In re Amoskeag Bank Shares CV-97-540-SD 09/10/98 UNITED STATES DISTRICT COURT FOR THE
DISTRICT OF NEW HAMPSHIRE
In r e : Amoskeag Bank Shares, Inc. Bankr. No. 91-13065
United States of America, Internal Revenue Service
v. Civil No. 97-540-SD
Amoskeag Bank Shares, Inc.; Thomas Quarles, S r .
O R D E R
The United States of America, Internal Revenue Service (the
government) appeals from the bankruptcy court's decision granting
defendant Thomas Quarles, Sr.'s motion for summary judgment and
denying the government's motion to dismiss or for summary
judgment. Two issues are presented on appeal: (1) whether the
bankruptcy court had subject matter jurisdiction; and (2) whether
the bankruptcy court properly determined that the estate's
proposed distribution to Quarles is wages from which the trustee
must withhold taxes. Background
Quarles retired from Amoskeag Bank (Amoskeag) in 1988. Upon
retirement he was promised lifetime health insurance coverage.
His health insurance coverage was terminated in 1991, however,
when Amoskeag Bank filed a voluntary petition for relief pursuant
to Chapter 7 of the Bankruptcy Code. Quarles filed a claim
against the estate for $56,000 to recover $16,000 spent on
medical services since he retired and to pay the cost of future
medical expenses and health insurance.
After Amoskeag filed for bankruptcy, its trustee, Dennis
Bezanson, initiated an adversary proceeding against the Internal
Revenue Service (IRS) seeking a declaratory judgment regarding
the estate's tax liabilities pursuant to 11 U.S.C. § 505(a).
Quarles intervened in the suit and filed a motion for summary
judgment. He requested the bankruptcy court declare that his
claim was not for wages, and thus not subject to Federal
Insurance Contributions Act (FICA) and Federal Unemployment Tax
Act (FUTA) taxes, and income tax withholding. Although FICA and
FUTA impose taxes on the employer, these taxes in essence would
be paid by Quarles because any money paid to the IRS would
deplete the fund available to satisfy his claim. After finding
that Quarles had standing to pursue this matter and that it had
subject matter jurisdiction, the bankruptcy court held that
2 Quarles' $56,000 claim was not wages within the meaning of the
Internal Revenue Code and that the trustee had no obligation to
pay FICA or FUTA taxes or to withhold income taxes. The
government appeals that decision.
Discussion
1. Standard of Review
A district court's review of a bankruptcy court proceeding
is de novo as to rulings of law, but all factual findings will be
accepted unless clearly erroneous. See Jeffrey v. Desmond, 70
F.3d 183, 185 (1st Cir. 1995) (citing In re SPM Mfg. Corp., 984
F .2d 1305, 1311 (1st Cir. 1993); In re GSF Corp., 938 F.2d 1467,
1474 (1st Cir. 1991)); Bankr. Rule 8013.1
1Bankr. Rule 8013 states:
On an appeal the district court . . . may affirm, modify, or reverse a bankruptcy judge's judgment, order, or decree or remand with instructions for further proceedings. Findings of fact, whether based on oral or documentary evidence, shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the bankruptcy court to judge the credibility of the witnesses. 3 2. Section 505(a)
The IRS argues that the bankruptcy court lacked subject
matter jurisdiction over the proceeding below. The bankruptcy
court decided the matter pursuant to 11 U.S.C. § 505(a), which
allows the bankruptcy court to
determine the amount or legality of any tax, any fine or penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.
On its face, the statute only provides for two exceptions.
The court may not determine "the amount or legality of a tax
. . . if such amount or legality was contested before and
adjudicated by a judicial or administrative tribunal . . . before
the commencement of the [bankruptcy] case." Id. Section 505(a)
also prohibits the court from determining the estate's right to a
refund until the trustee has properly requested a refund and 120
days have elapsed. Although the bankruptcy court's power under
section 505 appears broad, most courts have limited its
application to determinations of the debtor's or estate's tax
liability. See, e.g., Brandt-Airflex Corp. v. Long Island Trust
Co. (In Re Brandt-Airflex), 843 F.2d 90, 96 (2d Cir. 1988);
United States v. Huckabee Auto Co., 783 F.2d 1546, 1549 (11th
Cir. 1986). "[A] literal reading of § 505(a) could lead to
absurd results: '[T]aken at face value, without recourse to the 4 legislative history, § 505 makes the Bankruptcy Court a second
tax court system, empowering the Bankruptcy Court to consider
"any" tax whatsoever, on whomsoever imposed.'" Brandt-Airflex,
supra, 843 F.2d at 96 (quoting In Re Interstate Motor Freight, 62
B.R. 805, 809 (Bankr. W.D. Mich. 1986)).
In this case, the bankruptcy court's application of section
505(a) did not exceed its permissible scope. The court
specifically limited its decision, stating, "This determination
does not resolve any remaining disputes between the Internal
Revenue Service and Thomas Quarles, S r . regarding M r . Quarles'
gross income amount and tax liability thereon." Order of
September 18, 1997, at 7. Thus the bankruptcy court did not
overstep its subject matter jurisdiction under section 505(a).
The IRS nonetheless raises a host of defenses attacking the
court's decision. The government asserts that Quarles did not
have standing to raise the issue, the government has not waived
its sovereign immunity, and the controversy was not ripe. These
common defenses take on a slightly different hue in this case due
to Quarles' status as an intervenor rather than an original
party.2
bankruptcy Rule 7024 permits parties to intervene in adversary proceedings as provided in Fed. R. Civ. P. 24. 5 Article III of the Constitution forbids the federal courts
from deciding a case in the absence of a justiciable "case or
controversy."3 U.S. Con st, art. III. To satisfy the
constitutional requisite, the plaintiff must make three showings.
First, the plaintiff must have suffered an "injury in fact"— an invasion of a legally protected interest which is (a) concrete and particularized and (b) "actual or imminent" . . . . Second, there must be a causal connection between the injury and the conduct complained of--the injury has to be "fairly . . . trace[able] to the challenged action of the defendant, and not . . . the result [of] the independent action of some third party not before the court." Third, it must be "likely," as opposed to merely "speculative," that the injury will be "redressed by a favorable decision."
Lujan v. Defenders of Wildlife, 504 U.S. 555, 560-61 (1992)
(citations omitted). In addition to this constitutional aspect,
standing has a judicially created prudential component. 15 J a m e s
W m . M o o r e , M o o r e 's F e d e r a l P r a c t i c e 5 101.50 (3d ed. 1998) . "The
'prudential principles' of standing require that a plaintiff
establish that he or she is the proper proponent of the asserted
right, that the right asserted belongs to the claimant rather
3A1though the bankruptcy court is not an Article III court, its jurisdiction is similarly limited by the constitutional standing requirements. See In re Kilen, 129 B.R. 538, 542 (Bankr. N.D. 111. 1991). This conclusion follows from the fact that the district court has original jurisdiction in cases arising under Title 11, but may refer these cases to the bankruptcy court. See U.S.C. §§ 157, 1334. The district court cannot delegate a case to the bankruptcy court which the district court itself cannot hear. See Kilen, supra, 129 B.R. at 542. 6 than a third party, and that the grievances asserted are not
conjectural or generalized." Id. § 24.03[2][d].
In this case, there was already a justiciable controversy
before the bankruptcy court; the case was initiated by the
trustee, who unquestionably had standing to seek a tax
determination. Thus the question is not whether there was a
justiciable controversy, but whether Quarles was a proper party
to the action. Federal courts are not in agreement regarding
whether applicants to intervene must independently satisfy
standing requirements. See id. Courts that have required
intervenors to satisfy constitutional standing requirements, in
addition to Rule 24's requirements for intervention, reason that
"Congress could no more use Rule 24 to abrogate the Article III
standing requirements than it could expand the Supreme Court's
original jurisdiction by statute." Mausolf v. Babbitt, 85 F.3d
1295, 1300 (8th Cir. 1996). On the other hand, courts that do
not impose constitutional standing requirements on a would-be
intervenor reason that because the original parties have already
established a case or controversy, "there [is] no need to impose
the standing requirement upon the proposed intervenor." United
States Postal Service v. Brennan, 579 F.2d 188, 190 (2d Cir.
1978) .
7 The United States Supreme Court has not clarified the issue.
In Diamond v. Charles, the Court required an intervenor to meet
the constitutional standing requirements to continue a suit in
the absence of the original party on whose side he intervened.
476 U.S. 54, 64 (1986). The Court, however, explicitly declined
to decide whether a party must fulfill the constitutional
standing requirements to intervene. See id. at 68-69. In an
earlier case, the Court had held that a union member could
intervene in a suit, although he could not have initiated the
suit because the statute under which the suit was brought
provided that the Secretary of Labor was the only person who
could initiate suit. See Trbovich v. United Mine Workers, 404
U.S. 528, 537 (1972). Thus the Court held that statutory
standing is not a prerequisite to intervention.
In this case, the court need not decide whether Article III
standing is a prerequisite to intervention because constitutional
standing would not bar Quarles' participation in this suit.
Quarles faces an imminent injury because if the trustee withholds
FICA, FUTA, and income taxes from Quarles' claim, Quarles will
receive significantly less than the $56,000 he requested. The
injury is directly traceable to the conduct of the IRS, whose
assertions that Quarles' claim is wages and that the trustee must
withhold taxes are the cause of Quarles' injury. His injury is
8 likely to be "redressed by a favorable decision," Lujan, supra,
504 U.S. at 560, because if the court finds that his claim is not
wages from which taxes must be withheld, Quarles will receive the
exact sum he requested. Thus Quarles satisfies the
constitutional standing requirements.
Although Quarles meets the irreducible minimal
constitutional standing requirements, the government argues,
based on Middlesex Sav. Bank v. Johnson, 777 F. Supp. 1024, 1029-
30 (D. Mass. 1991), that a third party does not have standing to
contest another's tax liability. Although some courts have
applied the prudential standing requirements, such as the rule
disfavoring third-party standing, to intervenors, this court sees
no reason for doing so. See New Orleans Pub. Serv., Inc. v.
United Gas Pipe Line Co., 732 F.2d 452, 464-70 (5th Cir.), cert,
denied sub nom., Morial v. United Gas Pipe Line Co., 469 U.S.
1019 (1984). The prudential component of standing consists of
"judge-made limitations on standing, designed to foster
considerations of litigation effectiveness and judicial
restraint." Moore, supra, § 101.50. In a case such as this, in
which the court must decide the same issue regardless of whether
or not the intervenor participates, the prudential limits on
standing are less relevant. Because Quarles has not asserted any
additional claims, his participation in this case did not delay
9 disposition of the litigation nor offend the principle of
judicial restraint.
The IRS next argues that the bankruptcy court's exercise of
jurisdiction violated the principle of sovereign immunity because
the IRS has not consented to suit. Section 106 of the bankruptcy
code, however, explicitly waives sovereign immunity with respect
to section 505, the section under which the bankruptcy court
decided the case. See 11 U.S.C. §§ 105, 106. Thus sovereign
immunity is only a potential concern if section 505 is construed
as waiving sovereign immunity to actions by the trustee, but
prohibiting participation by an intervenor. The court finds no
reason to construe the law so strictly. Although waivers of
sovereign immunity are narrowly construed, the government has
explicitly waived sovereign immunity vis-a-vis section 505. See
Id. § 106. Quarles' presence in this case does not change the
nature of the proceeding sufficiently to raise sovereign immunity
concerns. Undoubtedly, if the intervenor had sought to add new
claims to the case, the court would need to find independent
waivers of sovereign immunity for the additional claims. In this
case, however, Quarles' participation did not expose the
government to unanticipated claims.
The government asserts that this matter was not ripe for
review because FICA taxes "are not incurred until the date that
10 the wages are paid," and FUTA taxes are due at the end of the
calendar year. Brief of the Appellant United States of America
at 20-21. Ripeness, like standing, is a blend of constitutional
and prudential requirements rooted in Article Ill's case or
controversy requirement. The ripeness requirement prevents
courts from issuing advisory opinions or deciding cases based
upon hypothetical facts. See M o o r e , supra, § 101.75. "The
difference between an abstract question and a controversy . . .
is necessarily one of degree, and it would be difficult, if it
would be possible, to fashion a precise test for determining in
every case whether there is such a controversy." Maryland Cas.
Co. v. Pacific Coal Oil Co., 312 U.S. 270, 273 (1941). The most
important factors the court must balance are "the fitness of the
issues for judicial decision and the hardship to the parties of
withholding court consideration." Abbot Laboratories v. Gardner,
387 U.S. 136, 149 (1967). The critical question in determining
whether an issue is fit for judicial decision is whether the
claim "'involves events that may not occur as anticipated, or
indeed may not occur at all.'" Lincoln House, Inc. v. Dupre, 903
F.2d 845, 847 (1st Cir. 1990) (quoting 13A W r i g h t & M i l l e r , Federal
Practice and Procedure § 3532.2, at 141 (1984)) .
This case clearly does not involve hypothetical facts or
contingencies that may never occur. The trustee will pay
11 Quarles' claim. And when he does so, if the IRS is correct, it
will be a taxable event. Waiting until the money has been paid
will not make the issue more amenable to judicial decision. Thus
the case is fit for judicial resolution.
Furthermore, waiting until after the tax has accrued would
impose a hardship on the parties. Indeed, section 505 was
intended to allow the trustee to settle the estate quickly
without "fac[ing] potential post-bankruptcy tax liabilities. . .
." S. Rep. No. 95-989, at 68 (1978), reprinted in 1978
U.S.C.C.A.N. 5787, 5854. Following the procedure suggested by
the government --distributing the money, withholding taxes and
then keeping the estate open while seeking a refund--would hinder
expeditious administration of the estate. Quarles also would be
injured because any tax paid out of the estate would diminish the
amount available to pay his claim.
The government's further assertion that section 505(a) does
not permit the bankruptcy court to determine tax liability before
the tax is due is not persuasive. The government calls the
court's attention to the Anti-Injunction Act, which prohibits
suits to restrain the assessment or collection of any tax. See
Brief of the Appellant United States of America at 21-22 (citing
26 U.S.C. § 7421(a)). Although it is true as a general
proposition that the statutory scheme seeks to facilitate the
12 expeditious collection of taxes by avoiding pre-enforcement
judicial interference, section 505(a) is an explicit exception to
the general rule. In contrast to the normal rule that taxpayers
must pay first and litigate later, section 505(a) expressly
allows the bankruptcy court to determine a tax "whether or not
previously assessed, [and] whether or not paid . . . The
Declaratory Judgment Act displays Congress's intent to make the
bankruptcy context an exception to the rule. See 28 U.S.C. §
2201. Although the Declaratory Judgment Act prohibits federal
courts from issuing declaratory judgments with respect to federal
taxes, section 505 is explicitly exempted from this prohibition.
3. Wages
Thus the court reaches the substantive issue presented by
this case--"whether lifetime medical insurance benefits are
'wages' within the meaning of the Internal Revenue Code."
Bankruptcy Court Order on Cross Motions for Summary Judgment at
4. The Internal Revenue Code requires employers to withhold
income taxes from their employees' wages. For this purpose,
wages are defined by section 3401(a) of the Internal Revenue Code
as "all remuneration . . . for services performed by an employee
for his employer" except for specific exclusions. 26 U.S.C. §
3401(a). Quarles does not argue that his claim is not
13 remuneration for services, but argues that it is excluded by an
exception for health benefit plans. Section 106(a) of the
Internal Revenue Code excludes employer-provided coverage under a
health plan from gross income. Even assuming payments excluded
from gross income under section 106(a) are not wages within the
meaning of section 3401(a),4 the proposed payment is not exempt
from income tax withholding. " [E]xemptions from taxation are not
to be implied; they must be unambiguously stated." United States
V. Wells Fargo Bank, 485 U.S. 351, 354 (1988). The plain
language of section 106 limits the exemption to employer
contributions to a plan. "There is nothing in the language of
the statute that provides an exemption for payments made by an
employer directly to employees." Adkins v. United States, 882
F.2d 1078, 1080 (6th Cir. 1989); see also Rev. Rul. 85-44, 1985-1
C.B. 22. Thus Quarles' claim is not exempt from income tax
withholding.
FICA and FUTA, like income tax withholding, are based upon
wages. Both FICA and FUTA require employers to pay taxes based
on wages paid to employees. The definition of "wages" excludes
payments "made to, or on behalf of an employee . . . under a plan
or system established by an employer which makes provisions for
4Section 3401(a)(21) makes an explicit exemption for amounts excludable under section 106(b), which pertains to qualified medical savings accounts. 14 his employees . . . on account of . . . medical or
hospitalization expenses. . . ." 26 U.S.C. § 3121(a)(2). The
relationship between wages for income tax withholding purposes
and wages for FICA and FUTA is far from pellucid. In a 1965
Revenue Ruling the IRS held that amounts paid by an employer
pursuant to a salary reduction plan were wages under FICA, but
exempt from income tax. See Rev. Rul. 65-208, 1965-2 C.B. 383.
The United States Supreme Court, however, disapproved this
ruling, holding that the term "wages" should be interpreted
similarly for purposes of FICA, FUTA, and income-tax withholding.
See Rowan Co. v. United States, 452 U.S. 247, 263 (1981).
Congress in turn responded by enacting provisions that
"decoupled" the interpretation of "wages" under FICA and FUTA
from the interpretation of wages for income-tax withholding
purposes. The added language provides that " [n]othing in the
regulations prescribed for purposes of chapter 24 (relating to
income-tax withholding) which provides an exclusion from 'wages'
as used in such chapter shall be construed to require a similar
exclusion from 'wages' in the regulations prescribed for purposes
of this chapter." 26 U.S.C. §§ 3121(a), 3306(b). It is not
clear, however, whether the law "permits the IRS to treat a
payment as excluded from 'wages' for FICA taxes and not as
excluded from 'wages' for income-tax withholding purposes."
15 Express Oil Change, Inc. v. United States, No. CV-95-B-1612-S,
1996 WL 679423, *7 (N.D. Ala. Sept. 30, 1996). Regardless of
whether wage exclusions in some cases may be interpreted more
liberally for FICA and FUTA purposes than for income-tax
withholding, the court finds that it is not appropriate to do so
in this case.
The plain language of FICA and FUTA limits the exclusion to
payments made under a plan or system. Although instituting a
plan may not have been an option in this case, the courts cannot
modify a statutory provision simply to avoid an "unfair result."
Brief of the Appellant Thomas Quarles at 15. The court finds no
reason to distinguish previous cases and revenue rulings that
have found payments made directly to an employee in lieu of
health benefits are not exempt from income tax. See Adkins,
supra, 882 F.2d at 1080; McKean v. United States, 33 Fed. Cl.
535, 539 (1995); Rev. Rul. 85-44, 1985-1 C.B. 22. Furthermore,
to the extent that different concerns underlie these systems,
these concerns support treating the amount in question as wages.
Congress provided an exclusion from employment taxes of amounts
paid into plans to counteract employer reluctance to establish
such plans. "'The reason for the exclusion was to save employers
time and money but what is more important is that it will
eliminate any reluctance on the part of the employer to establish
16 such plans due to additional tax cost.'" New England Baptist
Hosp. v. United States, 807 F.2d 280, 283 (1st Cir. 1986)
(quoting H.R. Rep. No. 76-728, reprinted in 1939-2 C.B. 538,
543). The so called "decoupling" amendment of 1983 was enacted
by a "Congress . . . looking to solidify the social security
system in the face of serious concerns about its solvency,
concerns that would motivate it to preclude possible claims for
refunds." Id. In this case, taxing the amount in question is
consistent with both the 1983 amendment and the intent of the
original exception.
4. Conclusion
For the abovementioned reasons, the bankruptcy court's
decision granting summary judgment to Thomas Quarles is reversed.
The case shall be remanded to the bankruptcy court for further
proceedings consistent with this opinion.
SO ORDERED.
Shane Devine, Senior Judge United States District Court
September 10, 1998
cc: Dennis G. Bezanson, Esq. Henry J. Riordan, Esq. Thomas B.S. Quarles, Jr., Esq. George Vannah, Clerk 17