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Retailer's Unpaid Sales Taxes Held to be Non-Dischargeable in Bankruptcy

Thursday, October 6, 2011

Adam Brown | Bloomberg LawIn re Calabrese, No. 10-6583, 2011 BL 233776 (D. N.J. Sept. 13, 2011) The United States District Court for the District of New Jersey affirmed a bankruptcy court's order holding a chapter 13 debtor individually liable for sales taxes collected in the course of operating his bankrupt business. Although the debtor argued that sales tax fell within the definition of "excise taxes," which are dischargeable under the bankruptcy code, the district court explained that Congress's intent was that only sales tax owed personally by the retailer qualified as "excise taxes," whereas sales taxes collected from customers and held in trust for the State are non-dischargeable.

Sales Tax Claim

Don's What a Bagel, Inc. ("Don's"), filed for bankruptcy relief under chapter 11. A few months later, the petition was converted to one for liquidation under chapter 7. Michael Calabrese ("Debtor"), the company's owner, subsequently filed for individual protection under chapter 13. In response, the State of New Jersey (the "State") filed a proof of claim, stating that Debtor owed sales taxes on behalf of Don's for years 2003 through 2009. Debtor disputed the claim, arguing that sales taxes qualify as "excise taxes" under the bankruptcy code, thus making them dischargeable in bankruptcy after three years, as opposed to "trust fund" taxes which are not dischargeable. After conducting a series of hearings, the bankruptcy court sided with the State and held that the sales taxes at issue were non-dischargeable trust fund taxes. Thereafter, the court entered an order stating that Calabrese owed more than $56,000 in sales tax on behalf of his company. Calabrese appealed the ruling.

11 U.S.C. § 507(a)(8)

Beginning its analysis, the district court sought to interpret which unsecured claims, made by governmental units, were allowed and under what conditions. Specifically, the district court looked to 11 U.S.C. § 507(a)(8)(e) which permits governmental units to make allowed unsecured claims for "excise tax" on transactions "occurring before the date of the filing of the petition for which a return, if required, is last due, under applicable law or under any extension, after three years before the date of the filing of the petition; or (ii) if a return is not required, a transaction occurring during the three years immediately preceding the date of the filing of the petition." By contrast, the district court found that under 11 U.S.C. § 507(a)(8)(c) of the same statute, governmental units may make unsecured claims if the claims are for "a tax required to be collected or withheld and for which the debtor is liable in whatever capacity." Moreover, the district court asserted that claims under this subsection are not subject to a three-year limitations period and, therefore, are not dischargeable.

Sales Tax Not Dischargeable

Issuing its decision on appeal, the district court explained that the language of § 507(a)(8)(c), covering any tax "required to be collected or withheld," would seem to include within its scope "sales taxes collected from the customer, held for the State, and then paid as a tax to the State." However, § 507(a)(8)(e)'s definition of "excise tax" did not specifically exclude sales tax that are held in trust, and the legislative history leading up to the passage of both subsections included statements from various lawmakers that excise taxes include sales taxes. Thus, the district court observed that there exists some overlap between the two subsections at issue. Citing the Second Circuit's opinion in In re DeChiaro, 760 F.2d 432 (2nd Cir. 1985) and the Ninth Circuit's opinion in In re Shank, 792 F.2d 829 (9th Cir. 1986), the district court reasoned that Congress intended to distinguish between two types of sales taxes: (1) sales tax owed personally by the retailer that are paid directly to the State," which are dischargeable under § 507(a)(8)(e); and (2) sales taxes that are incurred by customers, collected by the retailer at the time of sale, held in trust, and then remitted to the State, which fall within § 507(a)(8)(c) and, therefore, cannot be discharged. The district court remarked that separating the types of sales taxes contemplated by the two subsections in this way satisfied the traditional rule of statutory construction that competing statutes should be interpreted in a way that gives meaning to both sections. By looking behind the words in the statute to the operation of the provision, the district court found that "the purpose behind collecting a sales tax from customers at the time of sale is to pay such taxes to the State." Ultimately, the district court ruled that the clear intent of Congress was that any such tax collected by third parties, such as is Don's, be treated as a tax that is "held in trust and nondischargeable under 11 U.S.C. § 507(a)(8)(c)."

District Court Affirms Bankruptcy Court's Ruling

Accordingly, the Court affirmed the bankruptcy court's order holding Debtor personally liable for his business's unpaid sales taxes. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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