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

(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,

(1st Cir. 1995) (citing In re SPM Mfg. Corp., 984

F .2d 1305, 1311 (1st Cir. 1993); In re GSF Corp.,

(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

(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."

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),

, 96 (2d Cir. 1988);

United States v. Huckabee Auto Co.,

(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,

(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,

(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,

(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

. 6 than a third party, and that the grievances asserted are not

conjectural or generalized."

§ 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,

(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,

(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.

(1986). The Court, however, explicitly declined

to decide whether a party must fulfill the constitutional

standing requirements to intervene. See

. 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,

(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,"

, 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,

, 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.,

, 464-70 (5th Cir.), cert,

denied sub nom., Morial v. United Gas Pipe Line Co.,

(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

, 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

§ 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.,

(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,

(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,

(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

(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

. 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.

(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,

(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,

(6th Cir. 1989); see also Rev. Rul. 85-44, 1985-

. 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. . . ."

(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-

.

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,

(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."

(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,

, *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

; McKean v. United States,

(1995); Rev. Rul. 85-44, 1985-

. 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,

(1st Cir. 1986)

(quoting H.R. Rep. No. 76-728, reprinted in 1939-

,

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."

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