The opinion of the court was delivered by: J. Garvan Murtha Honorable J. Garvan Murtha United States District Judge
Plaintiffs Mark T. Brady and Mary T. Brady ("the Bradys") bring this action against the United States*fn1 for civil damages following a protracted dispute with the Internal Revenue Service ("IRS") over its application of a tax payment made in 1998. The Bradys have moved for summary judgment (Doc.12), which the United States has opposed. (Doc. 16.) The United States has also responded by moving to dismiss the Bradys' complaint for lack of jurisdiction or, alternatively, for summary judgment. (Doc. 17.) The Bradys have opposed this motion. (Doc. 19.) For the reasons that follow, the United States' motion to dismiss is GRANTED, and the Bradys' and the United States' motions for summary judgment are DENIED as moot.
In addition to these substantive motions, the United States has moved to strike the Bradys' reply to its summary judgment motion or, if denied, to file a sur-reply. (Doc. 20.) The motion to strike is DENIED, and the motion to file a sur-reply is GRANTED. The clerk shall docket the proposed sur-reply, which the United States attached to its motion. (Doc. 20-1.)
The Bradys were the principals of Pro-Radio, Inc., which began incurring significant tax liabilities with the IRS in the early 1990s. (Doc. 17-16 at 1-2.) These liabilities were comprised of two types of employment taxes: trust fund taxes and non-trust fund taxes. Id. at 3. A trust fund tax is withheld by an employer from an employee's wages for payment of that employee's taxes. William D. Elliott, Federal Tax Collections, Liens and Levies § 20.09(9)(a) (2012). An employer, in contrast, owes a non-trust fund tax directly to the IRS. Id. The Internal Revenue Code ("IRC") subjects a corporation's principals, as well other responsible persons, to trust fund recovery penalties ("TFRPs") for failing to remit a trust fund tax to the IRS. 26 U.S.C. §§ 6672(a), 6671(b). There is no analogous penalty for non-trust fund taxes.
Pro-Radio filed a chapter 11 bankruptcy petition in January 1997. (Doc. 17-16 at 2.) Later that year, the IRS began assessing TFRPs against both of the Bradys as individuals. (Doc. 17-11 at 4.) The IRS continued to assess TFRPs through December 1998. Id.
In June of 1997, Pro-Radio sought authorization from the bankruptcy court to sell an FM radio station it owned. (Doc. 17-4 at 1.) The proposed order Pro-Radio submitted applied the proceeds towards its trust fund taxes first, with the remaining proceeds covering non-trust fund taxes. Id. at 22. The United States filed a partial objection, arguing that United States v. Energy Resources Co., 295 U.S. 545 (1990) prevented Pro-Radio from designating the payment of trust fund taxes first absent a showing that its successful reorganization required such an arrangement. (Doc. 17-4 at 1-2.) The United States limited its objection to the allocation of the proceeds; it raised no objection to the sale of the radio station. Id. Following a hearing, the bankruptcy court entered Pro-Radio's proposed order with certain hand-written modifications, including a footnote with respect to the IRS's claim stating, "All rights of the IRS reserved as to the allocation." (Doc. 17-6 at 2.)
Pro-Radio sold the radio station in November 1998 and paid the IRS just under $220,000 the following month. (Doc. 17-11 at 2.) The IRS then allocated approximately $44,000 of this payment towards Pro-Radio's post-petition tax liabilities. Id. at 2. The approximately $175,000 remaining was applied towards pre-petition tax liabilities, with around $84,000 applied against non-trust fund taxes first and the remaining $91,000 applied against trust fund taxes. Id. at 2; Doc. 17-16 at 3. Immediately before the IRS processed this payment, Pro-Radio owed just over $219,000 in pre-petition trust fund taxes. (Doc. 17-11 at 2.) Pro-Radio owed approximately $128,000 in trust fund taxes after the IRS processed the payment on December 28, 1998. Id. at 3. Had the IRS first applied Pro-Radio's payment towards trust fund taxes, the payment would have covered this liability in full and eliminated the TFRPs against the Bradys.*fn3 The IRS would have had approximately $150 to cover Pro-Radio's remaining tax liabilities.
In the years following this payment, the IRS sought to collect the TFRPs assessed against the Bradys. (Doc. 19 at 3.) The Bradys disputed the assessment through various appeals within the IRS and entered several offers of compromise in the process. (Doc. 17-6 at 5-10; 19-2 at 1, 3; 19-7 at 3.) In a 2004 letter to the IRS, the Bradys made it clear they disputed the IRS's application of the payment from Pro-Radio's bankruptcy.
In accordance with the intent of The U.S. Bankruptcy Court in Vermont, the Judge in 1997 directed that payments owed be applied "to the trust fund portion of the IRS claim." Joe Barry, in the Burlington office, has calculated if that had occurred in accordance with The Court's wishes, the balance owed the trust fund portion would be $33,202 - provided his manual computations are correct. (Doc. 19-2 at 1.) A 2005 letter likewise demonstrates that the Bradys understood the IRS had not applied the payment against the trust fund taxes first.
The Bankruptcy Court's intent (attached) was clear. Payments were to have been applied to The Trust Fund Portion. It was only after the IRS representative in a motion that was arbitrary, capricious and perhaps punitive, requested the right to ...