Sales Taxes Under the Bankruptcy Code: A Fascinating, and Difficult, Issue of Statutory Interpretation

In re Michael Calabrese, Jr., 689 F.3d 312 (3d Cir. 2012).  Most issues of statutory interpretation can be resolved either by the plain language of the statute, by an analysis of legislative history, or by persuasive decisions of other courts on the issue.  Here, however, on the issue of whether retail sales taxes are “excise” taxes under 11 U.S.C. §507(a)(8)(E) of the Bankruptcy Code or “trust fund” taxes under 11 U.S.C. §507(a)(8)(C) of the Code, the Third Circuit found none of those factors particularly helpful.  The distinction was important because trust fund taxes are never dischargeable in bankruptcy.

In an opinion by Judge Hardiman, the panel said that the statutory language “is ambiguous because it contains two clear but contradictory instructions,” in that “[a]lthough neither subsection (C) nor subsection (E) is unclear, both may be read to apply to this kind of tax.”  The legislative history, said Judge Hardiman, was “murky” and “indefinite.”  Finally, though the panel ultimately agreed with decisions of the Second, Seventh and Ninth Circuits that sales taxes were to be treated as “trust fund” taxes, the court did not adopt the reasoning of those other Circuits.

Instead, Judge Hardiman relied on public policy considerations.  “[B]ecause sales taxes collected by a retailer never become the property of the retailer,” but instead are held by the retailer “in trust for the state,” and since “the incentives for a potential debtor like Calabrese would be quite perverse if, when he sees his business take a turn for the worse, he knows that he might obtain a discharge of his debt if he refuses to turn over to the state sales taxes collected from third parties,” public policy weighed in favor of declaring that sales taxes are trust fund taxes.  That result also comported with a New Jersey Tax Court decision that had expressly stated that a sales tax “is what is commonly called a ‘trust fund’ tax” because it is imposed on the customer, not the vendor, and the vendor holds the money in trust for the State.  That Tax Court decision was affirmed by the Appellate Division but did not reach the Supreme Court of New Jersey.  Thus, it was not dispositive at the Third Circuit but was another reason for the panel’s decision.

The underlying issue seems dry, at least if one is not a bankruptcy or tax lawyer.  But Judge Hardiman’s decision makes for interesting reading as he agonizes over the different methods of statutory interpretation, finds them all seemingly wanting, and eventually reaches his result.