On Appeal from the United States District Court for the District of New Jersey (Newark) (D.C. Civil No. 86-1846).
Sloviter, Becker and Garth, Circuit Judges.
The question presented by this appeal is whether a corporate debtor under reorganization pursuant to Chapter 11 of the Bankruptcy Code can specify in its plan of reorganization that federal tax payments shall be applied first to satisfy the corporation's trust found liabilities, thereby protecting the corporation's principals from potential personal liability in the event that the reorganization is unsuccessful. Because we conclude that payments on pre-petition federal tax liabilities by a debtor pursuant to a plan of reorganization under Chapter 11 are involuntary under the federal tax law, we hold that the debtor cannot direct the allocation of such payments between the trust fund and non-trust fund portions of the debtor's tax liabilities and that the bankruptcy court erred as a matter of law in approving the plan with such a designation.
On July 29, 1985 the debtor, Ribs-R-Us, Inc., filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of New Jersey. The United States subsequently filed a proof of claim for back taxes, including trust fund taxes, consisting of withholding and Social Security taxes deducted from the debtor's employees for which the debtor's principals, as responsible persons, are personally liable under 26 U.S.C. § 6672. Ribs-R-Us, which prior to the filing of its bankruptcy petition operated a restaurant in Verona, New Jersey, has remained at all times a debtor in possession pursuant to 11 U.S.C. § 1107, no trustee having been appointed.
Ribs-R-Us filed a Plan of Reorganization on October 23, 1985. Under the plan, repayment of priority claims would be funded by the proceeds from the sublease of a Ribs-R-Us restaurant and the sale of its liquor license. General unsecured creditors were to recover 25 cents on the dollar from funds contributed by two principals of Ribs-R-Us, Mitchell Mekles and Mitchell Levy, who in turn would receive all the stock in the reorganized Ribs-R-Us.
The plan provided that priority tax claims under 11 U.S.C. § 507(a)(7), including the United States' tax claims, were to be paid in full with interest*fn1 in equal monthly installments over the six-year maximum period permitted by the Bankruptcy Code. The plain further provided that "all payments to any member of this class shall first be applied, or shall be deemed applied, to reduce the 'trust fund' portion of the creditor's claim, if any." App. at 71.
The United States filed an Objection to Confirmation of Debtor's Plan of Reorganization contending, inter alia, that the payments of priority tax claims made pursuant to the bankruptcy proceedings were involuntary payments, and therefore could be applied as the Internal Revenue Service saw fit without designation by the debtor. The bankruptcy court denied the United States' objection on the ground that the debtor's payments of priority tax claims under the plan were voluntary and therefore Ribs-R-Us was entitled to direct that payments to the IRS be applied first to reduce the trust fund portion of Ribs-R-Us' federal tax liability. The bankruptcy court thus confirmed the plan, including the provision directing the application of payments, authorized Ribs-R-Us to designate payments to be applied first to the trust fund portion of its liability, and ordered the United States to apply the payments as designated by Ribs-R-Us. The United States appealed to the district court, which affirmed. This appeal followed.
LIABILITY OF RESPONSIBLE PERSONS FOR TRUST FUND TAXES
The applicable provision of the Internal Revenue Code provides that taxes such as withholding and Social Security taxes required to be deducted by employers from the wages paid to employees under 26 U.S.C. §§ 3102(a), 3402(a) "shall be held to be a special fund in trust for the United States." 26 U.S.C. § 7501(a). The withheld sums are commonly referred to as "trust fund taxes." See Slodov v. United States, 436 U.S. 238, 243, 56 L. Ed. 2d 251, 98 S. Ct. 1778 (1978). Where withholding and Social Security taxes are ...