UNPAID UNEMPLOYMENT INSURANCE TAX OBLIGATIONS ARE DISCHARGEABLE IN BANKRUPTCY
In In re Hansen, the Ninth Circuit Bankruptcy Appellate Panel ruled that the individual
owner of a staffing company could file bankruptcy and discharge over $3.7 million of unemployment insurance tax liabilities levied by the California Employment Development Department. In re Hansen BAP No. EC-11-1320-MkPaD (April 18, 2012).
In December 2002, Onvoi Business Solutions, Inc., a company owned by Michael Hansen,
purchased Birdcage Travel, a company which held an unemployment insurance tax rate of 0.9%. That rate, established by the EDD, was considerably lower than the 4.7% rate at which the EDD had assessed Onvoi’s unemployment insurance tax liability.
Once the sale closed, Onvoi transferred its employees from its existing EDD employer account – with the 4.7% rate – to the EDD employer account formerly maintained by Birdcage Travel – which had the 0.9% rate. On March 29, 2004, the EDD issued a notice of assessment, pursuant to California Unemployment Insurance Code § 1735, to Hansen, individually, and/or as a responsible person of the Onvoi Entities. The total amount assessed was $4,820,523.86. This amount included $2,872,050.34 in unpaid unemployment insurance taxes from January 1, 2003 through September 30, 2003; $1,753,521.28 in penalties; and $194,952.24 in unpaid interest. According to the EDD, the assessment represented the difference between the amount of unemployment insurance taxes Onvoi paid based on Birdcage Travel’s 0.9% unemployment insurance tax rate and the amount Onvoi should have paid had it applied the correct 4.7% rate.
Hansen and other principals of Onvoi signed a settlement agreement (the “Settlement
Agreement”) with the EDD, whereby they agreed to pay $1,600,000 in eleven monthly payments. From April 2009 to September 2009, Hansen made six payments under the Settlement Agreement, totaling $1,000,513.46. Hansen did not, however, make the remaining payments.
Hansen and his wife, Amy Hansen (the “Debtors”), filed a chapter 7 bankruptcy petition on
January 6, 2010. On March 30, 2010, the EDD commenced a lawsuit before the Bankruptcy Court seeking a determination that the $3,788,969 allegedly due and owing under the Settlement Agreement (the “UI Tax”) was a “tax” that survives his personal bankruptcy case. To do this, the EDD argued that the tax at issue was of the kind specified in §507(a)(8)(C) of the bankruptcy code, specifically:
“(a) The following expenses and claims have priority in the following order:
. . .
(8) Eighth, 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 . . . .”
The EDD argued that nothing in the plain language of §507(a)(8)(C) imposed a requirement
that the “tax required to be collected” be collected from a third-party. It maintained that the
UI Tax at issue was a tax of the kind specified in §507(a)(8)(C) because the EDD was required to collect it, and as such, the UI Tax gave rise to a nondischargeable debt under §523(a)(1)(A).
The Debtors, however, argued that the UI Tax was not a “tax required to be collected” because it was an employer paid tax, not a tax collected from third parties. On that basis, the Debtors contended that the UI Tax did not give rise to a nondischargeable debt within the meaning of § 523(a)(1)(A).
In making their argument, the Debtors relied on California Unemployment Insurance Code
§ 976. That section provides:
“Employer contributions to the Unemployment Fund shall
accrue and become payable by every employer, except an
employer as defined by Section 676, for each calendar year
with respect to wages paid for employment. The
contributions are due and shall be paid to the department
for the Unemployment Fund by each employer in accordance
with this division and shall not be deducted in whole or in
part from the wages of individuals in his employ.”
Cal. Unemp. Ins. Code § 976.
On appeal, the Bankruptcy Appellate Panel of the Ninth Circuit Court of Appeals stated:
“We focus our inquiry on the meaning of the phrase ‘tax
required to be collected.’ Even though the EDD concedes
that unemployment insurance tax is not withheld from employees,
it nonetheless maintains that the UI Tax falls within the
scope of § 507(a)(8)(C).”
The Bankruptcy Appellate Panel cited to the following legislative history:
“As set forth in the Joint Statement of Representative Edwards and
Senator DeConcini, which accompanied the negotiated provision,
subparagraph (C) would establish priority for claims arising from:
Taxes which the debtor was required by law to withhold or collect from others and for
which he is liable in any capacity, regardless of the age of the tax claims. This category covers the so-called “trust fund” taxes, that is, income taxes which an employer is required to withhold from the pay of his employees, and the employees’ share of social security taxes.
124 Cong. Rec. 32,415 (1978) (emphasis supplied).
Based on the legislative history, the Bankruptcy Appellate Panel resolved the dispute in favor
of the Debtors. It noted:
“The legislative history shows that under § 507(a)(8)(C), a ‘tax required to be collected’ must be collected from a third party. The UI Tax at issue here is not collected from a third party. Rather, as the EDD explained at oral argument, unemployment insurances taxes are payable directly by the employer; here, that was Onvoi. As such, it is not a ‘tax required to be collected’ from anyone; Onvoi was responsible for its own debts. For this reason, we cannot conclude that the UI Tax is a tax of the kind specified in § 507(a)(8)(C).”