Unpaid Corporate Taxes Are Priority Claim in Ch. 11

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By Diane Davis

Nov. 24 — Montana's tax claim for unpaid corporate taxes is a priority excise tax claim in the debtors' personal bankruptcy case, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit held Nov. 18 (Carpenter v. Mont. Dep't of Labor & Indus. Unemployment Ins. Contributions Bureau (In re Carpenter), 2015 BL 380901, B.A.P. 9th Cir., No. MT-14-1499-KlPaJu, 11/18/15).

Judge Christopher M. Klein of the U.S. Bankruptcy Court for the Eastern District of California, sitting by designation, concluded that the liability imposed upon corporate responsible officers by Montana Code § 39-51-1105 is a “tax that has the same status as the underlying corporate tax” for purposes of Bankruptcy Code Section 507(a)(8), which provides priority tax categories that qualify as priority debts.

The BAP's interpretation “opens the door for governments to greatly expand non-dischargeable vicarious personal liability for recent corporate taxes, and to argue that older vicarious taxes should not be discharged if the corporation failed to file its tax returns or to do so timely,” Professor Gregory Germain, Syracuse University College of Law, Syracuse, N.Y., told Bloomberg BNA Nov. 23.

According to Germain, the decision “greatly expands the exceptions to discharge for taxes that were not incurred directly by the debtor. If state law holds a ‘responsible person' personally liable for an entity's failure to pay its taxes of whatever kind, the Carpenter court held that the person's liability should be treated for bankruptcy purposes the same as if the person had incurred the taxes directly,” he said.

“While the Carpenter case involved rather obscure Montana unemployment taxes, the reasoning of the decision would apply to any corporate tax (and maybe any tax) imposed by state or federal law on a responsible individual,” Germain said. “That responsible individual may be an owner of the corporation, but it could also be an employee in an accounting department who did not benefit personally by the transaction out of which the tax arose or from the corporation's failure to pay the tax,” he said.

Excise Tax Priority Apply to Responsible Officers?

Debtors Daniel and Mary Carpenter are officers and owners of Big Sky Fire Protection, Inc., which sold and serviced fire protection equipment. Their corporation didn't pay its state unemployment taxes within three years before they filed their personal Chapter 11 bankruptcy cases. Chapter 11 reorganization is for businesses or individuals whose debts exceed the statutory thresholds for Chapter 13 bankruptcy.

The debtors argued that Section 507(a)(8)(E)'s excise tax priority can't apply to responsible officers such as themselves because the tax debt would be a Section 507(a)(8)(E) priority tax as to the corporate taxpayer but merely a non-priority tax claim as to them as vicariously-liable individuals. This theory, they contended, would allow them “to confirm a Chapter 11 plan without paying the tax debt in full and to escape the incidental consequence of nondischargeable status” under Section 523(a)(1) for any unpaid portion.

The BAP rejected the debtors' argument, concluding that while plausible, it runs counter to too much precedent, including United States v. Sotelo, 436 U.S. 268 (1978), in which the U.S. Supreme Court construed responsible officer liability as qualifying for priority status even though the Bankruptcy Code of 1978 didn't mention responsible officers. The BAP found that the current reasoning of Sotelo carried forward into the current Bankruptcy Code so the decision retains its vitality.

Broadening States' Aggressive Stance

The BAP's ruling, Germain told Bloomberg BNA, “opens the door to states expanding personal liability for corporate taxes to prevent their discharge in bankruptcy. Corporations have always been able to discharge corporate taxes, as the exceptions to discharge apply only to individuals,” he said, noting Section 523(a)(1). “But now governments can impose that tax liability on ‘responsible individuals' to avoid discharge,” Germain said.

“Given the aggressiveness with which many states are pursuing tax collection (including things like revoking drivers' licenses and other state privileges even for citizens who lack the wherewithal to pay their taxes), I would not be surprised to see states taking advantage of this new broad anti-discharge rule to expand vicarious corporate tax liability,” Germain opined.

“Vicariously liable debtors retain the ability to discharge old taxes that would be discharged if they had incurred them directly,” Germain said.

According to Germain, the “debtor in Carpenter could have avoided priority, and presumably could have thereby discharged his liability for the corporate unemployment taxes, by filing bankruptcy more than three years after the corporation's Montana unemployment tax return was due,” he said.

Open-Ended Questions

The BAP failed to address a few specific issues, however, Germain said.

“What if the corporation's tax return was filed late or not filed at all?” Germain queried. “Would the Carpenter court's theory that vicarious taxes should be treated as if they were directly incurred by the responsible person under Section 507(a)(8) carry over to the exceptions for late or non-filed return rules under Section 523(a)(1)?” he asked.

Priority Tax Claim

The unemployment tax contributions owed by Big Sky under the Montana statute weren't paid from October 2011 through June 2013.

The Montana Department of Labor and Industry, Unemployment Insurance Contributions Bureau filed a proof of claim for priority status in the debtors' bankruptcy case for $78,757, plus $125 in penalties.

The bankruptcy court overruled the debtors' objection to the claim and allowed Montana's claim as a priority claim to the extent of $78,632, and as a general unsecured claim to the extent of the $125 penalty.

The debtors appealed to the BAP, which affirmed the order of the bankruptcy court.

Judges Jim D. Pappas and Meredith A. Jury joined the opinion.

Harold V. Dye, Dye & Moe, PLLP, represented the appellants Daniel and Mary Carpenter; Joseph Richard Nevin represented appellee Montana Department of Labor and Industry Unemployment Insurance Contributions Bureau.

To contact the reporter on this story: Diane Davis in Washington at ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com