OTTE v. UNITED STATES
Legal provision: Internal Revenue Code
Argument of Howard Karasik
Chief Justice Warren E. Burger: We will hear arguments next in William Otte against the United States and others.
Mr. Karasik, you may proceed whenever you’re ready.
Mr. Howard Karasik: Thank you, Mr. Chief Justice and may it please the Court.
Justice Potter Stewart: Mr. Karasik, how do you pronounce your client’s name?
Mr. Howard Karasik: Otte.
Justice Potter Stewart: Otte.
Mr. Howard Karasik: I represent William Otte, the Trustee in Bankruptcy of Freedomland, the petitioner before the Court today.
This case is here on a writ of certiorari to the Court of Appeals for the Second Circuit.
The facts of this case are relatively simple.
Freedomland filed a petition under Chapter XI of Bankruptcy Act.
It was subsequently adjudicated as bankrupt.
413 priority wage claimant's file proofs of claim for a priority wage claims in the bankruptcy proceeding during the six month period, during which claims could be filed.
The United States government and the city of New York did not file any claims for withholding taxes or related taxes in connection with those priority wage claims.
As a matter of fact, they did not file any proofs of claim pursuant to the bar order entered in the proceeding which directed the taxing authorities to file proofs of claim, if they had any claims for withholding or related taxes.
During the course of the proceeding, the bankruptcy judge entered an order authorizing the bankruptcy trustee to make a priority wage claim distribution, without the necessity for withholding taxes.
This order was appealed to the District Court and the District Court held that it was incumbent upon the bankruptcy trustee to withhold taxes and that the withheld taxes were subject to the fourth priority of Section 64 (a) of the Bankruptcy Act.
On further appeal to the Court of Appeals, the Court of Appeals held that the withheld taxes were subject to the second priority under Section 64 (a) of the Bankruptcy Act.
Now, the issues before the Court are first; whether a bankruptcy trustee is required to withhold taxes in connection with a priority wage claim distribution.
Second, whether those withheld taxes are entitled to a priority.
Third, whether the ruling of the bankruptcy judge that it was not incumbent upon a bankruptcy trustee to prepare the W-2 forms and related forms because it was consistent with the general rule that a bankruptcy trustee need not incur unnecessary expenses in connection with the administration of mistake whether that ruling was clearly erroneous.
And fourth, whether it was incumbent upon the taxing authorities to file proofs of claim in this proceeding or be barred from asserting their claim in the proceeding.
Essential, absolutely crucial to an understanding of this case is that it is a bankruptcy case, it is not a tax case.
Every appellate court that has dealt with the issues before the Court today, has viewed the issues in terms of the Internal Revenue Code and has viewed the cases before them as tax cases.
I submit to the Court that this is a bankruptcy case and that if this Court recognizes that it’s a bankruptcy case that it will overrule all of the appellate courts that have dealt with the issues before the Court and will overrule the court below.
Section 64 (a) (2) of the Bankruptcy Act establishes a priority wage claim for wage earners.
Justice Potter Stewart: Where is that page?
Mr. Howard Karasik: It’s in the appendix Your Honor.
Justice Potter Stewart: It's not in your brief?
Mr. Howard Karasik: No, it’s not in the brief.
It’s in the appendix.
And it’s at 94 (a) and 95.
Now, this Court has dealt with Section 64 (a) (2) in two significant cases.
The Embassy Restaurant case and the Joint Industry Board case, this Court ruled, decided that Congress when it passed Section 64 (a) exempted to establish an economic cushion for wage earners who lost their jobs as a result of their employer's bankruptcy.
Now, I ask this Court in light of the obvious congressional purpose related to Section 64 (a) (2) whether withholding taxes in connection with a priority wage claim distribution would fulfill that purpose.
I say that it would not.
Moreover, in interpreting Section 64 (a) (2), this Court has said that it was incumbent upon a bankruptcy trustee to make a prompt distribution of the priority wage claim dividends.
Yet, if a bankruptcy trustee is required to workout the computations and prepare the W-2s and 941s and the related forms, it is inevitable that there will be delay in the distribution and again I say, that any requirement that would cause a bankruptcy trustee to delay a distribution would not fulfill the congressional purpose.
And that brings --
Justice William H. Rehnquist: Under your theory Mr. Karasik, would the employees be nonetheless credited with having paid the withheld taxes?
Mr. Howard Karasik: No, Your Honor.
My theory is this, they would receive their money.
If they owe money to the government on account of taxes, at the end of the year, they would pay the Government.
They would be clerical cost associated with the preparation of the W-2 forms and the related forms.
I don’t know how much that would be and obviously it would vary from case to case.
But it would cost something, some clerical personnel would have to be hired, some accountants would have to review the computations.
The amount of money that’s spent, might very well eat into the amount of money available for purposes of paying out the priority wage claim dividend.
Justice Potter Stewart: You mean that every time a tax return is filed, an accountant has to be employed, do you do that for your personal one?
Mr. Howard Karasik: I retain the accountant in my personal case and in this particular case, Your Honor.
Justice Potter Stewart: Do you think all tax payers do?
Mr. Howard Karasik: No, all taxpayers do not.
But most bankruptcy trustees do.
In this particular case we have an account, the accountant testified in the court below.
That he would ordinarily review the work product of the junior accountants, and any clerical staff that would prepare the computations and the related forms.
Justice Potter Stewart: So now, you have not only an accountant but junior accountants also?
Mr. Howard Karasik: Well, this District Court --
Justice Potter Stewart: Suppose there is just one employee here, is he still an accountant?
Mr. Howard Karasik: It might not have to be an accountant.
But nevertheless there would be an expense and it's possible under some circumstances that the expense would eat into the amount of money available for the priority wage claim dividend.
Justice William H. Rehnquist: They will show of any cost of administration isn't?
Mr. Howard Karasik: That’s correct.
But this would be an unnecessary cost of administration because if no deduction were made, if the tax payer, the recipient, the wage earner actually owed taxes, at the end of the year he would pay it, just like every other businessman who happens to receive a dividend in a bankruptcy proceeding.
There’s no deduction for that businessman.
Justice Potter Stewart: Well, if that were so, why do we have withholding?
Mr. Howard Karasik: Withholding applies to the ongoing relationship between an employer and an employee.
The government wants to collect money at the source on a pay as you go basis.
Justice Potter Stewart: Do you think that’s the only reason for withholding?
Mr. Howard Karasik: I think that’s the primary reason for withholding, unless the government assumes that the ordinary wage earner is going to default and not make the payment.
And I don’t believe that’s a valid assumption, because our --
Justice Potter Stewart: Do you have to assume that, can’t you assume that a recognizable proportion will?
Not the ordinary one.
Wasn’t the delinquency of accounts a reason for withholding as well as currency --
Mr. Howard Karasik: That maybe.
But in this particular type of situation that suggestion would be inapplicable because all of the priority wage claimants would have filed piece of claim in the proceeding.
The government would be completely aware of which people are receiving dividends and if these people do not pay taxes, if taxes turn out to be due and they very well not turn to be due, because after all, you’re dealing with wage claimants who receive a meager amount of money, $600.00.
If a man who’s earning $600.00 loses his job, perhaps by the end of the year, he may or may not have gotten a new and they have been hiatus.
At the end of the year, he may owe no taxes, whatsoever, and I submit that it’s unfair to deduct taxes when he receives a priority wage claim dividend.
It’s unfair to him, and it servers no valid purpose, the Brookings Institute report in its study indicates that taxes collected in connection with bankruptcy proceedings have a minuscule effect on the treasury.
Absolutely minuscule, but a very significant effect on the dividends that are paid out in bankruptcy proceedings.
Moreover, as I indicated before, the taxpayer, the wage earner, when he receives money, it’s incumbent upon him to pay a tax.
If he owes a tax at the end of the year, and I submit that the government would lose no money if that procedure were followed in this particular type of case.
Chief Justice Warren E. Burger: I’m not sure, I’m sure that I follow the theory behind your comparison, it doesn't hurt the government very much but it does hurt the creditors a great deal.
How is that relevant to issues here?
Mr. Howard Karasik: I'm just talking generally in terms of the Brookings report.
Brookings report indicated that taxes as a general proposition collected in bankruptcy proceedings have a minuscule effect on the treasury.
Chief Justice Warren E. Burger: That’s simply because we have a $300 billion or $400 billion I've forgotten what it is, now, $300 billion or $400 billion budget but what's that got to do with the creditor.
Creditors would vary from small creditors to large, many creditors to a few creditors.
Mr. Howard Karasik: Well, I was just suggesting that it's a general policy, the revision -- the proposed revision of the Bankruptcy Act suggested by the Brookings Institute that the amount of taxes collected are minuscule.
Suggested to them that priority taxes in general should be abolished in bankruptcy proceedings.
I’m further submitting that the government will not really be hurt in this particular case if we follow the suggestion that the trustee is making that no money be withheld, and that the wage earner at the end of the year if owes a tax, pays a tax.
Now, the government has recognized that the trustee might have some difficulty computing the deduction, and accordingly, they have established a bureaucratic practice that as far as I am concerned has no basis in law and not subject to any particular regulation but there is some kind of practice that the bankruptcy trustee take 25% off the top.
Well, the withholding tax statutes run from 14% on upwards and I submit that in the kind of cases we’re talking about where they are all wage earners and you are not talking about principles of business, or businesses, or salary personnel but just wage earners that 25% is excessive.
Justice William H. Rehnquist: Does that include social security as well as income tax too?
Mr. Howard Karasik: That’s correct!
That’s, that's the practice.
But even including social security at 5% and you end up with 20% as the total deduction, and I submit that the kind of people we’re talking about might not pay 20%.
Certainly, they’re not going to be paying 25%.
In this particular case you have got 413 people.
Many of whom are simple day laborers.
They need their money and they need their money quickly.
And to deduct 25% off the top or any, or any specific amount off the top is detrimental to them and does not fulfill the congressional purpose which was to establish an economic cushion for these people.
Now, the court below spoke in terms of control, that is that the bankruptcy trustee controlled the wage claim - -
Chief Justice Warren E. Burger: We’ll resume there right after lunch.
You may continue Mr. Karasik.
Mr. Howard Karasik: In order for the Court of Appeals of the Second Circuit to reach the conclusion, a bankruptcy trustee was required to withhold taxes.
It had to conclude that the bankruptcy trustee was in control of wage claim dividends.
Much like the other appellate courts, the court below simply ignored the bankruptcy context of this case and the point of fact, the bankruptcy trustee does not control the distribution of wage claim dividends, it’s the bankruptcy judge.
The bankruptcy judge appoints the trustee, the bankruptcy judge has a right in certain instances to remove the trustee, the bankruptcy judge declares the dividends, the bankruptcy judge must countersign the checks, and the bankruptcy judge mails out the checks.
So it is not the bankruptcy trustee whose in control, it’s the bankruptcy judge.
The government says, well if it’s the bankruptcy judge then perhaps the bankruptcy judge should withhold the taxes and prepare the W-2s and the related forms.
I say that this is ludicrous, that Congress never intended the withholding tax statutes to apply to bankruptcy judges and that the government is merely trying to force the issue as I will show in connection with the priorities.
Each court --
Chief Justice Warren E. Burger: Why would that be anymore true of the bankruptcy judge and a receiver for example, in a federal or a state proceeding trustee and bankruptcy?
Why would it be anymore true that the bankruptcy judge -- I don’t quite get your answer --
Mr. Howard Karasik: Well, the bankruptcy judge, under the Internal Revenue Code, it is only the person who is in control of the payment who is deemed to be the employer and it is only the employer who must withhold the tax and prepares the W-2 forms and the related forms.
Chief Justice Warren E. Burger: There are certain derivative responsibilities that follow the funds, are there not?
Mr. Howard Karasik: No, the Internal Revenue Code speaks in terms of the parties not the funds.
It’s only the employer and the employer is the one who withholds.
There’s nothing to do with the money that’s withheld.
Each of the appellate courts dealing with the issues before the court has come up with -- well, I shouldn’t say each of them, there have been divergent opinions as to what is to be done to the taxes that are to be withheld.
The government contends that the withheld taxes, taxes withheld on the second priority are bootstrapped to the first priority.
This is illogical.
And in addition to that, it’s not only illogical but it's contrary to the holding of this Court in (Inaudible) case.
The withheld funds are taxes that are withheld from the employees.
They are not expenses of the state and it’s only the expenses of the state that can be deemed to be administration expenses and would entitle the government to priority.
The city of New York says, as to the court below, that the withheld taxes are entitled to a second priority because they are “carved out” of the wages.
Yet this Court in the Embassy Restaurant case said that, “If anything is paid to a third party to someone other than the wage claimant that the moneys that are paid are not wages for purposes of the Bankruptcy Act.
So you cannot conclude that withheld tax is paid to the government can fall in to the second priority.
The Connecticut Motor Lines case says, “that the withheld taxes fall into the fourth priority.
Well, the taxes here are not the taxes of the bankrupt and the fourth priority only relates to taxes of the bankrupt.
Now, the petitioner does not concede that any taxes should be withheld at all, but if taxes are withheld and if the taxes do not fall within the priority category of Section 64 (a) (4) then perhaps they fall into the proviso that follows Section 64 (a) (4) which says that if a tax is not entitled to a priority that it falls into the general unsecured claim category.
Justice Byron R. White: What proviso is that?
Mr. Howard Karasik: That’s the proviso that follows the priority Section under 64 (a) (4) of the Bankruptcy Act.
Justice Byron R. White: I don’t find it in the act.
Mr. Howard Karasik: All right, Your Honor.
Chief Justice Warren E. Burger: It’s in the appendix --
Mr. Howard Karasik: It’s in the appendix of page 95 (a) it says provided however that no priority of a general unsecured claim shall pertain --
Chief Justice Warren E. Burger: Now Mr. Counsel hold on until we find the place here.
Mr. Howard Karasik: Yes, excuse me.
Justice Byron R. White: The bottom three lines.
Chief Justice Warren E. Burger: Yes.
Mr. Howard Karasik: That’s correct.
Justice Byron R. White: Thank you.
But Counsel as I understand that it’s your position that the wager should be paid in gross?
Mr. Howard Karasik: That’s correct.
Justice Byron R. White: And?
Mr. Howard Karasik: They’re not wages Your Honor.
They’re wage claim dividends, it's a significant difference.
Justice Byron R. White: I don’t care what you call them.
But anyway, you want them paid in gross?
Mr. Howard Karasik: That’s correct.
But if they’re -- if there is to be a withholding then at best the taxes should fall into the unsecured category.
The government will argue that this constitutes a windfall for the unsecured creditors but I submit to the court that this is what the statute says that the Congress when it promulgated this particular statute expected a certain “windfall” unsecured creditors.
At the risk of being repetitious, I say to this Court that we’re dealing with the bankruptcy case and not a tax case.
When this Court dealt in the Randall case with the conflict between the Internal Revenue Code and the Bankruptcy Act, this Court ruled that in the event of a conflict the Bankruptcy Act takes precedence and I submit that in this particular case if the Court finds that the Bankruptcy Act does take precedence and I submit that it should find that it takes precedence that it will also find, the bankruptcy trustee need not withhold any taxes in connection with priority wage claim dividends.
Justice Byron R. White: Do you have any of authority supporting your position flatly at all?
Mr. Howard Karasik: No.
Justice Byron R. White: You have an array of cases internally inconsistent, first, second and fourth, but none of them support your position at this point --
Mr. Howard Karasik: Well, the only indirectly.
The Connecticut Motor Lines case said that if the government failed to file a proof of claim that the withheld taxes would be entitled to a fourth priority but by virtue of the failure to file a proof claim that the taxes would fall into the general unsecured category.
But for the general proposition that a bankruptcy trustee is not required to withhold taxes, I have no authority at all except the Bankruptcy Act, and I request and respectfully submit to this Court that all of those appellate decision which rule that a bankruptcy trustee should withhold taxes, should be overruled.
Justice Byron R. White: Do you think that if you said that this tax claim was the fourth priority or unsecured at all, or not secured at all, or no priority at all.
Would it necessarily follow that the trustee would not have to file and withholding tax to pay?
Mr. Howard Karasik: Well, if they were no wages paid.
Justice Byron R. White: Yes.
Mr. Howard Karasik: Then the trustee would not have to file any returns.
These would not constitute wages.
Justice Byron R. White: But when you pay them?
Mr. Howard Karasik: These would be wage claim dividends, where it's this --
Justice Byron R. White: Well, I know, I know that he got to be paying wages, he is going to be paying $600.00.
Mr. Howard Karasik: He’s going to be paying $600.00 but these are not wages.
He’s not an employer, the recipients are not his employees.
Justice Byron R. White: Well, I know but it still could be held that he’s paying wages.
And if --?
Mr. Howard Karasik: If he is held -- if it is held that he’s paying wages --
Justice Byron R. White: Yes.
Mr. Howard Karasik: Then I would assume that it would -- that he would have to prepare the appropriate forms.
Justice Byron R. White: Well, I know but the -- the people by whom wages are owed, or owed by bankrupt up to $600.00 you’re going to paid, don’t you?
Mr. Howard Karasik: That’s correct.
Justice Byron R. White: The trustee is going to pay them, isn’t it?
Mr. Howard Karasik: Well, the trustee in conjunction with the bankruptcy judge.
Justice Byron R. White: With the judge?
Mr. Howard Karasik: Yes.
Justice Byron R. White: Yeah, well, so those are the distributions that are going to be made?
Mr. Howard Karasik: That’s correct.
Justice Byron R. White: And I suppose you could say that the trustee can withhold them -- can withhold the money?
Mr. Howard Karasik: There are several threshold questions, if we’re talking about a wage and if you’re saying that the bankruptcy trustee is the one in control and if you’re further saying that the Internal Revenue Code comes into play at this point.
Justice Byron R. White: But the claims that are going to be filed to pay their wage claims?
Mr. Howard Karasik: The claims or wage claims.
What is paid is a wage claim dividend.
Justice Byron R. White: Yes, I understand.
Mr. Howard Karasik: And there’s a difference I submit respectfully between a wage claim dividend and a wage.
Justice Byron R. White: Well, a fellow was owed this $599.00 and he gets it all, I suppose he thinks he's got his wages?
Mr. Howard Karasik: Well, if he got it several years after the event, I don’t know what he would consider it and he might considerate it a “windfall”, I don’t know Your Honor.
Justice Byron R. White: Don't you usually pay wages or wage claims pretty fast?
Mr. Howard Karasik: We attempt to do it.
In this particular case, there was a hiatus between the date of adjudication and the date of payment.
The reason for that is that first these estate must be liquidated, second, as in this particular case, there were liens that had to be invalidated, and third, in this particular case, the attorney who was handling the case (Inaudible) he was ill for several and then died.
Justice Byron R. White: But if you're right -- if you’re right that these wage claims, that these tax pay might be -- had no priority at all, what the trustee would do is to withhold the money and that would go into the unsecured --.
Mr. Howard Karasik: That’s correct – and that's illogical, Your Honor.
Justice Byron R. White: Well, -- is that what you claim here?
Mr. Howard Karasik: Well, it’s not my claim.
The illogicality of that and the fact that you have so many divergent opinions as to what is to be done with the withheld taxes, demonstrates to me and I hope to the Court that Congress never contemplated that withholding taxes would be applicable in a situation such as the one at bar.
If there were no further question, I respectfully reserve my time for rebuttal.
Chief Justice Warren E. Burger: Very well, Mr. Jones.
Argument of Keith A. Jones
Mr. Keith A. Jones: Mr. Chief Justice and may it please the Court.
I represent the United States in this case.
Mr. Warms who would follow me, represents the city of New York.
Three related questions are presented to you.
First, whether a trustee in bankruptcy must withhold income and social security taxes on the distribution of the wage claims.
Second, whether the taxing authorities must file formal proofs of claims with respect to these withholding taxes, and third, whether such taxes are entitled to first priority of payment or are payable in some other manner under the Bankruptcy Act.
As to the first question, the trustees' duty to withhold, not withstanding the trustees arguments here, the law is quite clear.
The Internal Revenue Code squarely requires the trustee in bankruptcy to withhold federal income and social security taxes on all wage claim distributions and to prepare and submit appropriate information returns and reports to the Internal Revenue Service and to the wage claimants.
The evidence in this case shows that contrary to the petitioners position, the cost of complying with these withholding and reporting requirements are trivial.
And in any event, even if the costs were more substantial they would not justify the trustees' failure to perform a statutory duty.
Our arguments to this effect are set forth in our brief and if there are no questions on this point and in the rest of time, I will go on to the other questions in this case.
As to the second question in this case, the filings of proofs of claims, we believe that it is also clear that no filings of proofs of claims are required with respect to withholding taxes that arise after bankruptcy as in this case.
The Bankruptcy Act requires the filing of formal proofs of claims only with respect to debts for which the bankrupt is or maybe liable and the bankrupt will never become liable for the withholding taxes in this case.
These taxes arise only after bankruptcy and their obligations incurred by the state in the course of administration and not by the bankrupt.
In this respect, they’re just like the expenses incurred by the trustee and employing clerical assistance to help administer the estate indeed are just like the costs incurred by the trustee in conducting this litigation.
Withholding taxes like other expenses incurred in a course of administration or obligations of the state which -- as I say which are incurred in the course of administration and the Bankruptcy Act does not require the filing proofs of claims with respect to such debts of the state as distinguished from debts of the bankrupt.
Moreover, the purpose of filing proofs of claims is simply to inform the bankruptcy trustee and the other creditors of the total amount of claims outstanding against the bankrupt.
Proofs of claims of withholding taxes here in question but not serve that purpose.
These withholding taxes do not add to the total amount of claims against the bankrupt or the estate, they arise only when the wage claims are paid out, they're deducted from the wage claims, paid over to the United States and they don’t reduce the fund remaining for payment to other creditors.
Therefore, filing the proofs of claims would serve no purpose under the Bankruptcy Act.
Moreover, any filing requirement of that kind for the government would be impracticable.
As we showed in our brief, the Bankruptcy Act requires proofs of claims to be filed as to debts of the bankrupt, within six months of the first date set, the first meeting of creditors.
No taxing authority could comply fully with that requirement.
Until the expiration of the six month period, it would be impossible to know just how much wage claims in fact were to be payable out of the estate.
Moreover, the actual amount of the tax that they would be due cannot be known until the actual amount of wages has been calculated and distributed because withholding rates fluctuate over time and the effective withholding rates at the time of bankruptcy maybe very different from those that are in effect at the time of the distribution of the wage claims.
Therefore, for all of these reasons, we believe it’s clear that Congress did not intend to require the filings of proofs of claims with respect to these withholding taxes.
With that in mind, I now turn to what we believe is the most important and substantial question in this case and that is the priority to which the United States is entitled or more generally a manner in which these withholding taxes are to be paid over to the United States.
Under Section 7501 of the Internal Revenue Code an obligation is imposed upon all persons responsible for collecting taxes to hold those taxes in a special fund and trust for the United States.
Under that provision, withholding taxes of the kind here in question or indeed any other withholding taxes are directly payable to the United States as a trust fund without regard to the provisions of the Bankruptcy Act.
However, the trustee in this case is not complied with the Section 7501, and we've recognized that under this court's holding in United States against Randall.
The trustees' duty to pay over cannot be enforced as against third party creditors.
The issue that arises in this case therefore as to what priority of payment if any, the United States is entitled when the trustee defaults on his duty to pay over the withholding taxes as a trust fund, and I turn now to that question.
Our position, simply put is that the United States is entitled to payment of these withholding taxes as the first priority administrative cost and expenses.
We reach this conclusion, both because such withholding taxes analytically fall within the category of administrative expenses and also because they don’t fit within any other priority or indeed non-priority category.
Justice Byron R. White: Well are you -- you’re supporting the judgment below?
Mr. Keith A. Jones: We’re supporting the judgment below in the sense that we’re supporting the distribution of assets ordered by the court in its judgment.
We’re not supporting the expressed holding that these wages claims are -- excuse me, of these withholding taxes.
Justice Byron R. White: But if you were -- but if you were --
Mr. Keith A. Jones: Are distributable as second priority objects.
Justice Byron R. White: If accept your argument, the result below might be different.
I mean in terms of who gets what?
Mr. Keith A. Jones: That’s true and you bring up the point I assume that --
Justice Byron R. White: But you're -- but you really want to secure more than you got on judgment below?
Mr. Keith A. Jones: Yes and no.
We want --
Justice Byron R. White: Did you petition or not?
Mr. Keith A. Jones: We didn't petition, but as we pointed out in our brief, the question of first priority was opened up, opened up by the petitioner in his petition.
The question presented in the petition, I will read it to the Court -- is whether -- this is question number two at page two of the petition.
Assuming arguendo that such a distribution is subject to the withholding tax and reporting the requirements of the Internal Revenue Code etcetera.
Should the monies withheld in connection with the distribution be accorded, the fourth priority tax claims status, first priority administration claim status, second priority wage claims status or a trust fund status.
Justice William H. Rehnquist: Well of course, it goes further than that?
Doesn’t it, Mr. Jones it isn’t just a question of what maybe raised here but it’s a question of whether if you want to get a more favorable result than the Second Circuit gave you whether you don’t have to cross petition.
Mr. Keith A. Jones: Well, I don’t think that’s true in this case Mr. Justice Rehnquist.
On that point, I would say that since the question in this case is how the monies are distributable.
Necessarily, the court has to consider whether the taxes are a first priority item.
Now, I would say that if the question were not properly before the Court were not presented by the petitioner then we would be entitled utmost to an affirmance of the judgment below, although we might also be entitled to a ruling that as a matter of law, such taxes are first priority claims --
Justice William H. Rehnquist: But that?
Mr. Keith A. Jones: In other words, you could if you saw fit determine that as a matter of law with these withholding taxes are the first priority items but that in the absence of a cross petition -- we were entitled only to an affirmance of the judgment below.
In this case, we would be perfectly satisfied by such an affirmance because the distribution of assets in this case is the same whether it’s a first priority or a second priority item.
That is I say, I think that in this case under the peculiar circumstances where the question necessarily is presented to the court in the petition and by the question raised by the petitioner that it’s open to the court to consider it and dispose off it.
Justice Byron R. White: I don’t know that -- it says you're not only, not entitled to the administration expenses but you’re not entitled to the priority (Inaudible).
So, I don’t know that the -- it's a very good position to or you're in a very good position to say that he's raising the issue.
He leaves you of the necessity to cross petition.
Mr. Keith A. Jones: I think analytically there are two separate questions, the first is whether the issue is properly before the Court and the second separable question, is whether this Court can modify the judgment of the court below in the favor of the respondent and as to the first question, I think it's clear that this issue is before the Court, as to the second question, I'm less clear in the circumstances of this case whether we really are entitled to a modification of the judgment.
Justice Byron R. White: And you're suggesting that surely we're not required by the failure of the government to cross petition, to affirm what we think is an erroneous holding the Court of Appeals.
Mr. Keith A. Jones: That's correct.
Justice Thurgood Marshall: Mr. Jones, it over simplifies, suppose you go a judgment for $15,000.00 in the Court of Appeals, and the other side brought it up and you didn't cross petition, would we be right in giving $25,000.00?
Mr. Keith A. Jones: I'm sorry what was the last question?
Would we be right in--
Justice Thurgood Marshall: You've got in the affirm judgment of $15,000.00 for damages.
Mr. Keith A. Jones: I say and --
Justice Thurgood Marshall: And the other side appealed that we say, you should have gotten $25,000.00.
Mr. Keith A. Jones: Well, and we don't cross appeal or cross petition.
Justice Thurgood Marshall: Right.
Mr. Keith A. Jones: But we present an argument which if accepted logically would entitle us to a judgment of $25,000.00.
And our position.
Justice Thurgood Marshall: Do they give it to you?
Mr. Keith A. Jones: No, and we have spelled out our position at greater length on this point.
Justice Thurgood Marshall: Yeah.
Mr. Keith A. Jones: In our reply brief in the Western Edition case which was filled last week.
Justice Potter Stewart: The fact is if you look at the petition for certiorari in this case, the question two doesn't raise the question that you raised.
Mr. Keith A. Jones: That's correct and it was in reliance upon that we acquiesced in this petition.
Justice Potter Stewart: And, we granted certiorari across the board.
Mr. Keith A. Jones: That's correct Mr. Justice.
Justice Potter Stewart: Pleasantly accepting the proposition that these questions were --
Mr. Keith A. Jones: And for that reason we believe that this case really doesn't even present the issue that we discussed in our reply brief in Western Edition.
So we think that this issue is before the Court and can be adjudicated in our favor and the judgment below be modified.
Justice Potter Stewart: Just two basic questions are these wage claim dividends subject to -- does a trustee have the duty to withhold at all and secondly, if it does what priority if do they dividend fall into?
Mr. Keith A. Jones: That's correct.
Justice Byron R. White: And would you expand for me the Government's theory as to why they should be first priority?
Mr. Keith A. Jones: Yes, Mr. Justice White, and I would be delighted to do that.
As I have already indicated --
Chief Justice Warren E. Burger: Contrasted was the Second Circuit's conclusion that they were derived from wages and therefore belong in the second priority.
Mr. Keith A. Jones: That's right.
Well, in the first place this is as I've already indicated an expense that's incurred by the state in course of administration.
And it seems clear to us that such expenses are administrative expenses entitled to first priority.
Justice Harry A. Blackmun: Now, why is that?
What is the state for -- as contrasted say with the trustee's fees or some --?
Mr. Keith A. Jones: Well, these are very much like the expenses of hiring secretaries to mail out the wage distributions, the state really doesn't get anything for it, it's just an obligation that incurs in the course of administration.
Justice Harry A. Blackmun: Well, I'll buy the obligation part but I wonder why it is a cost of administration?
Mr. Keith A. Jones: Why?
If it's an obligation and it's incurred, I'm not sure why it wouldn't be a cost.
Justice Harry A. Blackmun: I think the first priority originated in the Eight Circuit Fogarty case, isn't not?
Mr. Keith A. Jones: That's correct.
Justice Harry A. Blackmun: And I look at this, this was a tag ambition because there were other primary issues there such as the --
Mr. Keith A. Jones: That's right.
Fogarty did not devote much time to -
Justice Harry A. Blackmun: And as all that I see that Judge Wood had said, is that the taxes should be allowed and classified as an expense of administration having priority, they were not payable at the time the petition was filed by the bankrupt and only approved as and when they paid.
That is on that actual payment of 25% of the wage claims, during the administration of the estate pursuing to the orders of the bankruptcy court.
Well, I don't find much reason in that, it merely says that was paid pursuant in order of the court.
Therefore, it is a cost of administration.
Mr. Keith A. Jones: Well, we're not relying necessarily from the reasoning set forth from the Fogarty opinion.
Justice Harry A. Blackmun: I guess I'd like to know what reasoning then you are relying?
Mr. Keith A. Jones: Well, I'm not sure exactly what your question is, Mr. Justice Blackmun.
You're distinguishing between cost and taxes it seems me and it's clear that the taxes incurred in the course of the administration are the first priority items, whether or not they are of any substantial value to the state, I would quote in regards to that from call your you're on bankruptcy, paragraph 62.14 (3) “to the extent to which a receiver or trustee is under a duty to pay taxes, his expenses or tax liabilities are to be classified as necessary costs of operation, preservation, or administration and within the first priority.”
In other words, these are items, expense items, taxes, however you describe them, there are obligations that are occurred in course of administration.
Justice William H. Rehnquist: Is that Collier you're speaking or are there some cases to support it?
Mr. Keith A. Jones: That's Collier speaking.
There are many cases to support it, he addresses -- he is there addressing the question of the whether administration expenses have to be preservation cost, and he points out that clearly they do not, that why you are concerned about in the first priority administration expenses or the broad category expenditures that are made by the trustee without regard to whether they maybe directly related to the preservation or development of the state.
Justice Byron R. White: And that (Inaudible) the taxes which improve during the administration?
Mr. Keith A. Jones: Like this tax.
Justice Byron R. White: Well, yes but this tax had to be related to wages earned before bankruptcy and arguably these taxes would all be treated like real property taxes that were due and owing in kind of bankruptcy.
Mr. Keith A. Jones: I don't know Mr. Justice why they can't treated that way because they were not legally due and owing before bankruptcy.
And they were not legally due and owing by the bankrupt.
They only arise after bankruptcy and they are due and owing by the state and you can't fit that into fourth priority.
Justice Byron R. White: Did it say I would put it in the fourth priority.
It can't just that I would put it in the administration expenses.
Mr. Keith A. Jones: Well --
Justice Byron R. White: And I was also saying that Collier was directed to the taxes incurred in the operations of the business.
Mr. Keith A. Jones: Oh, no he was speaking more generally --
He was speaking more generally of taxes there.
Justice Byron R. White: Oh, there weren't lot of cases holding there for that statement?
Mr. Keith A. Jones: Well, of course this Court had spoken on it.
Justice Byron R. White: You say that word and you probably wouldn't be here.
Mr. Keith A. Jones: That's correct.
And my time has expired, I turn over the remaining appellee's time to Mr. Warms.
Chief Justice Warren E. Burger: Mr. Warms.
Argument of Samuel J. Warms
Mr. Samuel J. Warms: Mr. Chief Justice, and may it please the Court.
I shall confine my argument to the priorities question and support the holding of the court below which held that the withholding tax claims in question were wage claims.
Now, while the United States government's argument suits our book as well, we would fair just as well a distribution would be precisely that which was ordered by the court below.
We feel that the court's position which was our position there and is our position here is more logical and it also better answers the arguments of the trustee against any priority status.
Justice Byron R. White: Well, in some other case it can make a difference whether it was administration expense or second priority?
Mr. Samuel J. Warms: I can concede none under the way we rush --
Justice Byron R. White: Well, they've got to some reason for making this argument.
Mr. Samuel J. Warms: I beg your pardon?
Justice Byron R. White: I should have asked the government this question.
They must have some reason to be making the argument.
Mr. Samuel J. Warms: Yes, they do, Mr. Justice White they do, because they are afraid that in the case where after the payment of administration expenses other than these they will not -- and where there's nothing enough left to execute a payment in full, that there will be diminution in the amount of tax claims.
Now they set that forth in a very complicated example on page 40 and page 41 of their brief.
Justice Byron R. White: So where there's not enough assets to pay the wage claims they would suffer too if the court --
Mr. Samuel J. Warms: I don't believe so, Your Honor.
Justice Byron R. White: Well that's what their claim.
Mr. Samuel J. Warms: That's their claim, but I've analyzed the argument and I analyzed the example, what they say is this, if in a state where there is $40,000.00 worth of wage claims, there are are only $20,000.00 to pay them.
They would be paid in this way.
Justice Byron R. White: Well, you would say that as far as you can see it doesn't make that much difference in the state?
Mr. Samuel J. Warms: I would say it doesn't make any difference because in such a case -- the residue would be paid if we assume 25% is the rate, 75% to wage earner and 25% on his behalf to the government not half of 25% as they argue in their brief.
Justice William H. Rehnquist: But nonetheless it's 25% of a smaller amount in the total wages claimed, isn't it?
Mr. Samuel J. Warms: Well, that would be true in any case Your Honor.
Justice William H. Rehnquist: In other words, you tax only what is paid up.
Mr. Samuel J. Warms: That's correct Your Honor.
Withholding is based on the actual gross amount of wage distribution.
Justice William H. Rehnquist: Well, but so far as net receipts to the treasury is concerned, if you pay a $100,000.00 on a $100,000.00 wage claim, and subtract 25% for tax, the government is getting more money than it would if you pay $50,000.00 on a $100,000.00 wage claim and pay $12,500.00 to the government?
Mr. Samuel J. Warms: Well, that's absolutely correct, Mr. Justice Rehnquist because the wage claimants is getting half -- the wage claimants is getting less --
Justice Byron R. White: He is now got therefore, the only thing is the administration expense would be 25% of $50,000.00.
Mr. Samuel J. Warms: That is correct.
Justice Byron R. White: So it wouldn't, and you say that wouldn't make any difference.
Mr. Samuel J. Warms: It would make a slightest bit of difference.
You see, the government's example indicates that 25% of the $50,000.00 would be cut in half because it's 50% dividend.
It wouldn't be.
It'll be calculated on the amount of each wage paid.
Now, another reason we for our argument is it avoids the trustees' argument but in the administration expense mostly in the preservation of the estate or in connection with the acquisition of assets, we don't have to argue against that in presenting it as a second wage, a second priority wage claim.
Now, I don't do -- I've worked some of Mr. Justice Blackmun's questioning concerning the Fogarty case because that was the leading case and that was the case on which from this notion of administration expense priority.
Actually, I'm not sure that the Fogarty case wasn't correct because in the Fogarty case, there was no withholding as far we can see.
I believe the wage distributions were made without any withholding of tax and that the taxes were actually satisfied by offsetting them against the claim which the bankrupt had against the government for some ships that had built.
Now that means, probably that they were rightfully decided to be administration expenses because they weren't carved out of the wages.
The wages went 100% to the wage claimants.
The other came out of the estate and so, although the case was followed in Lines against California and then in the Curtis case in Ninth and Sixth Circuits which both held that the administration expense status was accorded to these claim.
I think we should bear in mind that Fogarty which was the father of all these cases is perhaps reconcilable with our view in this case.
Now, we say that the wage claim status depends on this.Withholding taxes are derived from and carved out of the actual wages paid to an employee and the wage distribution paid to a wage claimant.
There is if there an in envisioned assignment by the wage claimant to the governments involved.
Of that point of his wages which might reasonably be assumed to cover his taxes, the minute these taxes are withheld, he gets a credit on the books of the governments, for these withholdings.
If he (Voice Overlap) satisfying his taxing indebtedness if for example he's made estimates, he'll get those withholdings back in the form of the refund.
So he will ultimately realize in that case, what essentially his wages is.
He is required to include them in gross income, his income tax returns and this shows too that the amount of the withholding part of his salary and therefore are wages.
Justice Byron R. White: Mr. Warms, is this like a prior theories which I think emerged first time in this case in the Second Circuit, is this your argument below that the court pick it up on it's own clear argument?
Mr. Samuel J. Warms: I am sorry to say that it was my argument.
I say that because it makes me to appear to be very veined of try to support that in the case were I need not necessarily do so.
But it was indeed my argument and the Court was very kind and flattering me doing about this.
Part of an argument also is that proper segregation was made of these funds, they would also enjoy a trust funds status within the second -- within the range of the second priority.
Now, I've spoken about what I consider to be the unfounded fears of the federal government in the event that second wage -- second priority status has accorded these wage claims.
Finally I think I should point out that there is an anomaly in computing them, if that to be considered as administration expenses because administration expenses have to be computed before you can determine how much money is left in the state to pay wage claims, and it's only after you have determined how much you have left to wage claims that you can compute the taxes on them.
Justice Byron R. White: Mr. Warms, have you ever studied calculus of differential equations?
Mr. Samuel J. Warms: No, Your Honor, I haven't and I was wondering whether this was a case of them of the multiple variables.
Justice Byron R. White: Well, it just seems to me that here you have two dependent of variables with one constant which you've forgotten to with the amount of money.
Mr. Samuel J. Warms: That's correct.
Justice Byron R. White: I think it's a routine problem in either differential equations or calculus -- I don't go along with this argument and I'll be trying to say that it is capable of solution I'm sure.
Mr. Samuel J. Warms: Oh, just as the problem of the employer who pays the income tax on the employees' income is capable of solution, in a similar manner.
Justice William H. Rehnquist: (Inaudible)
Chief Justice Warren E. Burger: Thank you very much, you have two minutes left.
Do you have anything further?
Mr. Samuel J. Warms: If there are no further questions I will quit my time.
Chief Justice Warren E. Burger: Thank you gentlemen.
The case is Submitted.