Wasden v. Florida Department of Revenue (In Re Wellington Foods, Inc.)

Citations: 165 B.R. 719; 1994 Bankr. LEXIS 363; 73 A.F.T.R.2d (RIA) 1664Docket: 19-40167

Court: United States Bankruptcy Court, S.D. Georgia; March 22, 1994; Us Bankruptcy; United States Bankruptcy Court

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Wiley A. Wasden, III, as Trustee for Wellington Foods, Inc., filed a motion against the Florida Department of Revenue, the Georgia Department of Revenue, and the Internal Revenue Service (IRS) in a bankruptcy case initiated on April 10, 1991. The plaintiff seeks to recover a payment of $20,150 made to the IRS for employee withholding taxes within 90 days of the bankruptcy filing, arguing it was an avoidable preference under 11 U.S.C. § 547(b). 

The IRS contends that the payment cannot be deemed a preferential transfer because the funds were not property of the bankruptcy estate, citing the Supreme Court case Begier v. Internal Revenue Service, which establishes that trust-fund taxes do not belong to the debtor. Conversely, the Trustee argues that the payment lost its trust status since the debtor's bank account balance fell below the tax obligation amount at the time of payment, referencing a precedent in In re Wendy's Food Systems, Inc. 

The United States filed a Motion for Summary Judgment, to which the Trustee responded with a Cross-Motion for Summary Judgment. The court is tasked with determining the applicability of Begier and whether the payment qualifies as an avoidable preference, guided by the legal standard for summary judgment as outlined in Bankruptcy Rule 7056 and Federal Rule of Civil Procedure 56.

The moving party must initially demonstrate the absence of genuine issues of material fact, supported by relevant pleadings, depositions, and affidavits (Bald Mountain Park, Ltd. v. Oliver, 863 F.2d 1560; Celotex Corp. v. Catrett, 477 U.S. 317). Once the moving party meets this burden, the burden shifts to the non-moving party to provide evidence of a genuine issue of material fact (United States v. Four Parcels of Real Property, 941 F.2d 1428). The court must view evidence favorably toward the non-moving party (Rollins v. Tech-South, Inc., 833 F.2d 1525).

The issue at hand is whether a $20,150.00 payment made by the Debtor to the IRS is avoidable as a preferential transfer under 11 U.S.C. § 547(b). It is undisputed that the Debtor collected this amount as trust-fund taxes and paid it from general operating accounts within 90 days of bankruptcy filing, during which time the Debtor had minimal funds. The Supreme Court's ruling in Begier v. Internal Revenue Service, 496 U.S. 53, established that payments of trust-fund taxes do not constitute an interest of the debtor in property subject to avoidance under § 547(b), as the debtor lacks equitable ownership of the funds held in trust (Begier, 496 U.S. at 67).

Although the Trustee acknowledges the Begier ruling, they argue that this case fits an exception identified in In re Wendy's Food Systems, Inc., 133 B.R. 917, where the court determined that if a debtor remits trust-fund taxes from accounts with negative balances, the payment can be deemed from after-acquired property, making it avoidable as a preferential transfer under § 547(b). Section 547(b) allows a trustee to avoid transfers that unfairly favor one creditor over others, provided the transfer was made while the debtor was insolvent and within 90 days of the bankruptcy filing, and the creditor received more than they would in a Chapter 7 liquidation. However, when trust property is involved, the debtor's lack of interest in that property typically exempts it from this avoidance policy (Begier, 496 U.S. at 58).

When property is transferred to a trust beneficiary under preferential circumstances, the transfer is not avoidable as a preferential transfer under section 547(b) of the Bankruptcy Code. The central issue in this case is whether the $20,150.00 transferred to the IRS is characterized as 'trust funds' or as property of the Debtor's estate. The United States acknowledges that if this amount is estate property, the transfer is avoidable, while the Trustee agrees that if the Debtor held these funds in trust for the IRS, it is not avoidable.

The Supreme Court's decision in Begier, involving American International Airways, Inc. (AIA), is pivotal. AIA was mandated to collect and remit excise and income taxes, which were held in trust for the United States under 26 U.S.C. § 7501. After AIA fell behind on payments and subsequently filed for bankruptcy, the Chapter 7 trustee sought to recover funds remitted to the IRS as preferential transfers. The IRS contended these funds were from a trust and not part of the estate.

The Supreme Court interpreted § 7501 as establishing a statutory trust limited to the amount of taxes collected. It determined that a trust arises at the time of payment, regardless of whether the taxes were segregated in a separate account. However, the Court emphasized that to avoid characterization as property of the debtor, the specific funds remitted to the IRS must have been held in trust for the IRS. The Court clarified that common-law trust principles do not apply to the statutory trust under § 7501, which is based on an abstract dollar amount rather than specific identifiable property.

Common-law trust tracing rules are inadequate for addressing issues related to trust res in bankruptcy contexts, as noted in Begier. The Supreme Court determined that Congress intended to override its previous ruling in United States v. Randall, which prohibited the IRS from recovering section 7501 taxes before administrative expenses during bankruptcy. Despite this change, the IRS must still demonstrate a connection between the § 7501 trust and the assets targeted for trust-fund tax obligations. The Court found no clear guidance in the Bankruptcy Code regarding the extent of this required nexus, so it referenced legislative history, specifically a House Report indicating that a payment of withholding taxes qualifies as money held in trust under § 7501(a). This report suggests that such payments would not be considered preferences, provided the taxes were properly held for payment. The Court concluded that a debtor's voluntary payment of trust-fund taxes establishes the necessary nexus, as the ability to make payments satisfies the requirement that funds be properly held. Thus, the act of voluntarily paying these taxes creates a 'floating trust' under § 7501, linking the trust to the remitted funds, regardless of their source. However, in In re Wendy's Food Systems, Inc., the bankruptcy court did not interpret Begier in this way. Wendy's, which owed significant sales taxes and had negative bank balances before filing for Chapter 11, voluntarily paid over $200,000 in past due sales taxes to the State of Ohio, with minimal dispute over the collection and remittance of these taxes.

The Court determined that the Supreme Court's decision in Begier applies to state trust-fund taxes under Ohio law, requiring a taxing authority to establish three elements to prove that funds transferred from a debtor's non-segregated accounts were not the debtor's property for a preferential transfer under 11 U.S.C. § 547(b). These elements are: (1) the debtor must have collected or withheld taxes, creating a trust for those amounts; (2) the debtor must have made a voluntary payment to the taxing authority from unencumbered assets; and (3) a reasonable nexus must exist between the first two elements. The court clarified that this reasonable nexus is presumed if the taxing authority shows a voluntary payment was made; however, this presumption can be rebutted by evidence indicating no nexus exists.

In applying this test, the court found that the State failed to establish a reasonable nexus, noting that the funds were commingled and that the relevant bank accounts had a negative balance when payments were made. This undermined the presumption of reasonableness established in Begier. The court concluded that the sales taxes were property of the estate, except for any funds present in the accounts on May 19, 1987.

The analysis suggested a form of the common-law tracing doctrine, specifically the 'lowest intermediate balance' rule, but the author disagreed with the court's reasoning. They argued that Begier does not require the taxing authority to demonstrate a voluntary payment or a reasonable nexus, as the act of making a voluntary payment alone establishes the necessary connection between the trust creation and the payment. The author emphasized that Begier's interpretation allows for a conclusive presumption upon voluntary payment, regardless of the source of the funds or any intervening balances. This conclusion is supported by two precedential decisions applying the 'lowest intermediate balance' rule to trust-fund taxes.

In the cases of *In re R. T Roofing Structures* and *In re Copeland Enterprises*, the debtors did not make voluntary payments to tax authorities. In *R. T Roofing*, the IRS seized $18,850.18 from the debtor's accounts within 90 days before bankruptcy. The Ninth Circuit ruled that the seized funds were not trust-fund taxes but property of the bankruptcy estate, making the seizure avoidable under section 547(b) because the government failed to meet the 'lowest intermediate balance' rule. The Supreme Court in *Begier* referenced this case but did not overturn it, indicating it was related to but distinct from *Begier*'s main issue.

In *Copeland*, the debtor owed over $1.8 million in sales taxes collected pre-petition but had not remitted them. The State claimed these taxes were trust-fund taxes and not part of the estate. The bankruptcy court classified the taxes as trust-fund taxes under Texas law and referenced *Begier*. It required the State to prove that the debtor had sufficient funds to cover its trust-fund claims during the period between tax collection and bankruptcy. The court established that the debtor’s cash balances did not fall below the amount owed to the State, concluding that the $1.8 million was held in trust for the State rather than as part of the estate.

A critical distinction from *Begier* is that the debtors in *R. T Roofing* and *Copeland* did not make voluntary pre-petition payments of their trust-fund taxes. This lack of voluntary remittance means that a taxing authority must demonstrate a nexus using traditional tracing rules, such as the 'lowest intervening balance' rule, to establish trust-fund claims.

A voluntary pre-petition payment of $20,150.00 made by the Debtor to the IRS, designated as 'trust-fund taxes,' is deemed to originate from a trust established under 26 U.S.C. § 7501. Consequently, these funds are held in trust for the IRS, making them immune to being classified as a preferential transfer under 11 U.S.C. § 547(b). The Trustee's motion for summary judgment is denied, while the United States' motion is granted, resulting in a judgment that these funds cannot be recovered by the Trustee as a voidable preference. Both parties acknowledged the payment and did not contest the material facts relevant to the summary judgment motions. The court affirms that the changes in language within 11 U.S.C. § 547(b) further support the conclusion that trust-held funds are not subject to avoidance.

Justice Scalia, in his concurring opinion in Begier, critiques the majority's interpretation of the section 7501 trust, suggesting it overextends the application of the trust beyond what was necessary for the case at hand. The 'lowest intermediate balance' rule, a federal common-law trust-fund tracing principle, applies in bankruptcy when funds subject to a trust are commingled with other funds. This rule permits a claimant to trace these mingled funds but requires proof that the lowest balance in the account remained above the amount of the claimed trust between the deposit and bankruptcy. Notably, the Supreme Court refrained from overruling the District of Columbia Circuit's decision in Drabkin, which asserted that it is unreasonable to assume that funds used for trust-fund tax payments inherently possess trust characteristics. Although the cases are closely related, Drabkin involved payments from an account where no trust-fund taxes had been deposited, creating a potential distinction. The Supreme Court's failure to explicitly reject Drabkin is seen as puzzling, especially since the Third Circuit, which the Supreme Court affirmed in Begier, aligned with a dissenting view from Drabkin rather than its majority opinion.