Last month the United States Court of Appeals, Third Circuit considered for the first time whether retail sales taxes are “excise” taxes or “trust fund” taxes under the Bankruptcy Code. The distinction is significant because trust fund taxes are never dischargeable in bankruptcy. The decision by the Third Circuit reflected the decisions of the two previous Appeals Courts that in terms of a taxation purposes, a retail sales tax should be viewed as a Trust Fund that a retailer is holding for that state. Do you agree with the decision or do you disagree?
Appellant Michael Calabrese operated “Don’s What a Bagel, Inc.,” which filed for reorganization under Chapter 11 of the Bankruptcy Code. As proprietor of a restaurant, Calabrese was required by New Jersey law to collect sales tax from his customers. After failing to confirm a reorganization plan, the bankruptcy was converted to Chapter 7. Calabrese also filed a bankruptcy petition under Chapter 13.
The State of New Jersey Department of Taxation (New Jersey) filed several secured proofs of claim in Calabrese’s individual bankruptcy. Calabrese moved to expunge the claims. After briefing and a hearing, the Bankruptcy Court held the taxes at issue are trust fund taxes under 11 U.S.C. § 507(a)(8)(C) rather than excise taxes under § 507(a)(8)(E). Calabrese appealed that decision to the District Court, which affirmed.
The Court of Appeals had to decide whether the sales taxes held by Calabrese are “trust fund” or “excise” taxes under 11 U.S.C. § 507(a)(8). Excise taxes receive priority, and are non-dischargeable, if they are less than three years old, as measured from the date of the bankruptcy petition. Trust fund taxes are always prioritized and are never dischargeable irrespective of the age of the debt.
The Courts of Appeals for the 2nd, 7th and 9th Circuits have considered the question presented here. In each case, the court determined that the statutory text of § 507(a)(8) does not resolve the dispute. Proceeding to analyze the legislative history, all three Courts concluded that a sales tax paid by a third party is a trust fund tax within the meaning of subsection (C), and not an excise tax under subsection (E).
In sum, the Court believed that public policy concerns weighed against Calabrese, primarily because sales taxes collected by a retailer never become the property of the retailer; ab initio, the retailer retains those funds in trust for the state. Accordingly, it held that Calabrese’s sales-tax obligation is subject to § 507(a)(8)(C) and is not dischargeable, and affirmed the order of the District Court.
It is an intriguing decision because it implies that a retailer is basically holding any retail sales tax in trust for the state because the state already owns and is due the funds.
Please weigh in and let us know if you agree with this decision or if you disagree…