United States v. Sotelo
56 L. Ed. 2d 275, 98 S. Ct. 1795, 1978 U.S. LEXIS 9 (1978)
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Rule of Law:
A corporate officer's personal liability under Internal Revenue Code § 6672 for willfully failing to pay over federal withholding taxes collected from employees is a nondischargeable debt in bankruptcy under § 17a(1)(e) of the Bankruptcy Act.
Facts:
- Onofre J. Sotelo was the president, director, majority stockholder, and chief executive officer of his company, O. J. Sotelo & Sons Masonry, Inc.
- The corporation withheld federal income and Social Security taxes from its employees' wages as required by law.
- The corporation failed to pay these withheld funds over to the U.S. Government.
- Subsequently, Sotelo, his wife, and their corporation were all adjudicated bankrupts.
Procedural Posture:
- The Internal Revenue Service (IRS) filed a claim against Onofre Sotelo's personal bankruptcy estate, asserting he was personally liable under IRC § 6672 for his corporation's unpaid withholding taxes.
- The bankruptcy court (court of first instance) found Sotelo personally liable for $32,840.71; this ruling was not appealed.
- When the IRS later served a notice of levy on funds in the estate, Sotelo objected, arguing the liability was a 'penalty' discharged by his bankruptcy.
- The bankruptcy court ruled that the liability was nondischargeable, treating it as a tax in substance.
- The U.S. District Court for the Southern District of Illinois (trial court on appeal) affirmed the bankruptcy court's decision.
- Sotelo, as appellant, appealed to the U.S. Court of Appeals for the Seventh Circuit (intermediate appellate court), which reversed, holding that the liability was a dischargeable penalty. The United States was the appellee.
- The United States, as petitioner, was granted a writ of certiorari by the U.S. Supreme Court to review the Seventh Circuit's decision.
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Issue:
Does § 17a(1)(e) of the Bankruptcy Act, which makes nondischargeable any liability for taxes 'which the bankrupt has collected or withheld from others...but has not paid over,' prevent the discharge of a corporate officer's personal liability imposed as a 'penalty' under Internal Revenue Code § 6672 for the corporation's failure to pay over withheld taxes?
Opinions:
Majority - Justice Marshall
Yes, § 17a(1)(e) of the Bankruptcy Act prevents the discharge of a corporate officer's personal liability under IRC § 6672. The court reasoned that although § 6672 labels the liability a 'penalty,' its essential character is that of a tax, as the funds were unquestionably taxes when collected from employees. Because Sotelo's liability under § 6672 established him as a person 'required to collect, truthfully account for, and pay over' the taxes, he falls within the scope of a bankrupt who 'has collected or withheld from others' under § 17a(1)(e). The legislative history of the 1966 amendments to the Bankruptcy Act confirms that Congress specifically intended to prevent responsible persons from discharging their obligations for these 'trust fund taxes,' thereby ensuring the government could recover funds that were converted for corporate or personal use.
Dissenting - Justice Rehnquist
No, the liability should be discharged. The dissent argued that the majority misinterprets the statutory structure, as § 17a(1)(e) is merely a proviso to § 17a(1) and a debt must first qualify as a 'tax' under the main clause. The liability under § 6672 is explicitly denominated a 'penalty,' not a 'tax,' and Congress chose not to equate the two for bankruptcy purposes despite being aware of the distinction. The majority's holding contradicts the benevolent purpose of the 1966 amendments, which was to grant bankrupts a 'fresh start' by limiting the nondischargeability of old tax debts. By creating a harsh, nondischargeable liability for corporate officers, the court strains the statutory language to achieve a result contrary to the Bankruptcy Act's core policy of rehabilitation.
Analysis:
This decision solidifies the principle that the substance of a debt, rather than its statutory label, governs its treatment in bankruptcy. By classifying the § 6672 'penalty' as a nondischargeable tax, the Court significantly strengthened the IRS's ability to collect unpaid trust fund taxes from responsible corporate officers. This precedent prevents individuals from using the corporate form and personal bankruptcy as a shield to escape liability for taxes held in trust for the government, effectively closing a potential loophole. The ruling ensures that the personal liability of responsible officers for such 'trust fund' taxes survives bankruptcy, which has a major impact on business owners and corporate fiduciaries.
