1997 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

1-17-1997

In Re Michael Kaplan

Precedential or Non-Precedential:

Docket 95-5409,96-5180

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Recommended Citation

"In Re Michael Kaplan" (1997). 1997 Decisions. Paper 15.

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1

 UNITED STATES COURT OF APPEALS 

 FOR THE THIRD CIRCUIT 

 ___________ 

 Nos. 95-5409 and 96-5180 

 ___________ 

 IN RE: MICHAEL KAPLAN; MORRIS KAPLAN 

 Debtors 

 THE INTERNAL REVENUE SERVICE 

 vs. 

 MICHAEL KAPLAN; MORRIS KAPLAN, 

 Appellants in No. 95-5409 

 (D.C. Civ. No. 94-cv-05656) 

 IN RE: KAPLAN BUILDING SYSTEMS, INC. 

 Debtor 
2

 INTERNAL REVENUE SERVICE 

 vs. 

 KAPLAN BUILDING SYSTEMS, INC., 

 Appellant in No. 96-5180 

 (D.C. Civ. No. 95-cv-04331) 

 ___________ 

 Appeal from the United States District Court 

 for the District of New Jersey 

 ___________ 

 

Argued 

 December 10, 1996 

 Before: BECKER, MANSMANN and GREENBERG, Circuit Judges. 

 (Filed January 17, 1997) 

 ___________ 

Robert A. Baime, Esquire (ARGUED) 

Dechert, Price & Rhoads 

Princeton Pike Corporate Center 

P.O. Box 5218 

Princeton, N.J. 08563 
3

Joel H. Levitin 

Debra D. O'Gorman 

Dechert, Price & Rhoads 

477 Madison Avenue 

New York, NY 10022 

 COUNSEL FOR APPELLANTS 

Loretta C. Argrett 

Assistant Attorney General 

Thomas Linguanti, Esquire (ARGUED) 

Gary R. Allen, Esquire 

David English Carmack, Esquire 

Linda E. Mosakowski, Esquire 

United States Department of Justice 

Tax Division 

P.O. Box 502 

Washington, DC 20044 

 COUNSEL FOR APPELLEE 

Faith S. Hochberg 

United States Attorney 

 OF COUNSEL FOR APPELLEE 
4

 ___________ 

 OPINION OF THE COURT 

 __________ 

MANSMANN, Circuit Judge. 

 In this appeal, we are presented with two decisions of 

the district court dated May 18, 1995, and February 20, 1996, 

which reversed the orders of the bankruptcy court on two related 

bankruptcy cases. We are asked to decide whether the district 

court erred in determining that the bankruptcy court was not 

authorized to compel the Internal Revenue Service to reallocate 

tax payments first to trust fund taxes. We find that neither 11 

U.S.C. § 105 nor the Supreme Court's decision in United States v. 

Energy Resources Co., Inc., 495 U.S. 545 (1990), authorized the 

bankruptcy court to order the Internal Revenue Service to 

reallocate tax payments under the particular facts here. 

Accordingly, we will affirm the decisions of the district court. 

I. 

 We feel compelled to set forth the facts in detail 

because these bankruptcy cases are so heavily fact-intensive. 

 This consolidated appeal arises from two separate but 

related Chapter 11 bankruptcy petitions filed by Michael and 

Morris Kaplan and Kaplan Building Systems, Inc. ("KBS"). KBS 

is a Pennsylvania corporation formed for the sole purpose of 

acquiring and operating a modular home manufacturing business. 
5

Two brothers, Michael and Morris Kaplan, organized KBS and, at 

all relevant times, were its sole owners. During 1990, KBS made 

only one payment of employment taxes in the approximate amount of 

$200,000. That payment was not accompanied by a quarterly 

return. For the four quarters of 1990, KBS failed to file timely 

returns and to pay to the United States approximately $2 million 

in federal employment taxes. Of this amount, $1,564,468 were 

"trust fund" taxes.1 

 On February 11, 1991, Michael and Morris Kaplan filed 

two separate Chapter 11 petitions with the United States 

Bankruptcy Court for the District of New Jersey, which were later 

consolidated. KBS did not file for bankruptcy at that time. 

Although the Kaplans owned or were partners in approximately 89 

entities including KBS, they wanted to avoid preparing petitions 

and paying filing fees with respect to each of the entities. The 

Kaplans thus sought an injunction under 11 U.S.C. § 105 to enjoin 

specific creditors from instituting civil actions against the 

"non-filing" Kaplan businesses. Although a number of KBS's other 

creditors were named in the injunctions, the IRS was not one of 

the defendant-creditors named in the orders, nor did the IRS 

participate in the matter.2 Invoking its powers under section 

 

1. Trust fund taxes refer to the employees' share of FICA 

and FUTA taxes required to be withheld by the employer and held 

in trust for the federal government pursuant to 26 U.S.C. § 

7501(a). Under I.R.C. § 6672, the IRS may collect unpaid trust 

fund taxes directly from the employer's officers or employees who 

are responsible for collecting the tax. These individuals are 

commonly referred to as "responsible persons." 

2. In their Brief in Support of Debtors' Motion to Compel 

the Internal Revenue Service to Reallocate Certain Payments, the 

Kaplans indicated that, at some later time but prior to June 15, 
6

105, the bankruptcy court enjoined all of the named defendantcreditors from proceeding to litigate claims against the nonfiling Kaplan entities. The injunction dissolved ninety days 

after the effective date of the Kaplans' plan of reorganization. 

 In March of 1991, KBS filed its employment tax returns 

for the four quarters of 1990 and the corresponding taxes were 

assessed against KBS. In lieu of instituting formal collection 

proceedings against KBS, the revenue officer determined that KBS 

could make installment payments to satisfy the debts, provided 

the Kaplans executed Forms 2751--Proposed Assessment of 100 

Percent Penalty--and consented to the assessment and collection 

of a responsible person's penalty in connection with KBS's unpaid 

trust fund taxes for 1990. The Kaplans executed the necessary 

forms, thereby agreeing that the responsible person penalty could 

be assessed against them on or before December 31, 1995. 

 KBS and the IRS entered into two installment 

agreements. The first installment agreement provided that KBS 

would pay the IRS $30,000 per month from October, 1991 through 

December, 1991; $35,000 per month from January, 1992, through 

March, 1992; $40,000 per month from April through June, 1992; and 

$50,000 from July, 1992, until December, 1994, when the balance 

would be paid in full. Although the installment agreement 

contained several conditions, it did not address the allocation 

(..continued) 

1993, the IRS filed a proof of claim asserting an unliquidated 

KBS tax liability against the Kaplans in their individual 

bankruptcies. The Kaplans filed a motion to expunge the IRS's 

claim, giving actual notice to the IRS; the IRS did not oppose. 

Consequently, the bankruptcy court entered an order on June 15, 

1993, expunging the IRS's claim. 
7

of payments. By the end of 1993, KBS defaulted on the first 

installment agreement. 

 A second installment agreement was drawn up in May, 

1994, which required KBS to make monthly payments of $60,000 from 

July of 1994 to March of 1995, and $100,000 from April of 1995 

until the debt was paid in full. The installment agreement form, 

which had been revised in January, 1993, provided as one of the 

conditions that "[a]ll payments will be applied in the best 

interest of the United States." On May 27, 1994, the general 

counsel for the Kaplan companies wrote to the revenue officer 

advising him that before executing the installment agreement, KBS 

deleted the language on the form providing that payments will be 

applied in the best interest of the United States. The revenue 

officer informed KBS's counsel that the agreement could not be 

accepted by the IRS with the deletion of this condition. KBS 

reversed the deletion, but reserved its right to further contest 

this allocation. The IRS executed the second installment 

agreement on July 6, 1994 and KBS made payments through at least 

September of 1994. The Kaplans claim they have personally funded 

KBS's tax liability payments in an amount in excess of $1 

million. 

 On January 29, 1993, the bankruptcy court confirmed the 

Kaplans' first amended plan of reorganization. The confirmed 

plan dealt with some debts against the non-filing Kaplan 

entities. With respect to tax claims against KBS, the plan 

provided: 

Notwithstanding anything in this Plan to the contrary, 

Tax Claims against Kaplan Building Systems, 
8

Inc. shall be paid in accordance with and 

pursuant to installment agreements with 

Internal Revenue Service.3 

 On July 29, 1994, the Kaplans filed a motion in their 

individual bankruptcy cases to compel the IRS to reallocate the 

tax payments made by KBS (but funded by the Kaplans) to trust 

fund obligations.4 Without such reallocation, the Kaplans remain 

liable for 100% of KBs's unpaid trust fund taxes. The bankruptcy 

court held a hearing at which the Kaplans argued that because 

reallocating the payments to KBS's trust fund liabilities would 

"enhance the probability the Kaplans will fully consummate their 

confirmed Plan which requires payments to be made to creditors 

over time," the bankruptcy court has the authority to and should 

compel the IRS to change the allocation of KBS's payments that 

had been funded by the Kaplans, based on the Supreme Court's 

holding in United States v. Energy Resources Co., Inc., 495 U.S. 

545 (1990). The government opposed the motion, asserting that 

Energy Resources was inapposite here because the corporation was 

not a debtor in the Kaplans' bankruptcy proceedings and whatever 

the effect on KBS, the allocation of tax payments would not 

affect the reorganization of the Kaplans, who were the only 

debtors in the case. The bankruptcy court concluded that this 

case was completely analogous to Energy Resources, even though 

 

3. Article III, Section 3.1(B)(ii) of Debtors' First 

Amended Joint Plan of Reorganization. 

4. The KBS tax payments were made prior to the execution 

of the first installment agreement; these payments were also made 

pursuant to the first and second installment agreement s. Thus, 

the time period involved runs from 1990 to September, 1994. 
9

the structure here was not a textbook structure. Because it 

found that the reallocation of KBS's taxes was necessary for the 

Kaplans' reorganization, the bankruptcy court entered an order 

directing the IRS to reallocate the prior payments to trust fund 

taxes. 

 The IRS appealed the bankruptcy court's order to the 

district court. On May 18, 1995, the district court issued an 

order reversing the decision of the bankruptcy court, finding 

that because KBS was not a debtor in bankruptcy, the bankruptcy 

court was not authorized to order the IRS to reallocate payments 

made by KBS. The district court noted that unlike Energy 

Resources, the bankruptcy court here lacked jurisdiction over KBS 

and, therefore, was without the power to order reallocation of 

the tax payments under 11 U.S.C. §§ 1123, 1129 and 105, as those 

sections were not applicable. The district court further held 

that the bankruptcy court could order retroactive allocation of 

tax payments.5 In dicta, the district court commented that KBS 

could file its own Chapter 11 petition, thereby subjecting itself 

to the bankruptcy court's jurisdiction. The Kaplans filed a 

timely appeal to this court, which was stayed on September 12, 

1995, pending the district court's ruling on the same issue in 

the KBS bankruptcy case. 

 

5. In support of this holding, the district court cited In 

re Deer Park, Inc., 10 F.3d 1478 (9th Cir. 1993); In re FloLizer, Inc., 164 B.R. 79 (Bankr. S.D. Ohio 1993), aff'd, 164 B.R. 

749 (S.D. Ohio 1994); and In re M.C. Tooling Consultants, 165 

B.R. 590 (Bankr. D.S.C. 1993). 
10

 On June 2, 1995, KBS filed its own bankruptcy petition 

under Chapter 11 of the Bankruptcy Code. On that same date, KBS 

filed several motions with the bankruptcy court, one of which 

asked the court to compel the IRS to reallocate the tax payments 

funded by the Kaplans on behalf of KBS to trust fund taxes. KBS 

argued that reallocation of the tax payments was necessary for 

its successful reorganization, in that it would induce the 

Kaplans to provide KBS with new emergency funding necessary for 

the continued operation of KBS. The IRS opposed the motion on 

the basis that the bankruptcy court lacked authority to 

reallocate, arguing that all of the payments at issue had been 

made pre-petition and that the debtor had failed to designate the 

manner in which they were to be applied. The IRS applied the 

payments in accordance with IRS written policy, which requires 

that payments received be applied in a manner consistent with the 

best interests of the government, unless otherwise designated. 

 Having determined that it had jurisdiction over KBS, 

the bankruptcy court considered whether it had the authority to 

compel the IRS to reallocate the tax payments under Energy 

Resources. Concluding that the reallocation was necessary to 

KBS's successful reorganization, the bankruptcy court entered an 

order, with retroactive effect, directing the IRS to reallocate 

the tax payments made by KBS to trust fund taxes. 

 The IRS appealed that order to the district court. In 

reversing the decision of the bankruptcy court, the district 

court held that the Supreme Court's holding in Energy Resources

did not displace the rule of law that the IRS may designate 
11

voluntary payments in its best interests when the debtor fails to 

make a designation. Having found that KBS never designated the 

manner in which its tax payments would be allocated, the district 

court found that the IRS was free to apply the tax payments 

towards KBS's outstanding corporate income tax. 

 On March 20, 1996, KBS filed a notice of appeal of the 

district court's order and moved to consolidate the KBS appeal, 

No. 96-5180, with the appeal in the Kaplans' bankruptcies, No. 

95-5409. We granted that motion and consolidated the cases on 

June 10, 1996. We have jurisdiction over these consolidated 

appeals pursuant to 28 U.S.C. §§ 158(d) and 1291. 
12

II. 

 At the core of the district court's ruling in the 

Kaplans' bankruptcy cases stands its finding that the bankruptcy 

court lacked jurisdiction over KBS. Thus, we turn initially to 

the issue of whether the bankruptcy court had jurisdiction over 

KBS in the Kaplans' bankruptcy cases. We begin our analysis by 

examining 28 U.S.C. § 1334. 

 Section 1334(b) provides in relevant part that "the 

district courts shall have original but not exclusive 

jurisdiction of all civil proceedings arising under title 11, or 

arising in or related to cases under title 11." 28 U.S.C. § 

1334(b) (1990). The bankruptcy courts, in turn, obtain 

jurisdiction by operation of 28 U.S.C. § 157, which allows the 

district courts to refer, to the bankruptcy courts, cases over 

which the district courts have jurisdiction pursuant to section 

1334. Quattrone Accountants, Inc. v. Internal Revenue Service, 

895 F.2d 921, 926 n.3 (3d Cir. 1990). 

 We have held that in a case involving non-debtors, the 

bankruptcy court's jurisdiction is to be determined solely by 28 

U.S.C. § 1334(b). Id. at 926. The Sixth Circuit has agreed with 

our conclusion. In re Wolverine Radio Co., 930 F.2d 1132, 1140 

(6th Cir. 1991). But cf. United States v. Huckabee Auto Co., 783 

F.2d 1546, 1549 (11th Cir. 1986).6 The dispute at issue here 

 

6. In United States v. Huckabee Auto Co., 783 F.2d 1546, 

1549 (11th Cir. 1986), the court of appeals refused to extend the 

jurisdiction of the bankruptcy court to the section 6672 

liabilities of the taxpayers who were not debtors under the 

Bankruptcy Code. The court found that because the liability 

imposed under section 6672 was separate and distinct from that 

levied on the employer under sections 3102 and 3402 of the 
13

arose between KBS and the IRS, two non-debtors, which the Kaplans 

are attempting to bring within the jurisdiction of the bankruptcy 

court as a proceeding7 related to their Chapter 11 bankruptcy 

case. Thus, we must turn to the meaning of the terms, "related 

to," in light of our explanation in Quattrone Accountants and 

Pacor, Inc. v. Higgins, 743 F.2d 984 (3d Cir. 1984). 

 In Quattrone Accountants, we were asked to decide 

whether, inter alia, the bankruptcy court had jurisdiction 

pursuant to 28 U.S.C. § 1334 and 11 U.S.C. § 5058 to determine a 

(..continued) 

Internal Revenue Code, it was irrelevant that the section 6672 

liability, if assessed against the responsible persons, would 

adversely affect the corporate debtor's reorganization. Id. at 

1548-49 (citations omitted). 

 In Huckabee Auto, the corporation was the debtor and 

taxpayer; here, the situation is reversed: the responsible 

persons, i.e., the Kaplans, are the debtors and the corporation, 

a non-debtor, is the taxpayer. In addition, the court of appeals 

in Huckabee Auto failed to consider the bankruptcy court's 

jurisdiction under 28 U.S.C. § 1334(b). 

7. The dispute between the IRS and KBS constitutes a civil 

"proceeding" as that term is used in 28 U.S.C. § 1334. 

Proceeding "is used in a broad sense, referring to `[a]nything 

that occurs within a case,' including contested and uncontested 

matters." Melodie Freeman-Barney, Notes and Comments, 

Jurisdiction Under the Bankruptcy Amendments of 1984: Summing Up 

the Factors, 22 Tulsa L.J. 167, 180 (1986) (citing Collier on 

Bankruptcy (MB ¶ 3.01[1][c][ii] (15th ed. 1986)). The 

legislative history to the Bankruptcy Reform Act of 1978 confirms 

that the term "proceeding" should be broadly interpreted. H.R. 

Rep. No. 598, 95th Cong., 2d Sess. (1978), reprinted in 1978 

U.S.C.C.A.N. 5963, 6400-6401. 

8. Section 505(a)(1) provides in relevant part: 

. . . the court may determine the amount or legality of 

any tax, any fine or penalty relating to a 

tax, or any addition to tax, whether or not 

previously assessed, whether or not paid, and 

whether or not contested before and 

adjudicated by a judicial or administrative 

tribunal of competent jurisdiction. 
14

non-debtor's tax liability under section 6672 of the Internal 

Revenue Code. Concluding that section 505 did not address a 

situation involving non-debtors9 and, therefore, neither limited 

nor granted jurisdiction, we turned to section 1334 to resolve 

the issue of the bankruptcy court's jurisdiction. 895 F.2d at 

925-26. 

 We examined the "related to" language of section 1334 

by looking at our previous explanation of those terms in Pacor, 

Inc. v. Higgins, supra.

10 In Pacor, we explained that under 

section 1334, a civil matter is "related to" a bankruptcy 

proceeding when "the outcome of that proceeding could conceivably 

have any effect on the estate being administered in bankruptcy." 

 743 F.2d at 994 (citations omitted). We then stated that "[a]n 

action is related to bankruptcy if the outcome could alter the 

debtor's rights, liabilities, options, or freedom of action 

(either positively or negatively) and which in any way impacts 

upon the handling and administration of the bankrupt estate." 

Id. Our analysis of the "related to" language of section 1334(b) 

 

9. The IRS assessed a section 6672 responsible person 

penalty against the debtor, Quattrone Accountants, for failing to 

pay withholding taxes on behalf of its client, United Dairy 

Farmers Cooperative Association (UDF). Philip Quattrone, part 

owner and principal officer of the debtor, filed a complaint 

requesting the bankruptcy court to determine his section 6672 tax 

liability, as well as that of the debtor. 

10. In Pacor, we held that a personal injury suit in which 

the defendant filed a third party claim seeking indemnification 

against the debtor, JohnsManville, was not related to the 

JohnsManville bankruptcy, reasoning that the outcome of the 

original personal injury action would not bind JohnsManville 

until a third party action was actually brought and tried. 743 

F.2d at 995. 
15

was followed by the Supreme Court in Celotex Corp. v. Edwards, 

___ U.S. ___, 115 S. Ct. 1493, 1498-99 (1995). 

 Applying these decisions to the facts of this case, we 

conclude that the dispute between the IRS and KBS is related to 

the Kaplans' bankruptcy proceeding. Here the debtors, Michael 

and Morris Kaplan, agreed to section 6672 responsible person 

liability, in effect guaranteeing that KBS's trust fund taxes 

would be paid in full. By virtue of their agreement with the 

IRS, if KBS failed to pay its trust fund taxes in full, the 

Kaplans would automatically be liable for the shortfall. If the 

IRS is allowed to allocate the pre-petition tax payments it 

received to non-trust fund taxes, there is no effect on the 

Kaplans -- they are still 100% liable for the shortfall. If, 

however, the IRS is not permitted to designate how the payments 

will be applied, and the bankruptcy court is allowed to order the 

IRS to allocate the pre-petition payments to trust fund taxes 

first, then the Kaplans' responsible persons liability is reduced 

to the extent that the trust fund tax liability of KBS is 

likewise reduced. Thus, the outcome of the dispute between KBS 

and the IRS could conceivably affect, in a positive manner, the 

Kaplans' estate in bankruptcy. 

 We find, therefore, that the bankruptcy court had 

jurisdiction over the dispute between KBS and the IRS. 

III. 

 Although we have determined that the bankruptcy court 

had jurisdiction over the non-debtors pursuant to section 1334, 
16

our inquiry does not end there.11 Notwithstanding the bankruptcy 

court's jurisdiction, we must examine whether the bankruptcy 

court was authorized to issue the order to compel allocation of 

tax payments under the broad grant of equitable powers in 11 

U.S.C. § 105.12

 Section 105(a) states in pertinent part: 

 The court may issue any order, process, or 

judgment that is necessary or appropriate to 

carry out the provisions of this title.13

That the bankruptcy court has the power under section 105 to 

enjoin creditors from proceeding in a state court against third 

parties where failure to enjoin would affect the bankruptcy 

estate has been recognized by numerous bankruptcy courts and two 

courts of appeals.14 Moreover, the Supreme Court in Energy 

 

11. We note that while the district court found incorrectly 

that the bankruptcy court lacked jurisdiction over KBS in the 

Kaplans' bankruptcy, this error is not fatal to its decision. 

12. In In re Cardinal Industries, Inc., 109 B.R. 748, 752 

(Bankr. S.D. Oh. 1989), the bankruptcy court held that 

jurisdiction under section 1334 was not sufficient by itself to 

determine whether an injunction should issue; but rather, the 

court must examine, under 11 U.S.C. § 105(a), whether the usual 

standards for injunctive relief are met. 

13. The legislative history to section 105 is sparse. The 

House Report states merely that section 105 is similar in effect 

to the All Writs Statute, 28 U.S.C. § 1651. H.R. Rep. 595, 95th 

Cong., 2d Sess. (1978), reprinted in 1978 U.S.C.C.A.N. 6273. The 

legislative history further provides that section 105 authorizes 

a court of the United States to stay a state court action. Id.

at 6274. 

14. In re Monroe Well Service, Inc., 67 B.R. 746, 750-51 

(Bankr. E.D.Pa. 1986); In re Otero Mills, 25 B.R. 1018, 1021-1022 

(D.N.M. 1982); A.H. Robins Co. v. Piccinin, 788 F.2d 994, 1002 

(4th Cir.), cert. den., 479 U.S. 876 (1986). See also, National 

Labor Relations Board v. Superior Forwarding, Inc., 762 F.2d 695, 

698 (8th Cir. 1985) (Bankruptcy court is empowered under section 

105 to enjoin federal regulatory proceedings when those 

proceedings would threaten the assets of the debtor's estate). 
17

Resources found the Bankruptcy Code implicitly authorized the 

bankruptcy courts to approve reorganization plans designating tax 

payments as either trust fund or non-trust fund, based on the 

bankruptcy courts' residual authority to approve reorganization 

plans under section 1123(b)(5) and 1129 of the Bankruptcy Code, 

and on the statutory directive of section 105. 495 U.S. at 549. 

 Energy Resources involved two corporations which filed 

petitions for reorganization under Chapter 11 of the Bankruptcy 

Code: Newport Offshore, Ltd. (Newport) and Energy Resources Co., 

Inc. (Energy Resources). In the Newport bankruptcy, the IRS 

objected unsuccessfully to a provision in the reorganization plan 

which stated that Newport's tax payments would be applied to 

extinguish all trust fund tax liabilities prior to paying the 

non-trust fund portion of the tax liability. The IRS appealed to 

the district court, which reversed the decision of the bankruptcy 

court. The debtor appealed to the Court of Appeals for the First 

Circuit. 

 In the Energy Resources bankruptcy case, the bankruptcy 

court approved a reorganization plan which created a special 

trust to fund the corporation's federal tax liability. When the 

IRS refused to apply a tax payment out of the special trust to 

Energy Resources' trust fund taxes, the trustee successfully 

petitioned the bankruptcy court to order the IRS to allocate the 

payment to trust fund taxes. The IRS appealed this order to the 

district court, which affirmed the bankruptcy court. The IRS 

then filed an appeal to the Court of Appeals for the First 
18

Circuit. The Newport and Energy Resources cases were 

consolidated on appeal. 

 The court of appeals reversed in In re Newport Offshore 

Ltd. and affirmed in In re Energy Resources Co.15 Initially, the 

court of appeals examined the characterization of tax payments 

made pursuant to a Chapter 11 reorganization plan as "voluntary" 

or "involuntary."16 Although the court of appeals concluded that 

the payments were involuntary, deferring to the IRS's 

interpretation of its own rules, it held that the "Bankruptcy 

Courts nevertheless had the authority to order the IRS to apply 

an `involuntary' payment made by a Chapter 11 debtor to trust 

fund tax liabilities if the Bankruptcy Court concluded that this 

designation was necessary to ensure the success of the 

reorganization." 871 F.2d at 230-34. 

 The Supreme Court affirmed the judgment of the court of 

appeals, holding that regardless of whether the payments are 

properly characterized as "involuntary", a bankruptcy court has 

the authority to order the IRS to apply tax payments made by 

Chapter 11 debtor corporations to trust fund liabilities if the 

 

15. In re Energy Resources Co., Inc., 871 F.2d 223 (1st 

Cir. 1989). 

16. IRS policy allows taxpayers who "voluntarily" pay their 

tax liability to designate the manner in which the tax payments 

will be applied. Energy Resources, 495 U.S. at 548 (citations 

omitted). Traditionally, a tax payment has been considered 

"involuntary" when it is made to "agents of the United States as 

a result of distraint or levy or from a legal proceeding in which 

the Government is seeking to collect its delinquent taxes or file 

a claim therefor." United States v. Pepperman, 976 F.2d 123, 127 

(3d Cir. 1992) (citing Amos V. Commissioner, 47 T.C. 65, 69 

(1966)). 
19

bankruptcy court determines that this designation is necessary to 

the success of a reorganization plan. 495 U.S. at 548-49. To 

find such authority for the bankruptcy court, the Court looked to 

sections 1123, 1129, and 105 of the Bankruptcy Code. Under 

sections 1123(b)(5) and 1129, the Court found that the Code 

"grant[ed] the bankruptcy courts residual authority to approve 

reorganization plans including `any . . . appropriate provision 

not inconsistent with the applicable provisions of this title.'" 

 Id. at 549. Turning to section 105, the Court noted that the 

Code also provides that bankruptcy courts may "`issue any order, 

process, or judgment that is necessary or appropriate to carry 

out the provisions' of the Code." Id. (citing 11 U.S.C. § 

105(a)). The Court further noted that these "statutory 

directives are consistent with the traditional understanding that 

bankruptcy courts, as courts of equity, have broad authority to 

modify creditor-debtor relationships." Id. (citations omitted). 

 The Court rejected the government's argument that 

bankruptcy court orders directing allocation to trust fund taxes 

conflict with sections 507(a)(7), 523(a)(1)(A), 1129(a)(11), and 

1129(a)(9)(C) of the Bankruptcy Code, provisions which protect 

the government's ability to collect delinquent taxes. The Court 

found that the restrictions in those sections of the Code do not 

address the bankruptcy court's ability to designate whether tax 

payments are to be applied to trust fund or non-trust fund tax 

liabilities and, thus, did not preclude the court from issuing 

the type of orders involved here. Id. at 550. 
20

 The Court found equally unpersuasive the government's 

argument that it stands in a better position to have all of its 

debt discharged if the debtor corporation's tax payments are 

first applied to non-trust fund taxes because the debt that is 

not guaranteed will be paid off first. The Court stated that 

while from the government's viewpoint this result is more 

desirable, it is an added protection not provided for in the Code 

itself. Id. Finally, the government contended that the 

bankruptcy court's orders contravened section 6672 of the 

Internal Revenue Code, which permits the IRS to collect unpaid 

trust fund taxes directly from the "responsible" individuals. 

The government reasoned that if the IRS cannot designate a debtor 

corporation's tax payments as non-trust fund, the debtor might 

only be able to pay the guaranteed debt, leaving the government 

at risk for non-trust fund taxes. Discarding this argument as 

well, the Supreme Court found that section 6672, by its terms, 

does not protect against this eventuality. Id. at 551. 

 Despite the Supreme Court's finding that the residual 

authority of the bankruptcy court under sections 1123, 1129 and 

105(a) authorized the reallocation of tax payments, Energy 

Resources does not change the result here. The facts in the 

Kaplans' bankruptcy cases simply do not provide the bankruptcy 

court with the authority to grant the relief sought by the 

Kaplans. First and foremost, KBS, the taxpayer, was not the 

debtor. Indeed, we agree with the IRS that Energy Resources does 

not reach the situation where a third party might benefit: the 

Kaplans could not be deemed necessary to the success of KBS's 
21

plan because at the time the payments were made, KBS did not have 

a reorganization plan.17 In addition, as KBS was not a debtor 

prior to June 1995, the IRS was not afforded the usual 

protections in a Chapter 11 reorganization: a priority for 

specified tax claims, including trust fund taxes, and a provision 

making these tax debts nondischargeable, 11 U.S.C. §§ 507(a)(7), 

523(a)(1)(A); the requirement that the bankruptcy court assure 

itself that the reorganization will succeed, 11 U.S.C. § 

1129(a)(11), making it more likely that the IRS will collect the 

tax liability; and a provision that the tax debt must be paid off 

within six years, 11 U.S.C. § 1129(a)(9)(C). 

 As we stated in Pepperman, "the Court in Energy 

Resources consistently linked its holding with the fact of 

reorganization and the debtor's need for rehabilitation." 976 

F.2d at 130. Because KBS had not filed its own Chapter 11 

petition, the bankruptcy court did not have before it all of the 

 

17. Although KBS and some of its creditors were being 

reorganized under the Kaplans' bankruptcies, the IRS was not 

listed as a creditor of KBS in the schedule of defendants in the 

section 105 stay litigation. Moreover, the Kaplans' 

reorganization plan provided that the tax claims against KBS 

would be paid in accordance with the installment agreements with 

the IRS. We note, however, that these installment agreements 

were voluntary agreements which KBS could, and eventually did, 

default on. The fact that the Kaplans never sought the 

bankruptcy court's intervention with regard to the IRS's tax 

claims against KBS and, indeed, specifically provided in their 

plan that the normal rule pertaining to payment of allowed tax 

claims (i.e., allowed tax claims must be paid in full within 

fifteen days after the effective date of the plan or, pursuant to 

11 U.S.C. § 1129(a)(9)(C), paid in full over six years from the 

earlier of the assessment date or plan effective date), did not 

apply to the IRS's tax claims against KBS, mandates the 

conclusion that the bankruptcy court lacked authority to order 

the reallocation of KBS's tax payments. 
22

claims and, therefore, could not have made an appropriate 

determination as to whether the KBS reorganization was likely to 

succeed. Since this determination is a prerequisite to the 

Court's holding in Energy Resources, the bankruptcy court lacked 

the authority to order the IRS to reallocate tax payments in the 

Kaplans' bankruptcies. We observed in Pepperman that "section 

105 does not `give the court the power to create substantive 

rights that would otherwise be unavailable under the Code,'" 

noting that Energy Resources does nothing to undermine this 

observation. 976 F.2d at 131 (citations omitted). Further, 

"`[t]he fact that a [bankruptcy] proceeding is equitable does not 

give the judge a free-floating discretion to redistribute rights 

in accordance with his [or her] personal views of justice and 

fairness, however enlightened those views may be.'" Id. (quoting 

Matter of Chicago, Milwaukee, St. Paul & Pac. R.R., 791 F.2d 524, 

528 (7th Cir. 1986)). 

 Because KBS, the taxpayer, was not a debtor under the 

facts here,18 the bankruptcy court was precluded from making an 

appropriate determination regarding the likelihood of KBS's 

successful reorganization as required by Energy Resources. We 

hold, therefore, that the bankruptcy court lacked authority under 

section 105 to order the IRS to allocate KBS's tax payments in 

the Kaplans' bankruptcy. 

 

18. The IRS did not file a proof of claim against KBS in 

the Kaplans' bankruptcies. KBS was organized as a corporation, 

not a partnership. As a separate legal entity, KBS, in order to 

avail itself of the full protections and powers of the bankruptcy 

court, must itself be a debtor. See, In re FTL, Inc., 152 B.R. 

61 (Bankr. E.D. Va. 1993). The tax payments at issue were prepetition and not made pursuant to a reorganization plan. 
23

IV. 

 Likewise in KBS's bankruptcy, we are compelled to find 

that the bankruptcy court lacked authority under section 105 to 

order the IRS to reallocate tax payments to trust fund taxes 

first. The broad powers granted to the bankruptcy court under 

section 105 are insufficient alone to authorize a retroactive

allocation of pre-petition tax payments. Pepperman, 976 F.2d at 

131 ("section 105 does not `give the court the power to create 

substantive rights that would otherwise be unavailable under the 

Code.'") (citations omitted). The bankruptcy court's equitable 

powers under section 105 are not triggered where, like the 

situation before us, the requirements of Energy Resources have 

not been met.19 Indeed, since a reorganization plan was not 

filed in the KBS bankruptcy, the bankruptcy court had no basis 

upon which to exercise its equitable authority under section 

105.20

 We agree with the following inquiry set forth by the 

Court of Appeals for the First Circuit to be made by the 

 

19. When the bankruptcy court here determined that 

reallocation was necessary to the successful reorganization of 

KBS, it did not have before it a plan of reorganization. In 

Energy Resources, a reorganization plan existed under 11 U.S.C. 

§§ 1123 and 1129. In that situation, the bankruptcy court has 

the authority to oversee the reorganization and, under § 105, has 

the equitable power to do what is necessary to get the plan 

confirmed. 

20. Thus, the bankruptcy court could not have assured 

itself, as it was required to do under 11 U.S.C. § 1129(a)(11), 

that the reorganization plan would succeed; and that the debtor 

would take no more than six years within which to structure the 

tax payments, 11 U.S.C. § 1129(a)(9)(C). 
24

bankruptcy court when assessing whether reallocation for tax 

payments is necessary to the successful reorganization of the 

debtor: 

upon consideration of the reorganization plan as a 

whole, in so far as the particular structure 

or allocation of payments increases the risk 

that the IRS may not collect the total tax 

debt, is that risk nonetheless justified by 

an offsetting increased likelihood of 

rehabilitation, i.e., increased likelihood of 

payment to creditors who might otherwise lose 

their money? 

In re Energy Resources Co., Inc., 871 F.2d at 234. It is clear 

from the record that the bankruptcy court in KBS's case did not 

undertake to perform this analysis. Thus, the holding by the 

Supreme Court in Energy Resources, which clearly took into 

consideration the existence of a reorganization plan, does not 

control the resolution of this case.21

 We further note that all of the cases cited by KBS in 

support of retroactive allocation are factually distinguishable 

as they involved post-petition, post-confirmation tax payments.22

 Appellants do not cite any authority which would support a 

retroactive allocation involving pre-petition payments not made 

 

21. The fact that the IRS had not challenged the bankruptcy 

court's determination that reallocation was necessary for a 

successful reorganization is not dispositive here, as that 

determination was prematurely reached. 

 

22. In addition to Energy Resources, the appellants rely on 

In re Deer Park, Inc., 10 F.3d 1478 (9th Cir. 1993), and In re 

Flo-Lizer, Inc., 164 B.R. 79 (Bankr. S.D. Ohio 1993), 

to support their contention that the allocation order may be 

applied retroactively. In all three of these cases, the tax 

payments at issue were made post-petition, pursuant to an 

approved plan of reorganization. 
25

pursuant to a reorganization plan. Moreover, in asking us to 

approve the retroactive allocation of pre-petition tax payments, 

KBS is, in effect, asking us to extend the time applicable to 

preferential transfers under 11 U.S.C. § 547 well beyond that 

allowed by the Bankruptcy Code. We find no basis in the 

Bankruptcy Code or other legal authority which would justify this 

treatment. Accordingly, we find that retroactive allocation of 

pre-petition tax payments is not permitted.23 

 Because we find that Energy Resources does not 

apply here, we must turn to the common law regarding voluntary 

payments. The parties have agreed that the tax payments at issue 

were made voluntarily. "IRS policy has long permitted a taxpayer 

who `voluntarily' submits a payment to the IRS to designate the 

tax liability . . . to which the payment will apply." In re 

Energy Resources Co., Inc., 871 F.2d at 227 (citing Rev. Rul. 79-

284, 1979-2 C.B. 83; Slodov v. United States, 436 U.S. 238 

(1978)) (other citations omitted); Pepperman, 976 F.2d at 127. 

This policy reflects the generally recognized common law rule 

between debtors and creditors that "the debtor may indicate which 

debt it intends to pay when it voluntarily submits a payment to a 

creditor, but may not dictate the application of funds that the 

creditor involuntarily collects from it." Pepperman, 976 F.2d at 

127 (citing O'Dell v. United States, 326 F.2d 451, 456 (10th Cir. 

1964)) (citation omitted). 

 

23. To the extent that the district court in the Kaplans' 

bankruptcy cases ruled that retroactive allocation was allowed, 

that conclusion constitutes legal error. 
26

 The long-standing policy of the IRS with regard to 

voluntary payments is reflected in IRS Policy Statement P-5-60, 

which provides: 

In determining the amount of the 100 percent penalty to 

be assessed in connection with employment 

taxes, any payment made on the corporate 

account involved is deemed to represent 

payment of the employer portion of the 

liability (including assessed and accrued 

penalty and interest) unless there was some 

specific designation to the contrary by the 

taxpayer. The taxpayer, of course, has no 

right of designation in the case of 

collections resulting from enforced 

collection measures. To the extent partial 

payments exceed the employer portion of the 

tax liability, they are considered as being 

applied against the trust fund portion of the 

assessment. 

1 Administration, CCH Internal Revenue Manual at 1305-15 (Mar. 

1981). Rev. Rul. 79-284, 1979-2 C.B. 83, was promulgated in 

agreement with this policy. Kinnie v. United States, 771 F.Supp. 

842, 853 (E.D. Mich. 1991), aff'd, 994 F.2d 279 (6th Cir. 1993). 

 Rev. Rul. 79-284, modifying Rev. Rul. 73-305,24 1973-2 C.B.43, 

states that a taxpayer must provide specific written instructions 

 

24. Rev. Rul. 73-305, which provides that where no specific 

instructions are given by the taxpayer as to the application of a 

partial tax payment, the amount of the payment will be applied to 

tax, penalty, and interest, in that order, did not apply to 

withheld employment taxes. Rev. Rul. 79-284 made Rev. Rul. 73-

305 applicable to withheld employment taxes by providing: 

Rev. Rule 73-305 applies to withheld employment taxes . 

. . where the taxpayer provides specific 

written instructions for the application of a 

voluntary partial payment. If no designation 

is made by the taxpayer, the Internal Revenue 

Service will allocate partial payments of 

withheld employment taxes . . . in a manner 

serving its best interest. 
27

for the application of a voluntary partial payment of withheld 

employment taxes. 

 Revenue rulings are entitled to great deference, but 

courts may disregard them if they conflict with the statute they 

purport to interpret or its legislative history, or if they are 

otherwise unreasonable. Geisinger Health Plan v. C.I.R., 985 

F.2d 1210, 1216 (3d Cir. 1993) (citations omitted); Kinnie v. 

United States, 994 F.2d 279, 286 (6th Cir. 1993); Amato v. 

Western Union Intern, Inc., 773 F.2d 1402, 1411 (2d Cir. 1985); 

Certified Stainless Services, Inc. v. United States, 736 F.2d 

1383, 1386 (9th Cir. 1984). The Court of Appeals for the Sixth 

Circuit in Kinnie specifically found that the IRS's 

interpretation of Rev. Rul. 79-284 was not unreasonable, nor did 

it conflict with any specific statute. 994 F.2d at 287. The 

court of appeals further found that requiring the designation to 

be in writing serves an important purpose: it prevents 

litigation over various oral statements and understandings. Id.

 Accordingly, the court upheld the IRS's application of voluntary 

tax payments in the best interest of the government absent a 

written instruction from the taxpayer. Id. See also, Slodov v. 

United States, 436 U.S. 238, 252 n. 15 (1978) (acknowledging IRS 

Policy Statement P-5-60 prevails unless the government is 

notified in writing that taxes are to be applied in a different 

manner). 

 The crucial issue before us is what constitutes an 

effective designation where voluntary payments are involved. KBS 

would have us find that it effectively designated its payments to 
28

be applied first to trust fund taxes because it had an 

"understanding" with the IRS that payments were to be applied in 

that manner and because the IRS failed to notify them to the 

contrary. KBS further argues that to be effective, the 

designation need not be in writing. The weight of authority, 

however, goes against this argument. In addition, the cases 

cited by KBS to support their argument that the designation need 

not be in writing are factually distinguishable.25 

 We also reject KBS's contention that the language of 

the first installment agreement is consistent with its belief 

that payments were being applied to trust fund taxes first. 

While it is true that the first installment agreement does not 

contain any provisions contrary to the Kaplans' and KBS's beliefs 

that the payments would be applied first to trust fund taxes, 

this fact alone does not obviate the requirement that the 

taxpayers provide a written designation contemporaneously with 

their payment. 

 

25. Freck v. I.R.S., 37 F.3d 986, 994 (3d Cir. 1994) 

(Taxpayer did not have an opportunity to designate because tax 

payments were made by a third party); McKenzie v. United States, 

536 F.2d 726, 730 (7th Cir. 1976) (Bankruptcy Court found 

evidence established IRS agent told taxpayer he would apply 

payments first to trust fund taxes and, therefore, it was not 

necessary for taxpayer to give specific instructions or 

directions); In re Mallory, 32 B.R. 73, 74 (Bankr. D. Colo. 1983) 

(Even though government admitted that designation under Rev. Rul. 

73-305 can be oral if the designation is made when the payment is 

tendered, bankruptcy court found no "specific directions" were 

given with the tender of payment); In re T.M. Products, 118 B.R. 

131, 134 (Bankr. S.D. Fla. 1990) (where IRS's efforts and the 

court orders were specifically directed to the payment of trust 

fund taxes, the bankruptcy court found that the taxpayer was 

entitled to designate and, thus, the IRS could not apply payments 

to non-trust fund taxes after it learned that reorganization was 

no longer possible). 
29

 In our view, the record clearly establishes that a 

designation, written or otherwise, was not made with respect to 

any of the payments at issue. Undeniably, at the September 26, 

1994, hearing before the bankruptcy court, counsel for the 

Kaplans clarified that there was no written agreement to allocate 

tax payments to trust fund liabilities first, nor was there a 

binding oral agreement. In addition, the evidence suggests that 

a tax return was not filed with the 1990 payment,26 and that a 

designation did not accompany either the payments made before the 

first installment agreement, or those made pursuant to the 

installment agreements. 

 In order to prevail in the absence of a written 

designation, KBS must show that the IRS assured it that the 

payments would be allocated to trust fund taxes first, thereby 

equitably estopping the IRS from changing the allocation at this 

late date. The evidence of record, however, does not suggest 

that the IRS agreed to apply KBS's payments to trust fund taxes 

first, nor does it show that the Kaplans were led to believe the 

IRS was not contesting designation requests. Other than the 

statements of the Kaplans, there is no evidence to suggest that 

the designation requests were, in fact, made. 

 In support of its equitable estoppel argument, KBS 

cites In re Jones, 181 B.R. 538, 543-44 (D. Kansas 1995). That 

 

26. A tax return accompanying a payment is considered a 

written designation to apply the payment as shown on the return; 

a payment received without a return is considered undesignated 

and is applied first to the employer's non-trust fund taxes. 

Internal Revenue Manual 56(18)3.1 (11-21-89). 
30

case is distinguishable inasmuch as the Chapter 13 debtor had an 

oral agreement with a specifically identified IRS agent. The 

district court found that there was a running dialogue between 

the agent and the debtor in which the agent made it clear to the 

debtor that the IRS was interested in initially collecting the 

payroll withholding taxes and provided the debtor with an 

incentive to make these payments. The district court further 

found that the actions of the IRS gave the debtor strong reason 

to believe that his payment would be applied to his withholding 

taxes. The district court held that the debtor, having shown 

that the elements of equitable estoppel were met,27 was entitled 

to have his payment credited to his withholding tax liability. 

 Unlike In re Jones, the taxpayers here have not 

produced any evidence to suggest that the IRS engaged in conduct 

which could have led the Kaplans and KBS to believe that their 

tax payments were being applied to trust fund taxes first. KBS's 

equitable estoppel argument, therefore, fails. 

 Accordingly, we find that KBS failed to designate that 

its payments be applied to trust fund taxes first. The IRS was 

allowed, therefore, to apply the tax payments in the best 

interests of the government. 

 

27. The traditional elements of equitable estoppel are: 

"(1) the party to be estopped must have known the facts; (2) the 

party to be estopped must intend that his conduct will be acted 

upon or must so act that the party asserting the estoppel has the 

right to believe it was so intended; (3) the party asserting 

estoppel must be ignorant of the true facts; and (4) the party 

asserting estoppel must rely on the other party's conduct to his 

injury. In re Jones, 181 B.R. 538, 543 (D. Kansas 1995) (citing 

Penny v. Giuffrida, 897 F.2d 1543, 1545-46 (10th Cir. 1990). 
31

V. 

 For the reasons set forth above, we will affirm the 

decisions of the district court.