National Association of Attorneys General

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Read My Lips: No New Fees | Recognizing and Recovering "Tax" Claims in Bankruptcy Cases

Karen Cordry, NAAG Bankruptcy Chief Counsel and Mark D. Silverschotz, Co-Chair, Anderson Kill's Bankruptcy & Restructuring Practice Group

“What’s in a name? That which we call a rose by any other name would smell as sweet.”[1]

A rose is a rose is a rose.”[2]

I. Introduction

The U.S. Supreme Court and various circuit courts have tried to provide guidance on how best to determine whether a particular obligation owed to a governmental entity is a “tax,” “fee,” “penalty,” or a simple contract debt, but clarity on the subject remains lacking.[3] And, even if it were easy to define these terms, governments appearing in bankruptcy cases must still properly analyze their claims so as to be able to assert the most beneficial status that is legally appropriate. Failure to take those steps can result in millions of dollars lost to the states during these times of tight revenues and rising expenses. The goal of this article is to help government counsel avoid those losses.

The article first addresses the history of the distinctions among taxes, fees, penalties, and other types of debts, then reviews relevant opinions addressing those distinctions and the tests set forth, and, finally, assesses the merits of those tests. We will critique the cases we find less than persuasive and conclude with the same point we made to begin this article, namely that, as state lawyers charged with representing the best interests of our clients and their non-bankrupt taxpayers, attorneys general must put forward their strongest arguments for claiming the highest justifiable bankruptcy claim status for the states’ debts.

Importantly, we will not ruminate on the “proper” level of taxation; what goods and services government should provide and to whom; or who should pay for those goods and services. This article will simply point out the adverse effects, particularly in bankruptcy, of having monetary obligations owed to the state treated not as taxes, but rather as user fees or penalties or general debts. The bottom line is that those interests will almost always weigh in favor of arguing for treating government claims as taxes. The reason is simple – virtually all “taxes” receive priority in bankruptcy in laying claim to a debtor’s limited assets.[4] By contrast, “fees” or other non-tax debts owed to the state are normally relegated to the status of general unsecured claims. Penalties are usually even lower in the pecking order and are often subordinated to all other claims.

Moreover, where a debtor seeks to reorganize and continue to operate, its plan must provide for full payment of all priority taxes within five years from the date the case was filed with interest thereon being paid from the confirmation date.[5] There is no similar minimum payment requirement, on the other hand, for general unsecured claims. Those holding such claims may find themselves being paid only a fraction, or even nothing, of what they are owed. If there is not enough to pay all general claims, the status of the holder of a subordinated claim is even more woeful. And, finally, a priority tax debt automatically is excepted from discharge in an individual’s bankruptcy.[6] Thus, if the government seeks to protect its ability to collect amounts owed to it (and its other taxpayers), it is critical to carefully assess the exact nature of the obligation and, if possible, to demonstrate that — at least in the world of bankruptcy — it is a “tax.”

II. Why Not Call It a Rose?

There are many well-known quotes about taxes and their inevitability. Benjamin Franklin referred to the well-known axiom in 1789,[7] but its appearance is documented as early as 1716 in The Cobbler of Preston by Christopher Bullock — “Tis impossible to be sure of anything but Death and Taxes.” But, even if inevitable, the respect for taxes in modern day society appears to have suffered something of a setback from when Justice Oliver Wendell Holmes wrote in Compania General de Tabacos de Filipinas v. Collector of Internal Revenue, 275 U.S. 87, 100 (1927) that:

It is true . . . that every exaction of money for an act is a discouragement to the extent of the payment required, but that which in its immediacy is a discouragement may be part of an encouragement when seen in its organic connection with the whole. Taxes are what we pay for civilized society, including the chance to insure.[8]

And his was merely one in a long line of prior similar statements during the 1800s and well into the 1900s.[9] Holmes, indeed, according to Justice Felix Frankfurter, stated even more pithily, “I like to pay taxes. With them I buy civilization.”[10]

For the last few decades, however, the role of taxes and their claim for necessity has become more controversial. George H.W. Bush’s campaign promise: “Read my lips; no new taxes” is perhaps the clearest articulated antipathy to taxes.[11] Yet, as a practical matter, all governments are charged with undertaking certain minimum functions while providing for the health, safety, and welfare of their constituencies, and virtually all of those obligations come at a cost. While one may differ as to how to define those “minimums,” it is clear that at least some taxes will need to be assessed and collected.

But, in light of those sensitivities as to how raising funds will be perceived by voters, recent discussions often seek to describe money generation in terms other than “taxes.” In some cases, this is meant to signify a substantive difference; i.e., that one is not imposing involuntary “taxes,” but rather purportedly only charging voluntary “user fees.” For example, former Minnesota Governor Tim Pawlenty, seeking to raise some $380 million through charges on the sale of tobacco products, said “I believe this is a user fee. Some people are going to say it’s a tax. I’m going to say it’s a compromise and a solution to move Minnesota forward.”[12] An elegant side-stepping of the question, but —as will be shown — this pretty clearly is a tax.

As another example, in South Carolina, legislators proposing an increase in gasoline costs, differentiated between generally available tax revenue versus costs imposed for a specific purpose, contending that “[w]e are not going to raise anybody one penny in taxes . . . . The difference between a fee and a tax . . . is that a fee is revenue generated for a specific purpose. If that purpose goes 100 percent to fix the roads, then it is a fee. It is not a tax.”[13] As will be shown below, this isn’t really correct either.

And, as Thomas Donohue, former president of the U.S. Chamber of Commerce, noted in calling for an increase in the federal gasoline tax, “The right kind of tax reform will turbocharge our growth, create jobs and generate more revenues for government at all levels,” but “[a] lot of people in the Chamber get a little squishy because a lot of people on [Capitol] Hill don’t like anything that sounds like a tax. . . . It’s not a tax, it’s a user fee. And if you don’t want to ride on the roads you don’t have to pay for it.”[14]

In the non-bankruptcy world, it may not make much difference what one chooses to call a source of revenue, even if some attempts to avoid calling something a “tax” probably don’t pass the “I know it when I see it” test.[15] So, if one calls a payment a fee and, thereby obtains its passage, it rarely will make much difference. But, in bankruptcy cases, in particular, the category into which a payment obligation is deemed to fall can have immense real world consequences. And, as government lawyers, it’s your job to try to end up on the right side of those consequences, including by correctly analyzing the nature of the charge and arguing for it to be a tax if the claim can be fairly made.

III. When Did It Start to Make a Difference?

The first federal law to address payment of debts owed to the federal government was passed in 1797 and gave priority to all such debts over those owed to other parties (“[W]here any . . . person hereafter becoming indebted to the United States shall become is insolvent . . . the debt due to the United States shall be first satisfied.”)[16] The first true bankruptcy act, passed in 1800,[17] similarly provided in section 62 that “Nothing contained in this law shall, in any manner, effect [sic]the right of preference to prior satisfaction of debts due to the United States as secured or provided by any law heretofore passed, nor shall it be construed to lessen or impair any right to, or security for, money due to the United States or to any of them.”[18] (Emphasis added.) Although that law was repealed a few years later, the next law, passed in 1841 (and repealed in 1843), similarly gave priority to all debts owed to the United States.[19]

Then, in 1867, when a third bankruptcy act was passed,[20] the treatment of debts owed to the United States was extended to the state in which the bankruptcy was filed. Under that law, there was no functional distinction between “taxes” and “fees” insofar as the act gave priority of payment to all debts, taxes, and assessments due to the United States, and then the next priority to all debts, taxes and assessments due to the state in which the proceedings in bankruptcy were pending, and further provided that nothing contained in the act should interfere with assessment and collection of taxes by the authority of the United States or any state.[21] This Act, too, though was repealed (although it did manage to endure until 1878), but it was the precursor of the Bankruptcy Act of 1898, which had the distinction of being the first bankruptcy act that “stuck.”[22] Since 1898, there has continuously been federal legislation in place – first, the 1898 Act, with a major revision in 1938 — and then the Bankruptcy Code in 1978 that was a complete rewrite of the prior Act.

The 1898 Act provided, in section 64(a), that “[t]he court shall order the trustee to pay all taxes legally due and owing by the bankrupt to the United States, State, county, district, or municipality in advance of the payment of dividends to creditors . . . .” From the states’ perspective, this new provision was a bit of a mixed bag; now all states (not just the forum state) had their tax debts paid pro rata with the priority accorded to such debts owed to the United States, but they lost any priority for their other debts (as did the United States). The resulting distinction between the priority for tax debts and the lack thereof for other governmental claims lingers to this date.[23] As a result, if the government seeks to ensure priority for its claim, it will have to prove that the payment is a “tax,” not a fee, not a general debt — and certainly not a penalty. So — what is a tax?

IV. Knowing it When We See It – When is a Tax is a Tax is a Tax?

A. The U.S. Supreme Court Speaks

In New Jersey v. Anderson, 203 U.S. 483, 489 (1906) (Anderson), the Court addressed whether a particular “claim [was] a tax legally due and owing to the State of New Jersey[.]” The claim at issue was a charge on the existence of a corporation, based on the value of its stock. In a prior case (which had dealt with whether, under certain conditions, a corporation was exempt from any taxes on its stock), the New Jersey court had held that this same obligation was a “tax,” even though at times the relevant statute called the debt a “license fee.” The state court had held, though, that:

It is wholly immaterial what name may be given to it. The fact that it is called a “license fee” or “franchise tax” cannot validate it. It is levied under an act passed ‘to authorize the imposition of state taxes’ and it is none the less . . . a tax because it is given a new name.[24]

In deciding how much (or how little) weight to give to the state’s expressed view in its statute on the issue, the Supreme Court held that “the bankruptcy act is a Federal statute, the ultimate interpretation of which is in the Federal courts.”[25] More particularly, the Court stated that “[t]he state court may construe a statute and define its meaning [as to what its covers], but whether [that] construction creates a tax within the meaning of a Federal statute, giving a preference to taxes, is a federal question, of ultimate decision in this court.”[26]

In so construing the New Jersey statue, the Anderson court observed that:

[G}enerally speaking, a tax is a pecuniary burden laid upon individuals or property for the purpose of supporting the Government. . . . Taxes are not debts. . . . Debts are obligation for the payment of money founded upon contract, express or implied. Taxes are imposts levied for the support of the Government, or for some special purpose authorized by it. The consent of the taxpayer is not necessary to their enforcement.

And, although the corporation had “chosen” to come into being and seek a charter, the amount charged as the franchise tax and the need to pay that amount were matters not within its control and that could be changed by the state without its consent. As such, the payment was a tax and entitled to priority.[27]

In New York v. Feiring, 313 U.S. 283 (1941), the Court again addressed the issue in dealing with a claim for sales tax that the debtor had failed to collect from its customers. The Court condensed its holding in Anderson, stating that“the priority commanded by § 64 extends to those pecuniary burdens laid upon individuals or their property, regardless of their consent, for the purpose of defraying the expenses of government or of undertakings authorized by it.”

State statutory language and decisional law were relevant for the Court to determine whether the incidents that they imposed “are such as to constitute a tax within the meaning of [the Act].”[28] Under that law, the debtor was liable to pay the sales tax whether or not it collected the funds from its customers. “A pecuniary burden so laid upon the bankrupt seller for the support of government, and without his consent, thus has all the characteristics of a tax entitled to priority of payment in bankruptcy within the meaning of § 64 of the Bankruptcy Act.”[29] This definition seems straightforward, but it quickly became clear that some courts thought more was needed to stop governmental entities from being too easily able to turn all of their debts into priority taxes.

B. The Ninth Circuit Muddies the Waters in Lorber

The first significant appellate court decision dealing with the application of Anderson and Feiring was In re Lorber Industries of California, Inc., 675 F. 2d 1062 (9th Cir. 1982) (Lorber), which arose under the Act (although decided after the Code was enacted in 1978). Lorber addressed a statutory mechanism for allocating wastewater treatment system costs. The system previously had been fully funded by ad valorem property taxes (which no one questioned as being “taxes”), but when the Clean Water Act was enacted, it required applicants for grants to use a billing structure based on the volumes generated to encourage conservation and to avoid having high usage facilities subsidized by those using less. A surcharge was imposed on high volume users with a credit for the property taxes they paid; the balance above the property taxes was labeled as a “user fee.”[30] (It’s not clear if the statute so labeled this cost or if this was just the Ninth Circuit’s own choice of words.)

Lorber produced such large volumes of wastewater and was, accordingly, assessed a surcharge of $53,000 for the years 1974-77. When it filed bankruptcy, the local water district filed a priority claim for those amounts, asserting that they were taxes under section 64. The bankruptcy court initially concluded that the surcharge should be treated as a user fee, stating that Lorber was not legally required to use the district’s treatment system. On remand from the district court, however, the bankruptcy court found that, as a practical matter, there were no other economically feasible alternatives for Lorber to use.[31] Based on that finding, the district court concluded that the surcharge was a tax, since the water district was allowed to assess anyone who used its services without negotiating contractual terms and Lorber’s use was “involuntary,” as a practical, factual matter.[32]

On Lorber’s appeal, however, the Ninth Circuit took a different approach. It first stated that it must decide if the obligations were “taxes,” as defined in Anderson/Feiring, and then added that “their classification as priority claims must be consistent with the terms and purposes of section 64(a) and the other provisions of the Act. New York v. Feiring, 313 U.S. at 285.” However, while Feiring does refer to the “terms and purposes” of the Act as cited, it does so only to decide how to define what is a “tax” to begin with, not as an additional equitable limit on what qualifying tax obligations should be given priority.

In deciding how to characterize this obligation, the Lorber court began with its prior decision in Dungan v. Dept. of Agric., State of California, 332 F. 2d 793 (9th Cir. 1964). There, the court had affirmed the holding of In re Farmers Frozen Food Company, 221 F. Supp. 385, 387 (N.D. Cal. 1963), that a tax will have the following elements:

(a) An involuntary pecuniary burden, regardless of name, laid upon individuals or property;

(b) Imposed by, or under authority of the legislature;

(c) For public purposes, including the purposes of defraying expenses of government or undertakings authorized by it;

(d) Under the police or taxing power of the state.

Those criteria, of course, do little more than paraphrase Anderson, Feiring, and related cases. Indeed, some of the cases Farmers cited (such as In re MidAmerica Co., 31 F. Supp. 601, 604 (S.D. Ill. 1939)), had emphasized that taxes were not to be given an unduly narrow scope:

Some decisions narrowly restrict the meaning of the word, but there is nothing in the provisions of the Bankruptcy Act which justifies any such restricted definition. The words there used are: “* * * taxes legally due and owing by the bankrupt to the United States or state or any subdivision thereof.’ There is no justification in such language for a definition in a narrow or restricted sense.”

The Lorber court noted that there were several factors that suggested this charge was a tax: all users were assessed property taxes that were used to fund the water treatment system, the surcharge for excess industrial use was imposed under the same statutory authority as the property taxes, it was collected and enforced in the same way as the property taxes, and the amount collected took the amount of the property taxes paid as a credit, so the two charges were functionally related.

Nevertheless, the court concluded that the question, while “close,” should be resolved in favor of finding the charges to be “fees.” In so doing, it relied upon National Cable Television Association v. United States, 415 U.S. 336 (1964) (National Cable) which had analyzed the charges imposed by the Federal Communications Commission (FCC) on “community antenna television;” i.e., the then-nascent cable TV systems. In National Cable, the Court began with the critical point – that it was analyzing the authority of an agency to impose a charge under its regulatory authority, not the power of a legislature exercising its taxing power. The Court stated “It would be such a sharp break with our traditions to conclude that Congress had bestowed on a federal agency the taxing power that we read [the enabling legislation] narrowly as authorizing not a “tax” but a “fee.”[33] (Emphasis added.)

As such, the Court limited the types of charges the FCC could lawfully impose to only those that would benefit the applicant specifically and not those that would serve the “public interest” generally because the opposite approach would carry the agency “far from its current orbit and put[] it in search of revenue in the manner of an Appropriations Committee of the House.”[34] The Court further noted that legislatures had the power to impose heavy taxes to discourage an activity,[35] or light ones to encourage it, and the exercise of those prerogatives did not change the nature of the imposition as a tax. But, an agency — whose only authority was to be reimbursed for benefits it provided to the recipient — could not charge the full costs of its operations to the regulated entities because that would suggest that its regulatory efforts provided no benefit to the public. No agency would ever admit to having such a negligible effect (and presumably Congress would not have enacted a statute that did not purport to create a public benefit from the agency’s actions)! Thus, the Court held, the case should be remanded to have the charges limited to only those appropriate for a “fee” and not a ‘tax.”

In considering National Cable, it is critical to note that the Court did not decide this was a fee and not a tax because of the specific nature of the exaction — rather, the Court began with the premise that an agency can normally only impose a fee and then worked backwards to decide what charges could be imposed as a “fee.” The Court did not purport to set any limits on what could be a “tax” that the legislature imposed under its taxing powers. Yet, when the Ninth Circuit cited this case in Lorber, it ignored the distinction between agency and legislative powers and relied almost entirely on the voluntary choice of the industrial user to apply for a permit to use the system and discharge large volumes of water. Unlike in National Cable, Lorber did not receive some unique service from the government; rather it just received a lot more of the particular service than a typical residential user.[36]

For both types of users, the funds were applied to support the overall, integrated operations of the water treatment system. And, as the district court had noted, there was nothing truly “voluntary” about Lorber’s decision to seek a permit to use the district’s water treatment services. Short of shutting its business down entirely, the debtor was forced to use the services offered and forced to pay the charges that the district unilaterally imposed and modified when and if it saw fit. Certainly, there was nothing negotiated about those charges which is the usual hallmark of a “contractual” payment. So, the question as to what is meant by saying a party’s action is “voluntary” remains confusing – and led to a flurry of cases for a time (see below).

But first we must return to Lorber’s second added criterion, i.e., that finding a charge to be a tax must be equitably consistent with the goals of the Act. The court based this statement on a purported recitation of the history of the priority treatment of tax debts, but its discussion had several inaccuracies when checked against the history recited above. The Ninth Circuit wrongly thought the 1867 Act was the first to provide priority to tax debts (when in fact the United States had received such a priority since the 1800 Act), ignored the fact that all debts owed to the forum state were given priority in the 1867 Act, and then stated that the 1898 Act expanded the category of priority debts to include amounts owed to states and municipalities as well as the United States (instead of the correct facts that it narrowed the category of priority debts to exclude everything but taxes owed to any governmental entity). Thus, whatever the reasoning for excluding other debts, there is nothing in that history that suggests that Congress was trying to impose a narrow definition concerning which debts qualified as “taxes.”

In any event, the Ninth Circuit then stated that, as “accelerating taxation [after 1898] absorbed greater percentages of the bankrupt’s estate, Congress recognized that broad priority classifications hampered the goal of equitable distribution of the estate and penalized general creditors. As a result, the trend of amendments to section 64(a) has been to erode the preferred status of taxes.”[37] The court added that “[i]n view of this trend, it would be inappropriate for this court to expand priority status without a clear congressional mandate.”[38]

While that might sound plausible, the court actually cited nothing to support its assertion that the preferred status of taxes had eroded since 1898. And, in fact, the only “erosion” since 1898 in defining what constitutes a priority tax has been the imposition of time limits on how long taxes would retain their priority status.[39] That is, taxes that had become “stale” through the passage of time might eventually lose their priority status.[40] Nothing in that change indicated any revision to the nature of what was a tax, or any inclination of Congress to extend the limits on agency “fees” to the taxes that could be imposed by a legislative body under its taxing powers. Yet, based on that thinly supported reasoning, the Ninth Circuit essentially adopted a presumption against treating a state debt as a tax. In conclusion, having found that the district should have simply protected itself by imposing a lien on the debtor’s property, the court decided there was no need to accord priority status to these charges.[41]

C. The Sixth Circuit’s Post-Lorber Analysis

Many courts have had occasion since 1982 to rely upon the Lorber analysis in deciding the status of state claims, and some of those decisions have created more confusion than clarity. For example, in United States v. River Coal Co., 748 F. 2d 1103 (6th Cir. 1984) (River Coal) and In re Jenny Lynn Mining Co., 780 F. 2d 585 (6th Cir. 1986) (Jenny Lynn) the court considered two statutory mining laws. In the first, the Surface Mining Control and Reclamation Act of 1977 imposed both a prospective permit “fee” on mine operators and a requirement that each operator pay a per-ton “fee” into the Abandoned Mine Reclamation Fund to be held and administered by the secretary of the Interior to clean up mines generally and to protect the public health and safety. When the debtor in River Coal filed bankruptcy without paying the latter amounts, it argued that they were non-priority “fees” (as the statute’s wording literally said) and not priority taxes. The Sixth Circuit disagreed, stating that under National Cable, “the chief distinction is that a tax is an exaction for public purposes while a fee relates to an individual privilege or benefit to the payer.”[42] The court distinguished between the reclamation fees — which it found to be taxes – and the permit fee (noting that the analysis turned on the function the charge served, not the label applied thereto).

There is a clear distinction between the permit fee requirements and abandoned mine reclamation fees. The permit fee is charged for the privilege of carrying on mining operations. . . . Unlike the permit fee, the reclamation fee does not confer a benefit on the operator different from that enjoyed by the general public when environmental conditions are improved. On the contrary, it is an involuntary exaction for a public purpose to create a fund to be used for “reclamation and restoration of land and water resources adversely affected by past coal mining.” The reclamation fee has the essential characteristics of a tax, and we conclude it is a “tax” . . . [under the Bankruptcy Act].[43]

In Jenny Lynn, the court considered a similar state law that imposed a “permit fee” on the mine operator that was calculated by including a charge of $30 per acre to be mined as well as provision of a surety bond to cover the cost of reclamation of the land. The permit fee was also used to cover the costs of operating the agency. The bankruptcy court and district court found that the permit amounts were “excise taxes,” which are generally defined as “taxes imposed upon the performance of an act, the engaging in an occupation, or the enjoyment of a privilege."[44] The Sixth Circuit, however, held that the state permit amounts were fees, not taxes, pointing to its decision in River Coal, which had distinguished between permit fees and reclamation “fees,” both of which applied under the federal law. In the federal system, there appeared to also be a performance bond permit requirement that was separate from the reclamation fees and that had been treated (in dicta) in River Coal as a fee and not a tax. The court, thus, held that it should treat the similar permit/bond requirement in the state law as not being a tax.[45]

The Sixth Circuit rejected the view that the permit fee could be considered an excise tax “because the operator had requested a permit, and the permit bestowed a discrete benefit on the applicant — the privilege of operating a surface mine.”[46] However, while that statement is true, the court does not explain how that differs from the definition of an excise tax which includes, as noted, a “tax imposed upon the . . . engaging in an occupation.” The court did state that “Where a governmental unit imposes a charge in return for bestowing an individual benefit on one who requests permission to engage in a regulated activity, the charge is a fee rather than a tax.”[47] But, the court did not actually define what “benefit” the operator received from this charge (apart from simply being able to operate at all — which, as noted, is equally characteristic of an excise or franchise tax).[48]

In short, it is very difficult to determine how one distinguishes this case from a “franchise tax” imposed on those who choose to obtain the benefit of having a corporate charter from a particular state — a charge that Anderson treated as a tax. Moreover, the court placed great weight on the fact that, in River Coal, there were two separate amounts charged — one for the benefit of being allowed to operate and one for the abandoned mines fund, for which the operator received no separate benefit. Yet, would the situation have been different for the state in Jenny Lynn, had it merely broken up its single permit fee into two charges and argued that the portion used for reclamation activities were taxes? (They certainly would have comprised the great bulk of the amounts that would be owed.) If so, then this appears to be the type of “form over substance” approach that the Supreme Court has repeatedly rejected.

In short, it is difficult to understand how the Sixth Circuit draws the line it purports to establish in Jenny Lynn. One might have assumed that the court could have divided up the single payment and focused on the “public purpose” being served by at least part of the charge. A permit fee that only authorizes one to practice an operation will likely be quite limited in amount, scope, and benefit to the public. But, a fee that is large enough to cover all the costs of regulating and remedying the activities of a particular profession would be much more substantial. Is there a real analytical difference if the two amounts are charged in one versus two payments? If there is, the Sixth Circuit never explains what the difference would be. Instead, as the circuit court made clear later,[49] its primary concern was that focusing on the “public purpose” to be served by a payment would allow too many claims to be treated as taxes — a concern that, it conceded, it was “nearly alone” in raising. Thus, the result in Jenny Lynn appeared to have been result-driven; another example of when courts may force the government to operate under an adverse presumption in seeking tax status for their charges.

D. Voluntariness and Public Purpose Tests

Indeed, the problem with trying to rely too heavily on whether payments are mandatory or voluntary, as the Sixth and Ninth Circuit cases have done, rather than placing equal (or greater) emphasis on the “public purpose” served by the charge, can be seen in several cases that followed Lorber. In Oregon Dep't of Transp. v. Arrow Transp. Co. (In re Arrow Transp. Co.), 229 B.R. 456 (D. Ore. 1999) (Arrow), the district court was forced to reverse a decision by a bankruptcy court that had become too enamored with the “voluntary choice” analysis in Lorber. Under Oregon law, a motor carrier must pay a basic permit fee of $300 per year and then a “motor carrier tax” as well, which was imposed in lieu of payment of the ordinary 24 cents per gallon fuel tax charged to non-permit holders. Here, that tax totaled more than $75,000 for just two months, based on the weights of the debtor’s vehicles and the number of miles they traveled on Oregon roads. The funds were used for the “cost of administration of [the permit program] and for the maintenance, operation, construction and reconstruction of public highways.”[50]

Relying on Lorber, the bankruptcy court held that the motor carrier tax was a “fee” because it was the carrier’s voluntary choice to use the public roads that triggered its application. The court conceded that, “[a]dmittedly, it would be highly impractical, if not impossible, for a motor carrier to avoid using the highway and to stay in business” but Lorber had “unambiguously rejected” any reliance on the fact that practical alternatives were unavailable as proof that the fee was “mandatory.”[51] On appeal, the district court reversed, stating that “the involuntariness test in Lorber cannot be the determining factor in deciding whether an excise tax qualifies for priority under 11 U.S.C. § 507(a)(8)(E). Since an excise tax is, by definition, based upon a transaction which is voluntarily incurred, the application of the involuntariness test to an excise tax would render section 507(a)(8)(E) without meaning.”[52] And the court added, while Arrow could choose not to be a carrier at all, once it did decide to do so, “the obligation to contribute to the maintenance of the public highways is imposed by legislative fiat.”[53]

While the decision undoubtedly is correct, it is still somewhat difficult to determine exactly how to reconcile it with Lorber, or whether one should even try. Perhaps, one can simply say that, in Lorber, while there was a practical need to use the system if the debtor chose to operate at all, technically there was no legal requirement to do so. Perhaps another entity, with a smaller water usage, could have availed itself of other options that were not feasible as a practical matter for Lorber — and the decision as to whether an exaction is a “tax” must be made from the statute itself, not the individual facts of a particular case. But, if Lorber had taken that very narrow position, it would have been far less problematic than it has turned out to be for governmental entities over the years.

A further example of the when a “voluntary” decisions to incur charges is still a tax is seen in Trustees of the Trism Liquidating Trust v. Internal Revenue Service (In re Trism, Inc.), 311 B.R. 509 (8th Cir B.A.P. 2004) (Trism). In that case, the IRS sought priority status for an obligation imposed on the “operation of certain heavy motor vehicles” driven more than 5,000 miles per year. The obligation was set out in a statute entitled “Certain Other Excise Taxes.”[54] Despite this categorization, the estate’s trustees contended “the burden is voluntary because it is not imposed on the owner of every vehicle, only on those who choose to own and operate heavy trucks on the highways and drive at least 5000 miles annually”.[55] Moreover, they argued, since payment was a prerequisite to obtaining a trucking license, it should be treated as a permit, not a tax.

The BAP disagreed, finding that, while a label was not dispositive, the charge was a tax.

A tax is a general charge which does not correlate to any particular benefit to the payor. . . . In contrast, a fee is a charge exacted in exchange for a benefit to the payor not shared by other members of society. . . . The payor voluntarily pays a fee to receive a benefit or privilege which would not otherwise be available to it. (Citations omitted).

Here, the court held that the charge was involuntary in that it applied to every vehicle that fit the particular parameters in the Internal Revenue Code and was imposed by statute under the taxing power of Congress. The taxes collected under this section were to be used to build and maintain the highways generally, and the “benefit of improved highways is enjoyed by all members of society including those who do not drive on the highways yet benefit indirectly by the positive impact the highway system has on interstate commerce and the economy.” These costs did not provide a private benefit to the debtor.[56] Nor was it relevant that these taxes had to be paid in order to obtain the necessary permit to register and drive on a highway. “A tax is no less a tax because it has an impact on behavior or a regulatory effect.”[57]

And, finally, consider Fagan v. Collection Division, Michigan Department of Revenue (In re Fagan), 465 B.R. 472 (Bankr. E.D. Mich. 2012) (Fagan). The court there considered amounts owed for a $.15 per gallon fuel tax imposed on motor carriers under the Michigan Motor Carrier Fuel Tax Act. The debtors argued that the tax was “voluntary in the sense that a motor carrier could simply opt not to drive interstate but just stay within the state.” The court sharply disagreed: “This is sophistry. People can opt to be lawyers instead of motor carriers, but that does not make the tax on motor carriers voluntary. Once a motor carrier travels across state boundaries, the tax is imposed whether the motor carrier agrees to accept it or not.”[58]

These cases illustrate the basic fallacy in concentrating solely on the voluntariness of the conduct of the debtor. Other than breathing, almost any action by a debtor involves some sort of voluntary decision. Clearly, there must be both a voluntary decision to engage in some conduct and a voluntary decision to enter into a financial transaction with the state to carry out that conduct before one can even begin to argue about whether the payment to the state is a tax or a fee or some other form of debt. Where one chooses to operate a motor vehicle, or to own property, or to purchase cigarettes, and that choice carries with it the mandatory obligation to pay an amount set by the state legislature to be used for some public purpose that is enough to show that the payment is a tax.

E. Is the State Just Another Competitor? Workers’ Compensation in Focus.

Another problem emerges where one chooses to engage in conduct that requires a good or service that can be supplied by both the government and a private party. That issue, in the context of workers’ compensation obligations, has occasioned two influential (if not necessarily correct) Sixth Circuit decisions. It was also, at bottom, the issue in Lorber – while the simplest way to obtain water and sewage services was to use the municipal facilities, entities were not legally required to do so and the Ninth Circuit declined to find that the practical factors encouraging Lorber to use that service were sufficient to push this voluntary charge over the line into being a tax. Certainly, though, had the city required all entities within its boundaries to tie into the municipal water and sewer supply service, the case may well have come out the other way.[59]

In any event, there clearly are scenarios where the government offers a service but there are practical options that a debtor may choose to use instead. If so, does that automatically mean that the payments to the government are non-taxes even if they would otherwise qualify? The Sixth and Ninth Circuits have addressed this issue as well, [60] primarily in connection with claims arising from workers’ compensation systems. Those systems come in a variety of flavors. Some states impose premiums on all employers that are placed in a pool to administer and pay for benefits for all employees (often referred to as a “monopolistic” system). Other states offer a system that competes with private insurers, and still others merely require that an employer obtain coverage from a private insurer.

In Yoder v. Ohio Bureau of Workers' Compensation (In re Suburban Motor Freight, Inc.), 998 F.2d 338 (6th Cir. 1993) (Suburban I) in deciding whether state costs imposed in a non-exclusive situation were taxes, the court first noted two prior cases that, it stated (incorrectly), had disallowed tax status to payments to the state under non-monopolistic systems.[61] Although one case did rely on that factor, that case also relied in large part on the assertion that a fee imposed under a regulatory scheme, and not used to provide unrestricted general funds, did not qualify as a tax. See In re Metro Transportation Company, 117 B.R. 143, 154 (Bankr. E.D. Pa. 1990). While that latter point may also not be correct,[62] the former point; i.e., that the government may offer goods or services in a non-monopolistic system, is the same one addressed (albeit somewhat imperfectly) in Lorber. Such a competitive system tends to negate one of the primary criteria of a tax, i.e., that the charge is imposed on the taxpayer by governmental fiat. On the other hand, where all employers are required to operate under and pay into the government sponsored program, the Sixth Circuit agreed that such payments were taxes.[63]

The Sixth Circuit was not content, though, in Suburban I, to merely rely on the fact that the payments there were imposed on all employers to support a public program. Instead, it went out of its way to challenge whether the “public purpose” of the statute was even relevant. It found fault with the Lorber test, noting that its second and fourth prongs (legislative authorization and police/taxing power basis) “describe virtually every government program.”[64] Involuntariness, the first prong, had been conceded in Suburban I, leaving the court to only decide whether the levy had a “public purpose”. The panel asserted that “[t]he threat of the Lorber reasoning, then, is that the Government automatically wins priority for all money any debtor owes it, regardless of the nature of the payment.”[65] The court viewed this as potentially improperly returning to the state of the law under the 1867 Bankrupty Act where all government claims were given priority. It concluded that “to say as a matter of definition that all taxes are collected for public purposes does not allow the Government to say that all funds collected for public purposes are taxes; the converse does not necessarily follow from the premise.”[66] It ended, though, with agreeing that, in the monopolistic benefit system used in Ohio, the premiums imposed on all employers to provide for the medical and wage needs of injured workers were taxes.

The decision, standing alone, did not create a problem since this whole discussion was dicta in light of the nature of the system there. One might also note several arguable points in the court’s analysis — first, the second and fourth prongs of the Lorber test are not, in fact, universally applicable to government charges. To the contrary, they are precisely the basis on which National Cable distinguished the scope of permissible fees that an agency could impose under its non-legislative, regulatory powers from those a legislature could impose as taxes.[67] Second, involuntariness, while conceded in Suburban I, was, in fact, a distinguishing factor in other cases that had found charges under state laws in non-monopolistic states not to be taxes.

And, finally, the bete noire for the Sixth Circuit, the formulation in Lorber of the test for the law’s purpose; i.e., that it must be “for public purposes, including the purpose of defraying expenses of government or undertakings authorized by it,” is almost a word-for-word quote from Feiring. As such, the Sixth Circuit’s disagreement really appears to be with the Supreme Court, not the Ninth Circuit. Moreover, as shown above, the need to consider the purpose of a provision is undoubtedly critical — and is at the heart of the attempt to distinguish between user fees and other costs that only benefit a private party versus amounts collected by the government and used for the overall public’s benefit.[68]

F. Suburban II adds “Universal Applicability” and “No Governmental Advantage” to the Lorber Test

In any event, the Sixth Circuit soon returned to this same battlefield in Ohio Bureau of Workers’ Compensation v. Yoder (in re Suburban Motor Freight), 36 F. 3d. 484 (6th Cir. 1994) (Suburban II). The debtor there had self-insured in some years but had failed to make payments for its injured workers.[69] The state bureau, per state statute, stepped in, paid the claimants from an account funded by employers who paid premiums to the state, and sought priority for its claim for reimbursement of those costs. The Sixth Circuit refused to grant that treatment.

The circuit court first stated that, while satisfaction of the Lorber test was “necessary” for priority treatment, it was not “sufficient”[70] Rather, two additional tests must be satisfied: first, the obligation must be “universally applicable to similarly situated entities” and second, “according priority treatment to the government claim [must] not disadvantage private creditors with like claims.”[71] These tests, the court held, “refined” the public purpose test: the “universally applicable” provision ensured that the payment benefitted the general public and not just the payor, and the “not disadvantaging” private creditors test applied where the state had established a non-monopolistic system.[72]

The first provision is less problematic although it is far from clear that making everyone in a particular group pay a charge somehow proves that the public will benefit from that charge.[73] In any event, it is not clear that this adds anything to the “public purpose” test in Anderson/Feiring. The second criterion is more problematic in the context of the states’ costs to protect workers in a non-monopolistic system. In declining to grant priority status to the state’s claim, the court observed, that:

Suburban’s liability arises solely by virtue of its default, and is not a liability “universally applicable to similarly situated persons or firms.” The benefit resulting from Suburban’s liability for these claims payments is not one inuring to the public generally, and Suburban’s liability is a penalty discretely imposed due to its disregard of its statutory obligations. This lack of universality prevents the [workers’ compensation] Bureau’s claim from being accorded priority status.[74]

Yet, that seems to turn the provision on its head — of course, not everyone has to pay this amount since not everyone defaults, any more than everyone drives a truck across state lines. But, everyone that does default, whether self-insured or making payments under a state system, is liable to repay the amounts the state expends on its behalf, just as is anyone who drives a truck must pay for upkeep of the roads. Absent advances from the state fund, the debtor’s employees would be left without medical care or wages for extended periods of time until enforcement actions could be taken against their employer, a situation that is plainly in the public interest to remedy. But, here, the court held those factors would not suffice. Rather, the court held that, because there were private sureties who had provided bonds to help cover those same costs (and had their own claims for reimbursement), those private competing claims barred the state claims from being taxes. (The case is further complicated in that the state was seeking both payment of premiums and compensation for claims actually paid, which the court saw as seeking a double, i.e., punitive, remedy and that may also help explain the result.)

The Sixth Circuit’s approach is not universal: other courts, for instance, have found an obligation to reimburse benefits paid by the state to one’s employees when one fails to obtain required insurance to be a tax. For example, in Industrial Comm'n v. Camilli (In re Camilli), 94 F.3d 1330 (9th Cir. 2006), an employer’s decision to violate the law was held not the sort of “choice” that would detract from the involuntary nature of the reimbursement obligation.[75] And, the court held, the fact that private insurers who might receive premiums that they used to pay claims in the ordinary course were not comparable to the state’s reimbursement claims for purposes of the second prong of the Suburban II test. Here, the state was the only party paying for employees where coverage premiums had not been paid and, as such, the court saw no conflict with the decision in Suburban.[76]

In any event, the field of workers’ compensation is particularly complex.[77] But, as we move on, the question becomes whether — in concert with an additional analysis required by the Supreme Court in a third case — the two additional “Suburban tests” are of any use in determining when an obligation will be found to be a tax.[78]

G. Lorber and Suburban II Tests Yield to “Functional” Analysis; 

“Public Purpose” by Another Name?

Two years after Suburban II, the Supreme Court returned to this area in United States v. CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996) (CF&I). That case dealt with a statute that imposed a charge — labeled an “excise tax” — on underfunded plans. When the debtor filed bankruptcy, it argued that the payment was not a tax but, rather, a subordinated penalty. After reviewing Anderson, Feiring, and later cases, the Court noted that “in each instance the decision [as to the nature of the payment] turned on the actual effects of the exactions,”[79] thus requiring that the Court conduct a “functional examination” of the obligation owed to the governmental entity.”[80]

The Court noted that a “’tax is an enforced contribution to provide for the support of government; a penalty, as the word is here used, is an exaction imposed by statute as punishment for an unlawful act.’ United States v. La Franca, 282 U.S. 568, 572 (1931).” While taxes may, in some cases, be imposed to deter conduct, in most cases they are applied to actions that bear no sense of wrongdoing or taint. Penalties, on the other hand, always involve some form of misconduct and the Court found that to be the case here. Thus, it concluded that the delinquency charge, while labeled as a tax, really functioned as a penalty. In the end, while useful in helping to distinguish penalties and taxes in general, this case did little to help with the broader issue of whether a charge is a “tax” or some other form of debt, other than again to remind us to look beyond the label to the “function” of the payment, and who benefits from that payment.

One useful case for the states to illustrate the intersection of “functionality” and “public purpose” is Boston Regional Medical Center, Inc. v. Mass. Div. of Health Care Fin. and Policy, 365 F.3d 51 (1st Cir. 2004). That case dealt with a program that taxed all paid private sector care to create a pool of funds to pay hospitals for uncompensated care, thus providing “at bottom, [ ] a net transfer of revenue” from ‘richer’ hospitals to ‘poorer’ ones.”[81] The debtor owed some $1.7 million to that pool and the issue was whether that amount qualified as an excise tax. The debtor argued that under a “functional analysis” this amount was merely a risk-sharing “regulatory fee” imposed on the privilege of operating a hospital in Massachusetts (as in River Coal) and was not a tax.

Relying on the Lorber/Suburban factors, though, the First Circuit held, first, that the burden was involuntary because all hospitals had to pay into the pool. While the net amount due might vary based on the amount of free care the hospital chose to provide, it could not avoid payment altogether (except by going out of business).[82] Since the funds collected were for a public purpose — providing health care to the poor through the conduit of the hospitals — this satisfied one Lorber prong. The court also noted other decisions that had found that amounts collected for a fund to satisfy a public purpose (such as compensating those injured by uninsured motorists) were taxes.[83]

The court also found that the tax was uniformly applied even though certain hospitals would receive more in general and that those with the greatest need for reimbursement would receive the most. The tax was uniform, it held, because “acute hospitals with the same financial profiles in any given year will have the same liability in the Pool,” noting that “[u]nder debtor's reasoning, the federal personal income tax, which treats people with different incomes differently, would not constitute a tax.” So an exaction may be a tax even though it may apply differently to various entities, provided that the differences relate to the purposes of the tax.”[84] Finally, the court held that this charge did not fall into the “regulatory fee” category because it did not just provide a narrow benefit to the party paying the tax, or just defray the cost of regulation, but instead provided a benefit to the general public, i.e., ensuring health care for all.[85] Thus, contrary to the Sixth Circuit’s concerns in Suburban II about relying on the “public purpose’ to be served, this case suggests that that issue is very much a vital part of the tax analysis. Indeed, it appears to your authors to be inextricably intertwined with the “functionality” analysis, and, perhaps is even the most important starting point for the analysis.

Another case, for instance, found a payment to be a tax based on the “public purpose” served by the funds generated. International Tobacco Partners, Ltd. v. United States Department of Agriculture (In re International Tobacco Partners, Ltd.), 468 B.R. 582 (Bankr. E.D.N.Y. 2012) (ITP) dealt with the Fair and Equitable Tobacco Reform Act of 2004, which imposed assessments on tobacco manufacturers and importers to provide funding for a program used to wean tobacco growers off governmental price supports.[86] Although the debtor conceded that Lorber was otherwise satisfied, it argued that the payments were not for a public purpose because they solely benefitted a limited private group (the farmers).[87] The court rejected that argument, accepting the government’s view that a transition to a free market system would benefit the industry as a whole, that stabilizing a particular industry (even tobacco) was a public purpose, and that it would enable growers to have an economic buffer as they transitioned out of the industry.[88]

On the other hand, courts concerned with giving the government too much leeway can sometimes apply the “public benefit” test too literally. For example, unemployment benefits are surely an area of public concern and benefits.[89] Federal law dictates the structure of the programs that the states implement. One such federal requirement is that nonprofit employers must be allowed to make a “payment in lieu of taxes” (PILOT). A nonprofit that opts to make PILOTs does not pay unemployment premiums to the state (or contribute to the general overhead of the program); instead, it is only required to reimburse the unemployment fund for any payments actually made to its employees. A state may require such an employer to obtain a surety bond but not all do since this puts additional financial burdens on the employer (and the point of this provision was to help nonprofits by reducing their costs). The problem for the state arises when the nonprofit employer lays off a large number of employees at one time (often because it isspiraling into bankruptcy) and becomes liable for a huge lump-sum reimbursement obligation. Not surprisingly, the nonprofit employer probably cannot afford to make that payment, leaving the state with a large PILOT claim against the employer in the bankruptcy and the need to argue for priority tax status for that claim (in the same way it would have sought tax status for unpaid premiums owed by a for-profit employer).

In Mass. Div. of Empl. and Training v. Boston Reg'l Med. Ctr. (In re Boston Reg’l Med. Ctr.), 291 F.3d 111, 117 (1st Cir. 2002), both the bankruptcy court and the Bankruptcy Appellate Panel (BAP) viewed the PILOT claim as functionally equivalent to those premiums paid by for-profits, with merely a benefit to the nonprofit through their exclusion from liability for administrative costs. The First Circuit disagreed, though, holding that, in the absence of liability for that overhead cost, the nonprofit employer was only paying the costs for its own employees, which was not a public benefit.[90] While that might seem logical at first glance, it ignores that fact that it is not the employer who is benefitting at all. To the contrary, it is the employees who benefit and the debtor is acting more as a mere conduit for financial support to them, akin to the role played by the hospitals providing service to the poor. As such, this would appear to be consistent with a finding that the PILOT structure served a public interest.

The court also noted that these employers were not subject to income tax and found that that factor, along with the state’s choice not to demand a bond (so that it was not an involuntary creditor in the way that occurs for most tax debts) were sufficient to tip the scale against tax status.[91] Thus, the fact that these worthy, but not wealthy, employers were exempted from certain tax liabilities then became a basis to allow them to escape even more taxes. In the end, the court decided it was more appropriate to impose the burden of the losses from this nonprofit employer on the other employers in the state (who had no involvement with this debtor) than on the debtor’s other creditors who presumably had some choice as to whether to deal with it or not and who had benefitted prior to the bankruptcy from its lower operating costs.[92]

The same approach was taken by in Reconstituted Comm. of Unsecured Creditors of the United Healthcare System v. State of New Jersey Department of Labor (In re United Healthcare System), 396 F. 3d 247, 262, n. 26 (3rd Cir. 2005) (United Healthcare). Again, both the bankruptcy and district courts viewed the PILOT claim as equivalent to the taxes paid by other employers, but the Third Circuit (in a 2-1 decision) reversed. It held that, under CF & I, it was to conduct “a functional examination that balances the characteristics of the obligation at issue [to] signal whether an obligation is a tax for bankruptcy purposes, and that an examination should be flexible enough to allow for consideration of any relevant factor.”[93] Such an examination, it held, would obviate the concerns expressed in Suburban II that the four-factor Lorber test is too porous.[94]

Although agreeing that the issue was a close one, the Third Circuit held that, while the unemployment contribution obligation was a tax, a “payment in lieu of” that tax, was not. It was, instead, an “alternative to paying taxes rather than . . . an alternative method to pay a tax.”[95] Since the payments made by the non-profit only covered the costs of what it (or more accurately, its employees) received, this was not a public purpose, unlike those employers who contributed but might never have employees who collected from the fund. Although both employers taxes and PILOTs all served the same overall goal (and despite the fact that any amounts repaid by the debtor would go into the general fund and could pay for other employees), the amount of the payments was still only limited to benefits received directly by the debtor’s employers. Thus, the court held, it was not a question of “whether some pay more or less, but whether some are paying to sustain a general governmental undertaking while others only are reimbursing the system for exactly the benefits paid to their former employees.”[96]

The lower courts continue to be split on this issue. In re The Albert Lindley Memorial Hospital, 428 B.R. 283 (Bankr. N.D.N.Y. 2010), the court adopted the dissenting view of Judge Anthony J. Scirica and held that the payments were taxes. The court did note that New York law did not allow the government to require a surety bond so there was no third party entity that might be disadvantaged if the government claim were treated as a priority tax. On the other hand, the bankruptcy courts in Michigan, as set out in In re Community Hospital, 494 B.R. 906 (Bankr. E.D. Mich. 2013), have followed the First and Third Circuit analysis. In the end, this issue may need to be resolved by clarifying the Code.

H. Are Other Entities With Similar Claims Disadvantaged?

This is perhaps the most problematic aspect of the Suburban II test. To be sure, any payment to a priority creditor inherently reduces payments to other creditors. But, it is not clear why the fact that the burden may affect a creditor with a similar claim is any more important than if it affects disparate creditors. This test appears to be based on an assumption that a tax only exists if it provides a unique benefit from the government and not one where there may be private competitors. Yet, on reflection, it is obvious that taxes are often paid for things where a private supplier may also exist. Taxes are imposed to pay for schools even if some choose to send their children to private school and incur a debt for tuition. Yet the fact that the private school might lose out on its tuition claim in bankruptcy if the debtor’s limited assets are first used to pay local property taxes for those schools hardly changes the status of those debts as priority taxes. Or consider trash collection — this service is again often provided from general property taxes, yet one might well choose to pay a private trash collector. Doing so, though, does not defeat priority status for the taxes used to pay for that trash pickup.

In short, the issue is not really whether there exists a competitor to the service provided by the government. The real question is whether one must pay a mandatory charge to the government irrespective of one’s choice to use another provider. If the charge to the government may be avoided altogether by using an alternative service, then the decision to incur that charge is more in the nature of a voluntary contractual decision and less of a mandatory imposition. But, if so, then that issue is already subsumed in the original tests that look to the mandatory nature of the charge. In Lorber, there was no mandate on the employer to use city water charges even if it never used those services. Thus, the Lorber court perhaps was justified in saying that the payment obligations were not taxes. But the question of whether there was another entity that might compete with the government in providing a given service shouldn’t be the deciding factor. Those faced with an argument based on this Suburban factor should raise examples such as these to force the court to confront the illogic of this criterion. A voluntary contract with the government is not a tax, but a mandatory payment is, even if there are competitors who might like to offer the same service.

V. Why Does It All Matter?

To return to our opening proposition, the point of this article is to illustrate some of the ways in which it may be critical to determine if a payment is a “tax,” both within and outside of the bankruptcy context. The Supreme Court’s decision on the Affordable Care Act, for instance,[97] is an example of where the decision truly made a difference. That case, like others cited above, turned on a close examination of the “function” of the required payment, not the “form” of the label applied. The nature of the “individual mandate” came up in two ways: first, the decision to call the mandate a penalty was dipositive for purposes of deciding whether the Anti-Injunction Act applied (which bars suits to restrain the collection of taxes).[98] Since the Anti-Injunction Act exists to protect the government, the Court held that the government could equally choose to waive that protection by labeling the charge as a penalty. But under the “functional analysis” approach, that initial determination did not resolve the second question, i.e., whether the payment was substantively a tax.[99] As the Court cited, “’Magic words or labels’ should not ‘disable an otherwise constitutional levy.’ Quill Corp. v. North Dakota, 504 U.S. 298 (1992).” An amount labeled a tax may actually be a penalty (as was found in the CF & I case) or an amount labeled as a penalty may be a tax.[100]

The government argued that one could be taxed on the choice to not buy insurance and, while the issue deeply divided the court, the majority held that the mandate was, indeed, a tax. “[G]oing without insurance is just another thing the Government taxes, like buying gasoline or earning income.”[101] The payment is assessed on one’s tax return, is not owed if one does not otherwise owe taxes, is decided by the same factors that decide how much income tax is owed, is enforced by the IRS, and has “the essential feature of any tax: It produces at least some revenue for the government.” Conversely, compared to a true penalty, the amount owed under the “mandate” is generally far less than the cost to buy insurance, there is no implication of wrongdoing by those paying the mandate, and the IRS may not use criminal sanctions to collect the amounts.[102] And, while the mandate is expected to affect conduct, that does not detract from its being a tax. According to the Court, many taxes are meant to discourage particular conduct, noting, for instance, that federal and state taxes comprise more than half of the cost of cigarettes, and are imposed “not just to raise more money, but to discourage people from smoking.”[103] Discouraging conduct (such as going uninsured) is different from declaring the action to be unlawful or culpable such as would be the case with a true penalty.[104] Accordingly, the majority upheld the imposition of the “individual mandate” as a valid tax.

VI. Final Thoughts

Our ultimate observation simply is that the “functionality test” under CF & I often requires more than a cursory analysis. Further, it may sometimes be incumbent upon those of us who represent governmental entities to politely sidestep the stated public positions of our elected officials and perhaps even ignore the explicit nomenclature appended to a particular charge when determining how to argue its status under the bankruptcy code. Governments and their lawyers are not constrained by what their local politicians, agency executive directors, or anyone else for that matter, say about the “true” nature of a particular claim. What matters are the bankruptcy code, case law, and use of the proper tests. Each of us when representing a governmental entity must take an independent look at our claims, and ask whether the underlying obligations, as a matter of law, are taxes or “something else.” In times of shrinking budgets, no one with a bankruptcy claim should be “leaving money on the table.” Not “raising taxes” is one thing; not collecting taxes that have been imposed is quite another. So a few closing points:

  • Don’t get too hung up on labels. As the Supreme Court has repeatedly made clear, the analysis of what is a tax for bankruptcy purposes is a question of federal law that is based on careful examination of the precise characteristics and facts of the imposition at issue, not what it’s called.
  • Don’t assume that the analysis of a tax versus “something else” that is made under a different statutory scheme will be dispositive within the Code. Many of the discussions of “fees” versus taxes are made in the context of an amount imposed by an agency using its regulatory powers, not the legislature using its taxing powers. The National Cable decision, for instance, is often cited, but rarely with recognition of the limited basis of the holdings in that case. Similarly, citing isolated sentences from a case plucked out of their factual and legal context is rarely a way to get to the right result – and that is true even if the misuse of those sentences gets carelessly repeated and expanded over time.
  • Do concentrate on the truly salient factors:

I. Does the obligation to pay the amount look like something arrived at by contract, in which case a state couldn’t simply alter the obligation without violating the Impairment of Contracts Clause? Or is this an amount decided, imposed unilaterally, and alterable at will by the government?

II. Is there a discernible purpose that benefits the public at large rather than simply providing goods or services to a particular entity?

III. Can one avoid the payment by contracting with a private entity to provide the equivalent service (so that the payment is not “mandatory”) or must one still pay the government charge even if one also pays a private entity?

IV. If the charge is part of a regulatory scheme, is the amount more like that needed for simple administration of the program (especially if the program appears to benefit the payors), or is the amount substantially larger so that it raises revenues to provide benefits to the public at large?

V. Is the amount imposed for some wrongdoing (as opposed to a simple disincentive) and is the amount highly disproportionate to the underlying costs)? If so, this is more likely to be a penalty than a tax.[105]

If you are lucky, you will not be in a jurisdiction that has explicitly adopted the Suburban II factors, and you won’t have to try to explain how they apply (or are irrelevant to your scenario). If you do have to deal with a Suburban II analysis, the discussion above should give you some answers and tips as to the best way to get the court focused on the truly salient factors expressed by the Supreme Court and not sidetracked on the question of whether the state is getting too much of a benefit from the funds it collects.

We end as we began: our job as lawyers for — ultimately — taxpayers in our states is to make the best possible arguments for tax status recovery. We hope this discussion helps and are always available to discuss the issues in your scenarios.


[1] Romeo and Juliet (II, ii, 1-2) (Juliet rejecting the unwanted label “Montague” for her beloved Romeo).

[2] Gertrude Stein in various forms and contexts.

[3] The point of this article will become clear if one merely substitutes “taxes” for “roses” in the above quotes and then considers how difficult it is to decide whether one has a tax claim or not.

[4] Not all tax claims receive priority, but those that do not receive that treatment are typically excluded because they are “stale”; i.e., they were assessed more than a specified number of years prior to the bankruptcy case filing but have not yet been collected. Virtually any form of true tax is initially given priority under the Code.

[5] See section 1129(a)(9)(C) of the Bankruptcy Code, 11 U.S.C. § 101 et seq. (Hereafter all “section” references will be to the sections of the Bankruptcy Code unless otherwise noted.)

[6] In Chapters 7 and 11, the debt is directly excepted from discharge pursuant to Section 523(a)(1)(A) which covers all priority tax debts. In Chapter 13, the so-called “wage earner” chapter, the “super discharge” available under section 1328(a)(2) applies to most priority tax debts if the debtor completes his plan — but, to be confirmed, the plan must provide for full payment of those claims. See section 1322(a)(2). If the debtor cannot complete his plan, he may still receive a hardship discharge under section 1328(b), but that discharge is restricted to the same debts that are dischargeable under a Chapter 7 or 11 case. See section 1328(c).

[7] See Letter from Benjamin Franklin to M. Le Roy (Nov. 13, 1789), in 10 Works of Benjamin Franklin 410 (1944). (‘Our new Constitution is now established . . . but in this world nothing can be said to be certain, except death and taxes’)” cited in National Federation of Independent Businesses. v. Sebelius, 567 U.S. 519 (2012) (upholding the Affordable Care Act as an exercise of the taxing power).

[8] In light of the discussion in Sebelius, it is interesting to note that the Holmes quote itself comes out of a case about taxes on insurance premiums.

[9] See http://quoteinvestigator.com/2012/04/13/taxes-civilize/.

[10] Felix Frankfurter, Justice Holmes Defines the Constitution, Atl. Monthly484, 495 (Oct. 1938).

[11] The pledge supported by Grover Norquist’s Americans for Tax Reform for state legislators to sign (see www.atr.org) is perhaps the strictest example, reading simply that “I, [____], pledge to the taxpayers of the State of [____], that I will oppose and vote against any and all efforts to increase taxes.”

[12] Fee — “It’s not a Tax”— Could Hit Smokers. Laura McCallum, Minnesota Public Radio,

http://news.minnesota.publicradio.org/features/2005/05/20_mccalluml_cigfee/.

[13] Jason M. Rodriguez, Legislators: Fix South Carolina Transportation Department before Thinking Tax, Sun News, Jan. 9 2014, Myrtlebeachonline.com.(ellipsis and brackets in original)

[14] Liz Farmer, U.S. Chamber Chief Calls for Higher Gas Tax, Governing.com, Jan. 10, 2013, www.governing.com/news/state/gov-us-chamber-chief-calls-for-higher-gas-tax.html.

[15] See Jacobellis v. Ohio, 378 U.S. 184, 197-98 (1964), where Justice Stewart famously concurred in overturning Mr. Jacobellis’ obscenity conviction, stating “criminal laws in this area are constitutionally limited to hard-core pornography. I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.”

[16] Fourth Congress, Sess. 1, Ch. 20, Sec. 5 (1797) viewable at

https://memory.loc.gov/cgi-bin/ampage?collId=llsl&fileName=001/llsl001.db&recNum=638.

[17] Sixth Congress, Sess. I, Ch. 19, (1800) viewable at

https://memory.loc.gov/cgi-bin/ampage?collId=llsl&fileName=002/llsl002.db&recNum=73.

[18] The Court misread this provision in Central Virginia Cmty. College v. Katz, 546 U.S. 356 (2006) when it assumed that the term “preference” there meant the same thing as a “preference” in section 547 of the Code, i.e., a payment received by a creditor just before the bankruptcy that allowed it to receive more than other similarly situated creditors. This provision, to the contrary, uses “preference” for what we now refer to a “priority” under the Code. There is a provision in the 1800 Act that deals with “preferences” akin to those in current law, but this is completely separate from section 62, cited above, which protects both the states and the United States from any impairment of their right to be paid. Regardless, bankruptcy laws were only in place for a few years during the first century of American history and had little effect on the states. But as the number of cases has grown, the effects on the states has become more salient.

[19] Twenty-Seventh Congress, Sess. I, Ch. 9, Section 5 (1841), viewable at

https://memory.loc.gov/cgi-bin/ampage?collId=llsl&fileName=005/llsl005.db&recNum=481.

[20] Thirty-Ninth Congress, Sess. II., Ch. 176, Sec. 28 (1867), viewable at

https://memory.loc.gov/cgi-bin/ampage?collId=llsl&fileName=014/llsl014.db&recNum=562.

[21] Indeed, the language used was even broader than that contained in the current Tax Injunction Act and the Tax Anti-Injunction Act (28 U.S.C. § 1341 and 26 U.S.C. § 7421, respectively). These anti-injunction provisions relating to the collection of taxes are another reason why states should be interested in defining whether a particular payment is a tax, since they only preclude interference with collecting taxes, not other types of state debts.

[22] That said, much of what is in the Code can be traced back hundreds of years to English law that originated and codified provisions that are readily recognizable in modern day bankruptcy law.

[23] The priorities under the Code are spelled out in section 507(a). Since the 2005 amendments to the Code, claims for “domestic support obligations” (“DSOs”;” i.e., child support, alimony and maintenance) have been given first priority and, if the state is entitled to collect such obligations on its own behalf (i.e., where the state is owed the money directly based on having housed and fed a child, those payments are also first priority. After that, the next government priority does not occur until section 507(a)(8), covering taxes. There is one other priority at section 507(b)(9) for amounts owed to a federal agency to maintain capital of an insured depository institution, but all other governmental debts have lost priority status..

[24] Anderson, 203 U.S. at 490 (quoting Hancock U. Singer Mfg. Co., 62 N.J.L. 289 (Ct. of Errors & Appeals, NJ. (1898))

[25] Anderson, 203 U.S. at 491.

[26] Id. at 493.

[27] Id.

[28] Feiring, 313 U.S. at 285.

[29] Id. at 287.

[30] Lorber, 675 F.3d at1064.

[31] Id. at 1065.

[32] Id.

[33] National Cable, 415 U.S. at 341.

[34] Id.

[35] At some point, the burden of taxation arguably can be so high as to make the cost a penalty, but that presupposes that the same cost at a lower level would be a tax. Cf. Justice Holmes’ pithy assertion that "The power to tax is not the power to destroy while this Court sits." Panhandle Oil Co. v. Knox, 277 U.S. 218, 223 (1928) (dissenting opinion).

[36] Lorber, 675 F.2d at 1067.

[37] Id. at 1067-68.

[38] Id. at 1068.

[39] There has been some change in the level of priority granted vis-à-vis other priority claims, but taxes, as such, still remain a preferred object of payment in general and they must be paid in full in order to confirm a plan.

[40] In that regard, the limits on priority for older taxes are similar to other “caps” in the Code, such as on how many years of future rent a landlord may seek if a tenant debtor breaches the contract. See section 502(b)(6)). The general goal of such provisions is to not have one claim grow so large as to consume the entire estate

[41] 675 F.2d at 1068

[42] River Coal, 748 F.2d at 1106.

[43] Id.

[44] Jenny Lynn, 780 F.2d at 587.

[45] Id. at 588.

[46] Id.

[47] Id. at 589.

[48] See, e.g., Rizzo v. Mich. Dep’t of Treasury (In re Rizzo), 741 F.3d 703, 706 (6th Cir. 2014), where the same Court of Appeals explicitly stated that “[t]he consensus is that ‘excise tax’ as used in § 507(a)(8)(E) generally refers to ‘[a] tax imposed on the manufacture, sale, or use of goods (such as a cigarette tax), or on an occupation or activity (such as a license tax or an attorney occupation fee).’"

[49] Yoder v. Ohio Bureau of Workers' Compensation (In re Suburban Motor Freight, Inc.), 998 F.2d 338 (6th Cir. 1993) (Suburban I).

[50] Arrow, 229 B.R. at 457.

[51] In re Arrow Transp. Co., 227 B.R. 183 (Bankr. D. Ore. 1998).

[52] Arrow, 229 B.R. at 460.

[53] Id.

[54] Trism, 311 B.R. at 513.

[55] Id. at 514-15.

[56] Id. at 515.

[57] Id. at 516.

[58] Fagan, 465 B.R. at 476.

[59] That is particularly true if there is a base charge to cover the costs of building and maintain the utility service that may be substantially more than the costs for the services actually rendered. One author’s charge for water and sewer services at a beach house is an example – the “ready to serve” charge is $85 a month; while the charge for the minimal water and sewage actually during the winter was less than $2.

[60] The authors have no particular explanation for why so many of these cases come from those Circuits.

[61] Only one of the cases, though, actually, was based on that issue. The other, Brock v. Washington Metropolitan Area Transit Authority, 796 F.2d 481 (D.C. Cir. 1986), dealt instead with whether a federal “tax” imposed on a state entity was precluded by the doctrine of intergovernmental immunity. Prior cases had held that where a generally applicable “tax” a) did not discriminate against the state, b) did not produce revenues in excess of the benefits provided, and c) apportioned the amounts charged fairly to the beneficiaries), it could be treated as a “user fee” rather than an otherwise a “proscribed tax.” In any case, the court there noted that “the tax exemption [for WMATA is based on] concerns different from those reflected in § 64(a) of the Bankruptcy Act. . . . WMATA misses the point that the characterization of a payment as a ‘tax’ in certain contexts has no ‘talismanic’ significance.’” Brock, 796 at 487, n.10 (emphasis added). The same failing can be attributed to the Sixth Circuit in Suburban I which uncritically took the holding in this case as applicable outside the governmental immunity context.

[62] The cases cited in Metro Trans. for that proposition dealt with government charges that, as in Brock and in National Cable, could not be used to raise general revenues. Those courts did agree that the limited regulatory charges imposed were lawful and were not meant to be included in the term “tax” as that term was used in a particular statute. See, e.g., Union Pac. RR v. PUC, 899 F.2d 854, 860 (9th Cir. 1990). The court there cited Brock to reiterate that the meaning of the term “tax” in the context of those statutes was not meant to dictate how it might be applied in the context of the Bankruptcy Act.

[63] Suburban I, 998 F.2d at340-42. See also New Neighborhoods v. West Virginia Workers' Comp. Fund, 886 F.2d 714, 718-19 (4th Cir. 1989) and In re Pan Am. Paper Mills, 618 F.2d 159, 162 (1st Cir. 1980) (finding similar monopolistic programs to be taxes).

[64] Id.at 341.

[65] Id.

[66] Id. at 342.

[67] And the government may charge true user fees to fully cover the charges of operate a park, for instance, without any subsidy from mandatory tax revenues.

[68] Marketing programs operated by the government to promote sales of agricultural commodities, which are funded by mandatory charges on the growers, are another example of non-tax programs.

[69] Employers like to self-insure because it tends to cost them less since they are not paying for any of the overhead costs of the state insurance system. However, self-insurance for costs of employee care tends to be one of those oxymoronic concepts, akin to “self-bonding” for the costs to clean up closed mines. In both cases, unless the state requires more, the entity often sets aside little or nothing concrete to pay the costs; rather, the “insurance” or “bonding” is little more than an unsecured promise to pay. When the entity goes bankrupt, the promise, to quote Samuel Goldwyn, is like a verbal contract — not worth the paper it’s written on. A number of coal companies that filed bankruptcy in recent years with “self bonds” have been forced to agree to set aside actual collateral for those costs in order to confirm a plan. See http://www.insurancejournal.com/news/west/2016/09/13/426155.htm.

[70] Suburban II, 36 F.3d at 488.

[71] Id.

[72] Id. at 489.

[73] Again, the growers’ programs noted above are an example of this type of mandatory fee.

[74] Suburban II, 36 F.3d at 489.

[75] Camilli, 94 F.3d at 1333.

[76] Id. at 1334.

[77] In George v. Uninsured Employers Fund (In re George), 361 F.3d 1157, 1162 (9th Cir. 2004), the court held, in considering yet another state workers’ compensation system, that it was not necessary that there be an actual competing creditor, it was enough if one could merely be “hypothesized,” in order to find that the payment was not a tax. The reality is that there are serious problems with the entire treatment of workers’ compensation claims in bankruptcy, where the obligations to the employee do not fit well into the traditional bankruptcy mold of what is a claim. But, that is a topic for another day and another article.

[78] For instance, does the first test, whether the charge is “universally applied,” really help is to capture the distinction between fees and taxes so that we “know a tax when we see it?” The problem is that one has to decide who is “similarly situated” and the answer to that usually depends on how one wants to have the case turn out. An example in a related context is Hegar v. Tex. Small Tobacco Coalition, 496 S.W.3d 778 (Tex. 2016) which dealt with the taxation structure in a state that had settled its case against the major tobacco companies prior to the date that the remaining states signed the Master Settlement Agreement (the MSA) with those companies. The MSA imposed strict restrictions on advertising and marketing by the companies and required payment of billions of dollars a year in perpetuity; the MSA States also separately imposed a requirement that non-signatory companies pay a similar amount into escrow to level the economic playing field with the MSA parties. To reach the same result, Texas imposed a tax on all manufacturers, but those that joined its settlement (or the MSA) paid a much lower rate than those not covered by a settlement. Those paying the higher amount convinced the lower courts that this tax violated the Equal Protection clause because it was not uniformly applied to similarly situated entities selling the same product. The Texas Supreme Court reversed, holding that “similarity” was to be decided based, not the product being sold, but the nature of the taxpayer. Because non-settling manufacturers had payment and regulatory obligations different from the settling entities, that was sufficient to allow the tax on each to be separately structured, thus making “similarity” very much in the eye of the beholder.

[79] CF&I, 518 U.S.at 221.

[80] Id. at 225.

[81] Boston Regional, 365 F.3d at 55.

[82] Id. at 60.

[83] Id. at 61-62.

[84] Id. at 63.

[85] Id.

[86] Indeed, in light of the diminishing market for smoking in this country, part of the goal was also to wean farmers from growing tobacco entirely, and, in any event, to remove the government from supporting them in growing tobacco for cigarettes. ITP, 468 B.R., at 588. This did largely occur with many dropping out of the market or diversifying into other crops (while those remaining have become more competitive by selling at a non-inflated price. See Nathan Borney, Thousands of Farmers Stopped Growing Tobacco after Deregulation Payouts, U.S.A. Today, Sept. 2, 2015,

http://www.usatoday.com/story/money/2015/09/02/thousands-farmers-stopped-growing-tobacco-after-deregulation-payouts/32115163/. The most striking statistic is that, in 2002, almost 57,000 famers had the right to grow tobacco under federal quotas; after this program ended in 2014, the number of growers declined to less than 4300.

[87] ITP, 468 B.R. at 588.

[88] Id. at 595-97. This is by contrast with the marketing programs noted above that did not have a separate public purpose beyond the benefit to the farmers themselves. Another program that imposes payments on an industry group to provide general benefits is the fund established under Title IV of the Americans with Disabilities Act (ADA) to ensure the availability of interstate telecommunications relay series for the speech and hearing impaired. In an unpublished decision in one of the author’s case of Cherry Communications, Inc., Case No. 97 B 32873 (Bankr. N.D. Ill)(bench decision of March 29, 2000), the court held that it was irrelevant that the FCC had labeled the charges as a fee imposed under its Commerce Clause powers, since “[w]hether the fees are a tax under Section 507, . . . is a question of bankruptcy law and not of state or federal law on subjects other than bankruptcy.” The judge held that “[e]veryone benefits when basic services are available to disabled persons and those persons can function effectively in society . . . [and] [t]he statute and regulation appear to create a mandatory payment.” As such, the court found the fee to be a tax.

[89] “Surely, you can’t be serious. I am serious — and don’t call me Shirley.” Airplane(Paramount Pictures 1980).

[90] Boston Reg’l, 291 F.3d at 122.

[91] Id. at 122-23.

[92] Id. at 123.

[93] United Healthcare, 396 F.3d at 255.

[94] Id at 255-56.

[95] Id. at 258.

[96] Id. at 259-60. In ultimately deciding the question, the court relied on the reasoning of National Cable, to show when a payment is a tax versus a “fee” — despite the fact that National Cable was dealing with the authority of an agency to impose a cost, not the right of a government taxing authority. Nor does this court ever address what is the benefit received by the employer (as opposed to its employees). There are, to be sure, as will be discussed below, situations such as in Lorber, where the government truly is providing a purely private benefit to the debtor and is being paid for that benefit. But here the only “benefit” the court cites to show that this payment is not a tax is the right to not pay a “tax.” [96] That seems to be a circular proposition at best, as Judge Scirica’s dissent cogently argues. Id. at 264.

[97] National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012) (Sebelius).

[98] Id.at 2582.

[99] Id. at 2594-95.

[100] Id. at 2595.

[101] Id. at 2594.

[102] Id. at 2595-96.

[103] Id. at 2596.

[104] Id. at 2596-97.

[105] This isn’t the worst thing — penalties, including many tax penalties, are generally excepted from discharge for individuals (section 523(a)(7)) and penalties are not always subordinated. See U.S. v. Noland, 517 U.S. 535 (1996). But, still, pursuing a pure tax is by far the easier course of action.

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