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United States Bankruptcy Court
Western District of Wisconsin

Cite as: 153 B.R. 835

In re Bruce G. Felland, Debtor
Bankruptcy Case No. MM7-85-00519

United States Bankruptcy Court
W.D. Wisconsin

April 15, 1993

David A. Lange, Madison, Wis., for the Wisconsin Dept. of Revenue.
Michael E. Kepler, Kepler & Peyton, Madison, Wis., trustee.

Robert D. Martin, United States Bankruptcy Judge.


The issue in this case is whether corporate sales taxes and responsible person withholding taxes are entitled to administrative expense status in an individual debtor's bankruptcy case. The parties have stipulated to the relevant facts and have submitted briefs in support of their positions. As there are no material facts in dispute, the matter is ripe for summary judgment. See FRBP 7056.

The debtor, Bruce G. Felland ("Felland") filed a petition under Chapter 11 of the Bankruptcy Code on April 29, 1985, which case was converted to Chapter 7 on May 26, 1989. During the Chapter 11 case, Felland continued to operate two corporations, Northgate Lanes Corporation ("Northgate") and Global Investors, Inc. ("Global"). In both corporations, Felland was responsible for collecting withholding taxes from the employees. Felland was also the party responsible for paying Northgate's corporate sales tax. The sales tax permit was in Northgate's name and not in Felland's individual name.

The Wisconsin Department of Revenue ("Department") filed a proof of claim against Felland's estate on August 14, 1989 in the amount of $6,614.82.(1) The Chapter 7 trustee and the Department agree that $83.55, representing postpetition income taxes for 1985 and 1986, is an administrative expense pursuant to  503(b)(1)(B) and  507(a)(1) and $32.31, representing prepetition income tax for 1984, is a priority claim pursuant to  507(a)(7). The parties further agree that $437.75, representing the penalty portion of the claim, is allowable pursuant to  726(a)(4).

The parties dispute, however, the classification of the remaining $3,857.78, consisting of a sales tax component and a withholding component. The sales tax component of $1,631.05 and interest of $645.04 arose when postpetition, Felland willfully failed to pay Northgate's corporate sales tax to the Department. The withholding component of the claim totaling $1,581.69(2) arose from postpetition withholding liability for employees of Northgate and Global.

The Department claims that the $3,857.78 is entitled to administrative expense status pursuant to  503(b)(1)(B) and  507(a)(1). Conversely, the Chapter 7 trustee argues that the claim is only entitled to priority status pursuant to  507(a)(7). Section 503(b)(1)(B) provides in relevant part:

(b) After notice and a hearing, there shall be allowed administrative expenses . . . including--

(1)(B) any tax--

(i) incurred by the estate, except a tax of a kind specified in section 507(a)(7) of this title;

11 USC  503(b)(1)(B). Section 507 provides in relevant part:

(a) The following expenses and claims have priority in the following order:

(1) First, administrative expenses allowed under section 503(b) of this title, and any fees and charges assessed against the estate under chapter 123 of title 28.

. . .

(7) Seventh, allowed unsecured claims of governmental units, only to the extent that such claims are for--

(C) a tax required to be collected or withheld and for which the debtor is liable in whatever capacity;

11 USC  507(a).

Although not clearly stated in the stipulated facts, the parties do not dispute that Felland is personally liable for Northgate's sales and the corporations' withholding taxes. Pursuant to  77.60(9),(3) an individual responsible for paying corporate sales tax who willfully fails to pay is liable "if that corporation is unable to pay such amounts to the department." In their stipulated facts, the parties do not state whether Northgate is unable to pay the tax or whether the Department has personally assessed Felland for the tax. However, in its brief, the Department states that Felland was personally assessed for Northgate's tax debt. Department's Brief at 3. Moreover, although the trustee disputes whether Felland is primarily or derivatively liable, he does not dispute that Felland is liable. See Trustee's Reply Brief at 1 (stating, "Felland's liability arose only upon default of another entity which had the primary responsibility for the payment of the taxes"). Pursuant to  71.83(1)(b),(4) Felland's failure to pay the corporations' withholding taxes renders him liable for an amount equal to the amount not paid to the Department. Again, although the parties dispute whether Felland is primarily or derivatively liable for his failure to withhold and pay these taxes to the Department, the parties agree that Felland is liable in some capacity.

To be entitled to administrative expense priority, the taxes must fall within the language of  503(b)(1)(B) which requires that the tax be "incurred by the estate." Although this language is typically invoked to distinguish prepetition claims from postpetition claims, it may also be interpreted to distinguish taxes incurred by the individual debtor from taxes incurred by the debtor in possession through his administration of the bankruptcy estate. For example, in discussing the relationship of  502(i) with  503(b)(1)(B), one commentator states that ". . . a tax arising after a petition is entitled to the 11 USC 507(a)(7) priority only insofar as it is based on prepetition or postpetition activities by a debtor. Insofar as such tax is entirely based on postpetition activities by a debtor in possession or trustee and arises after the petition, it is an administrative claim." 1 Ginsberg & Martin, Bankruptcy: Text, Statutes, Rules,  10.08[p] at 10-70 n 308 (Prentice Hall, 3d Ed 1992). In discussing  503(b)(1) in general, and not subsection (B) in particular, the commentator states that: "[t]he requirement that the claim be against the estate means that postpetition claims against the trustee arising from activities in administering the estate qualify, while the claims arising against the debtor personally after a petition is filed do not qualify unless the debtor is administering the estate as a debtor in possession." Id.  10.11[f] at 10-103. The legislative history for  503(b)(1)(B) further supports the interpretation that the tax must be incurred in the operation of the debtor's estate:

In general, administrative expenses include taxes which the trustee incurs in administering the debtor's estate, including taxes on capital gains from sales of property by the trustee and taxes on income earned by the estate during the case.

S Rep No 95-989 to accompany S 2266, 95th Cong, 2d Sess 66 (1978) (emphasis added).

Apart from stating Felland's responsibility vis--vis the corporate sales and withholding taxes, the parties do not volunteer Felland's relationship or interest in Northgate and Global. Felland's interest--whatever it may be--in the corporations is assumably part of his bankruptcy estate pursuant to  541. Nonetheless, the corporations are separate legal entities and as such, are not a part of the estate. Any sales or withholding tax incurred in the operation of the corporations does not become a tax incurred in the administration of Felland's bankruptcy estate by virtue of Felland's personal liability for the taxes. Although the bankruptcy estate may have received some benefit from Felland's relationship to the corporations, the link between that benefit and the administration of Felland's estate is too tenuous to impose an administrative expense on the estate for the sales and withholding taxes.

The case of In re Alton, 81 BR 97 (Bankr MD Fla 1987) supports the proposition that Felland's bankruptcy estate did not incur the corporate sales and withholding taxes. In Alton, the court addressed whether a tax liability incurred postpetition by a partnership under Chapter 11 may be charged as an administrative expense pursuant to  503(b)(1)(A) against the estate of the general partner who was also a Chapter 11 debtor. After dismissal of the partnership's case, the state asserted a claim against the partner in his individual case for the unpaid unemployment tax incurred by the partnership. Id. at 98. Finding a paucity of legal authority, the court analyzed "the legal character of the players and the nature of the liability represented by the unpaid employment taxes." Id. at 99. The court noted that a partnership is a separate legal entity and that a general partner's liability for partnership debts is secondary. Id. If the debtor's estate included his partnership interest, arguably the tax obligation was incurred in conjunction and preservation of property of the estate, and thus could be charged as an administrative expense. Id. The court found that under this line of reasoning, administrative expense priority could be allowed in an individual case for all debts incurred by a partnership under Chapter 11. Unwilling to reach such a result, the court concluded:

This result would inevitably lead to total frustration of the individual partner's ability to achieve reorganization. Moreover, as administrative expenses and priorities in general are narrowly construed, . . . this Court is satisfied that Congress did not intend that an indirect expense such as the one incurred by the Debtor in this case should be given first priority status under  507(a)(1) of the Bankruptcy Code.

Id. (citation omitted). Accordingly, the court allowed the claim under  507(a)(7)(C). Id.

Although not directly on point, the Alton case is analogous to this case. Like the debtor in Alton who, as a general partner, was secondarily liable for the debts of the partnership, Felland is liable for the corporations' sales and withholding taxes. With respect to Northgate's sales tax, Felland's liability did not arise under Wis Stat  77.60(9) until Northgate was found unable to pay the tax. Additionally, Felland's liability for the penalty under  71.83(1)(b) arose upon the corporations' failure to pay the withholding taxes. In both Alton and this case, business entities incurred taxes in the first instance which imposed liability on the individual debtors upon the entities' failure to pay those taxes.

The Alton case addressed administrative expense priority under  503(b)(1)(A), which focuses on "actual and necessary costs and expenses of preserving the estate," rather than  503(b)(1)(B) which concerns "any tax incurred by the estate." Despite this difference, the "preserving the estate" language in  503(b)(1)(A) serves a similar purpose as the "incurred by the estate" language in  503(b)(1)(B). Both phrases require that the claim be against the bankruptcy estate. Indeed, the "incurred by the estate" language is arguably more stringent than the "preserving the estate" language which the Alton court found did not encompass the debtor's partnership tax liability.

The sales and withholding taxes are entitled to priority status under  507(a)(7)(C). The legislative history for  507(a)(7)(C) states in part:

This category also covers the liability of a responsible corporate officer under the Internal Revenue Code for income taxes or for the employees' share of employment taxes which, under the tax law, the employer was required to withhold from the wages of employees. This priority will operate where a person found to be a responsible officer has himself filed a petition under title 11, and the priority covers the debtor's liability as an officer under the Internal Revenue Code, regardless of the age of the tax year to which the tax relates.

S Rep No 95-989 to accompany S 2266, 95th Cong, 2d Sess 71 (1978). The Department argues that, because  507(a)(7)(C) does not encompass postpetition tax debt,  503(b)(1)(B)(i) becomes the appropriate section to apply. The trustee contends that because subsection  507(a)(7)(C), unlike the other subsections of  507(a)(7), imposes no time limit on tax obligations that are entitled to priority, it encompasses postpetition tax obligations.

Courts generally state that  507(a)(7)(C) governs prepetition liabilities. See, e.g., In re Major Dynamics, Inc., 897 F2d 433, 436 (9th Cir 1990) ("The phrase 'for which the debtor is liable' in section 507(a)(7)(C) refers to pre-petition liabilities") (citing United States v Friendship College Inc., 737 F2d 430, 432 (4th Cir 1984); Matter of Lumara Foods of America, Inc., 50 BR 809, 814 (Bankr ND Ohio 1985); In re Carlisle Court, Inc., 36 BR 209, 216 (Bankr D Columbia 1983). Likewise, one commentator notes:

[T]his provision [ 507(a)(7)] deals directly only with the priority of prepetition tax claims; apparently postpetition tax claims against the estate--that is, those based on postpetition activities of the trustee or debtor in possession, as opposed to those assessed after a petition but based on prepetition activities--are entitled to be treated as first priority administrative expenses.

1 Ginsberg & Martin, Bankruptcy: Text, Statutes, Rules,  10.11[l] at 10-111 (Prentice Hall, 3d Ed 1992). Nonetheless, under  502(i), a tax claim that arises postpetition, but which would be a priority tax claim had it arisen prepetition, is deemed a prepetition claim entitled to priority under  507(a)(7). See id.  10.08[p] at 10-70; In re Carlisle Court, Inc., 36 BR 209, 217 (Bankr D Columbia 1983) ("To the extent that a tax claim merely arises after commencement of the case, is a tax within the defined parameters of  507(a)(6) [now  503(a)(7)], and is not incurred by the estate, as is required by  503(b)(1)(B) then it is properly relegated to a pre-petition status under 502(i)") (emphasis in original) (footnotes omitted). While  502(i) is usually invoked to afford priority status to tax claims which are based on prepetition activities that are assessed postpetition, the section appears to apply to this case as well.

Felland's tax liability also falls within  507(a)(7)(C) by operation of the case conversion. Section 348 governs the effect of conversion and provides:

(d) A claim against the estate or the debtor that arises after the order for relief but before conversion in a case that is converted under section 1112, 1307, or 1208 of this title, other than a claim specified in section 503(b) of this title, shall be treated for all purposes as if such claim had arisen immediately before the date of the filing of the petition.

11 USC  348(d). Because the tax obligation was not an administrative expense claim in the Chapter 11 case, it is deemed a prepetition claim subsequent to the conversion by operation of  348(d). As a prepetition claim, it is entitled to priority under  507(a)(7)(C).

For the foregoing reasons, the trustee's objection to the Department's proof of claim is sustained.