so collected or withheld by
the person so required, and only if by that person alone, shall
be held to be a special fund in trust for the United States.
Such a limit is present neither in the statute’s text nor in the
Supreme Court’s opinion in Begier.
The Trustee cites various cases in support of its
interpretation, but none carry the day. He quotes seemingly
helpful language from In re Warnaco Group, Inc., but omits
16
crucial details. Warnaco involved a staffing company (Pro
Staff) that provided the debtor with employees in exchange
for fees and reimbursements. 2006 WL 278152, at *1
(S.D.N.Y. Feb. 2, 2006). Rejecting Pro Staff’s argument that
certain payments from the debtor to Pro Staff represented
employees’ withheld taxes and were not avoidable, the
District Court distinguished Begier because “[i]n that case,
the employer, and no one else, withheld taxes.” Id. at 5.
Although this snippet appears to support the Trustee’s
argument that third-party involvement vitiates trust status, the
real reason the situation was distinguishable from Begier was
that the transfers the debtor sought to avoid were not
payments of withholding taxes, but rather, reimbursements to
Pro Staff “for monies already paid by Pro Staff to employees
for salaries, taxing authorities and insurance premiums.” Id. at
5 (emphasis added). As the court explained, “none of the
amount paid to Pro Staff was specifically and directly
reserved for withholding taxes. Rather, Pro Staff could do
with that money as it saw fit.” Id. Thus, the arrangement in
Warnaco differed markedly from the one at issue in this case,
where the amount paid to the IRS was reserved by the
employer (Altus) for withholding taxes.
The bankruptcy court’s decision in In re U.S. Wireless
Corp. is similarly inapposite. Net Pay cites that case for the
proposition that trust status is dependent upon the identity of
the person who does the withholding. But U.S. Wireless says
no such thing. Rather, it merely held that no statutory trust
was created when the debtor-company forgot to withhold
taxes from an employee’s paycheck and then simply paid the
taxes itself. 333 B.R. 688, 695 (Bankr. D. Del. 2005).
Because “the statute’s own terms limit the trust to the amount
so ‘collected or withheld,’” the bankruptcy court reasoned,
the fact that the debtor “never collected or withheld any
money from [the employee]” meant that “no trust could have
been created” and that “[t]he property belonged to the
[debtor] and is, therefore, potentially recoverable.” Id. Here,
by contrast, we are dealing with amounts that were properly
withheld and paid over to the IRS.12
12
One bankruptcy court decision does support Net
Pay’s interpretation. See In re FirstPay, Inc., 2012 WL
17
 * * *
Section 7501(a)’s language is broad enough to cover
the facts of this case. It makes no difference that Net Pay’s
customers used the company as an intermediary to withhold
and pay its employees’ taxes. The Altus payment represented
an amount it was “required to . . . withhold,” 26 U.S.C.
§ 7501(a), and that was so withheld pursuant to the contract
between Altus and Net Pay. The Tax Code thus deems the
amount to have been “held to be a special fund in trust for the
United States.” 26 U.S.C. § 7501(a). And because the amount
was paid out of Altus’s assets, the traceability nexus is met.
See Begier, 496 U.S. at 66–67. Accordingly, the District
Court did not err when it held that Net Pay lacked any interest
in the property and may not avoid the transfer.
C
The Trustee argues that even if the statutory trust
provision applies, $6,527.90 of the Altus payment may be
avoided as a preference because it was marked for employer,
non-trust-fund tax obligations. An internal payroll summary
indicates that Altus had generated $25,769.90 in trust fund
taxes and $6,527.90 in non-trust-fund taxes during the period
covered by the summary: April 1–May 31, 2011.
Accordingly, the Trustee argues that it’s unclear that the
entire $32,297 sum was applied to Altus’s trust fund tax
obligations.
3778952 (Bankr. D. Md. Aug. 30, 2012). But that decision—
which also involved a payroll-company debtor—is virtually
devoid of analysis. See id. at *5 (“In the present case, in
contrast to Begier, FirstPay was not holding the subject funds
in a statutory trust for the IRS pursuant to 26 U.S.C. § 7501,
as the funds were not collected or withheld by FirstPay to
meet its own trust-fund tax obligations.”) (emphasis added).
Rather than correcting this faulty and conclusory reasoning,
the Fourth Circuit simply held that the relevant funds were
held in a state-law trust and did not consider whether the
federal statutory trust provision applied. See In re FirstPay,
Inc., 773 F.3d 583, 592–94 (4th Cir. 2014).
18
The District Court did not err in holding that there is
no genuine issue of material fact as to whether the entire
Altus payment was applied to Altus’s trust fund obligations.
The record shows that on April 28, 2011, Net Pay withdrew
$114,335 from Altus’s bank account, of which $32,297 was
designated for payment to the IRS on or before May 6, 2011.
Both trust-fund and non-trust-fund portions of federal
employment taxes were generated throughout the quarter as
Altus’s employees earned wages. See Donelan Phelps & Co.
v. United States, 876 F.2d 1373, 1374–75 (8th Cir. 1989);
Calabrese, 689 F.3d at 316. Critically, the moment when
taxes accrue is irrelevant to which portion of the tax liability
is actually paid. Consistent with standard IRS practice, non-
trust-fund taxes are deemed to be paid first, even though they
may accrue later in that quarter. In re Ribs-R-Us, Inc., 828
F.2d 199, 201 (3d Cir. 1997); see also Westerman v. United
States, 718 F.3d 743, 749 (8th Cir. 2013). There was
unrebutted testimony on the record to this effect. And while
the document upon which the Trustee relies does not identify
what portion of Altus’s non-trust-fund and trust fund tax
obligations were outstanding at the time, the record does. In
the relevant period, Altus owed $164,504 in employment
taxes. Of that amount, $137,521 consisted of trust fund taxes,
and $26,983 consisted of non-trust-fund taxes. By the time
the IRS received the $32,297 transfer from Net Pay, Altus
had made deposits exceeding its $26,983 non-trust-fund
liability for the second quarter of 2011. Consequently, the
$32,297 payment was applied to Altus’s trust fund tax
liability.
Stated differently, Altus was required to withhold
$137,521 from its employees’ wages during the relevant
period, and that “amount of tax so collected or withheld [was]
held to be a special fund in trust for the United States.” 26
U.S.C. § 7501(a). This is further demonstrated by the
consequence of Net Pay’s logic: were some portion of that
amount to revert to Net Pay’s estate, Altus would be on the
hook for that exact amount in unpaid trust fund taxes.
Because what matters for purposes of the statutory trust is the
overall “amount” withheld, and because there is unrebutted
evidence that the full $32,297 was withheld by Altus and paid
over to the IRS, the District Court correctly held that there is
no genuine issue of material fact as to whether the entire
19
Altus payment was applied to Altus’s trust fund obligations
and was held in trust by Net Pay for the United States.13
13
Although the foregoing resolves this appeal on the
same grounds as the District Court, we note that, under
Pennsylvania state law, Net Pay would not be entitled to the
money at issue even if its interpretation of the minimum
threshold and the federal trust provision were correct. Absent
federal preemption, we look to state law to determine the
nature of a debtor’s interest in property. Butner v. United
States, 440 U.S. 48, 54–55 (1979) (“Property interests are
created and defined by state law. . . . [u]nless some federal
interest requires a different result.”). Net Pay’s agreements
with its customers designate Pennsylvania law as the
governing law. Assuming arguendo that federal law is silent
and that Pennsylvania law does not conflict with federal
interests, we would conclude that the funds were held in a
resulting trust (i.e., one implied by the circumstances) under
Pennsylvania law. The Government has produced more than
sufficient evidence “showing circumstances which raise an
inference that in making the conveyance to [Net Pay], there
was no intention [by Net Pay’s customers] to give [Net Pay]
the beneficial interest in the property.” Mooney v. Greater
New Castle Dev. Corp., 510 A.2d 344, 346 (Pa. 1986). See
also In re Vosburgh’s Estate, 123 A. 813, 815 (Pa. 1924)
(“[E]very person who receives money to be paid to another or
to be applied to a particular purpose is a trustee, if so applied,
as well as when not so applied.”). Were it otherwise, Net Pay
would not have bothered to contract for a set-off right and
security interest to secure payment of service fees since, as it
claims, all the money it received from its customers would
have been its property anyway. And without an equitable
interest in the money withdrawn from each client’s account,
§ 547(b) does not apply. See 11 U.S.C. § 547(b) (requiring
the debtor to have an interest in the property in order to avoid
a transfer); Begier, 496 U.S. at 59 (observing that “[b]ecause
the debtor does not own an equitable interest in property he
holds in trust for another, that interest is not ‘property of the
estate’”).
Moreover, even if we were to determine that
Pennsylvania law conflicts with an important federal interest
such that federal law governs the “interest of the debtor in
20
IV
Our legal analysis is supported by common sense. It is
hard to fathom that Net Pay’s clients intended anything other
than to “transfer only bare legal title” to Net Pay with respect
to the funds meant for payment to the IRS. Galford v.
Burkhouse, 478 A.2d 1328, 1334 (Pa. Super. Ct. 1984). Of
course, “[w]hether the money is held in trust must be
determined . . . not merely by reliance on common sense, but
also by application of traditional legal doctrines.” In re Penn
Cent. Transp. Co., 486 F.2d 519, 524 (3d Cir. 1973). Here, as
we have explained, those legal doctrines cohere with common
sense.
Net Pay is not entitled to recoup the money it
transferred to the IRS on behalf of its clients. Four of its
transfers may not be challenged as preferences because they
did not meet the statutory threshold of 11 U.S.C. § 547(c)(9),
and the Altus payment may not be avoided because Net Pay
lacked an equitable interest in the property by operation of 26
U.S.C. § 7501(a). For these reasons, we will affirm the
judgment of the District Court.
property” inquiry, we would conclude that Net Pay held the
funds in trust pursuant to federal common law. In re
Columbia Gas Sys. Inc., 997 F.2d 1039, 1056 (3d Cir. 1993)
(“Federal common law imposes a trust when an entity acts as
a conduit, collecting money from one source and forwarding
it to its intended recipient.”); see also In re Penn Central
Transp. Co., 486 F.2d 519, 523–27 (3d Cir. 1973) (en banc).
As for the tracing requirement—which in either case
calls for application of federal rather than state tracing rules,
see City of Farrell v. Sharon Steel Corp., 41 F.3d 92, 95–96
(3d Cir. 1994)—we agree with the Fourth Circuit that “the
law will presume that any funds received, held, and ultimately
transferred by a trustee in accordance with the trust purpose
are indeed trust funds.” FirstPay, 773 F.3d at 595. As stated,
the Trustee has not rebutted this presumption; the funds paid
to the IRS are clearly traceable to the funds deposited into Net
Pay’s account just days before the transfers at issue.
21