UNITED STATES OF AMERICA, PETITIONER V. MERCHANTS NATIONAL BANK OF MOBILE No. 85-1480 In the Supreme Court of the United States October Term, 1985 Petition for a Writ of Certiorari to the United States Court of Appeals for the Eleventh Circuit Petition for a Writ of Certiorari to the United States Court of Appeals for the Eleventh Circuit TABLE OF CONTENTS Opinions below Jurisdiction Statutes involved Questions Presented Statement Reasons for granting the petition Conclusion Appendix A Appendix B Appendix C Appendix D Appendix E Appendix F OPINIONS BELOW The opinion of the court of appeals (App., infra, 1a-4a) is reported at 772 F.2d 1522. The opinion of the district court (App., infra, 5a-9a) is unreported. JURISDICTION The judgment of the court of appeals (App., infra, 10a-11a) was entered on October 7, 1985. On December 16, 1985, Justice Powell extended the time within which to file a petition for a writ of certiorari to and including March 6, 1986. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1). STATUTES INVOLVED Sections 3505 and 6303 of the Internal Revenue Code of 1954 (26 U.S.C.) are set out in a statutory appendix (App., infra, 13a-14a). QUESTION PRESENTED Section 3505 of the Internal Revenue Code provides that, where a lender furnishes funds directly or indirectly to an employer for the payment of wages, the lender in certain circumstances may be personally liable if the required employment taxes are not withheld from those wages and paid over to the IRS. The question presented is whether, as a prerequisite to the government's maintenance of a civil suit to collect the lender's personal liability in such circumstances, the IRS must have sent to the lender, within 60 days of making an assessment of the unpaid taxes against the employer, a copy of the tax bill that is required to be sent to the employer under Section 6303(a). The Solicitor General, on behalf of the United States, petitions for a writ of certiorari to review the judgment of the United States Court of Appeals for the Eleventh Circuit in this case. STATEMENT 1. On November 9, 1977, the Commissioner made an assessment of unpaid employment taxes against Dri-Mix Products, Inc., for the third quarter of 1977 (App., infra, 6a). This assessment was in the amount of approximately $212,000 (R. 2). The assessment reflected Dri-Mix's liability for the income and social security taxes that it was required to withhold from its employees' wages and pay over to the IRS, but which it either did not withhold or did not pay over. On May 15, 1978, the Commissioner made a similar assessment against Dri-Mix, in the amount of approximately $184,000, for the fourth quarter of 1977 (App., infra, 6a; R. 2). Section 6303(a) of the Internal Revenue Code /1/ provides that the Commissioner, as soon as practicable after making a tax assessment, and in any event within 60 days of making an assessment, must "give notice to each person liable for the unpaid tax, stating the amount and demanding payment thereof." The Commissioner typically provides such notice by sending the taxpayer a "Request for Payment of Balance Due" -- in essence, a tax bill -- notifying the taxpayer of the amount owed and requesting payment within 10 days. See M. Saltzman, IRS Practice and Procedure Paragraph 14.03, at 14-11 et seq. (1981). On the same day that the Commissioner made each of the above-described assessments against Dri-Mix, he sent Dri-Mix a notice pursuant to Section 6303(a) stating the amount of its unpaid employment taxes and demanding payment thereof (App., infra, 6a). In each instance, Dri-Mix failed to pay, in whole or in part, the taxes thus assessed (R. 3). 2. On March 18, 1983, the United States brought this action in the United States District Court for the Southern District of Alabama against respondent, a bank with its principal place of business in Mobile, Alabama (App., infra, 1a, 5a; R. 1-2). The government's complaint alleged that respondent, beginning in January 1977, had lent funds to Dri-Mix under circumstances that rendered respondent personally liable, under Section 3505 of the Code, for a portion of Dri-Mix's unpaid employment taxes (App., infra, 2a, 6a; R. 3). Specifically, the complaint alleged (R. 3) that respondent had "pa(id) wages directly to (the) employees" of Dri-Mix, in consequence of which respondent under Section 3505(a) became "liable in (its) own person and estate to the United States in a sum equal to the taxes (together with interest) required to be deducted and withheld from such wages" (I.R.C. Section 3505(a)). The complaint further alleged (R. 3) that respondent had supplied funds to Dri-Mix "for the specific purpose of paying wages," with knowledge that Dri-Mix did not intend, or would not be able, "to make timely payment or deposit of the (taxes) required * * * to be deducted and withheld" from its employees' wages, in consequence of which the bank had incurred personal liability under Section 3505(b). The government's complaint alleged that respondent's total liability under Section 3505 for the third and fourth quarters of 1977 was approximately $220,000, plus interest (R. 3-4). This sum roughly corresponded to the portion of the overall assessment against Dri-Mix that was for unpaid withholding taxes, as opposed to Dri-Mix's own share of the payroll tax. By way of amended answer, respondent asserted as an affirmative defense that the government was precluded from suing it because it had not been notified of the assessment against Dri-Mix within the 60-day period specified in Section 6303(a). See App., infra, 2a; R. 354-356. Respondent submitted that, if the instant suit were successful, it would be a "person liable for the unpaid tax" (I.R.C. Section 6303(a)). Respondent accordingly argued that the Commissioner was required, within 60 days of making the assessments against Dri-Mix, to send respondent as well as Dri-Mix a notice "stating the amount (of the unpaid tax) and demanding payment thereof" (ibid.). Respondent further contended that the Commissioner's failure to give it timely notice of the assessment against Dri-Mix erected an absolute bar to the instant suit, and it moved for summary judgment on that basis. App., infra, 2a, 6a; R. 358-361. The district court granted respondent's motion for summary judgment and ordered the government's suit "dismissed with predjudice" (App., infra, 12a). Relying on United States v. Associates Commercial Corp., 721 F.2d 1094 (7th Cir. 1983), the district court held that Section 6303(a) requires the IRS to give notice "'to lenders allegedly subject to * * * liability'" under Section 3505, thus "'alerting (them) to a possible civil action'" (App., infra, 8a & n.1 (quoting 721 F.2d at 1099 & n.10)). The court found that the IRS had not given respondent written notice of the assessments against Dri-Mix within 60 days of making either assessment, and it concluded that the Commissioner's "failure * * * to give the required notices of assessment to (respondent) precludes this civil action" (App., infra, 9a). /2/ 3. The court of appeals affirmed the dismissal of the government's complaint (App., infra, 1a-4a). It rejected the government's argument that Section 6303(a) requires notice only to those persons against whom taxes have actually been assessed, and not to third parties who might under certain circumstances incur a personal liability for part or all of the assessed tax (App., infra, 2a-3a). Citing the Seventh Circuit's opinion in Associates Commercial, the court of appeals stated that, "(s)ince Section 3505 did not exempt from Section 6303(a) lenders potentially liable, and since no other exemption could be found, * * * the lender, 'a person liable for the unpaid tax' within the meaning of Section 6303(a), was entitled to notice of assessment of the unpaid tax" (App., infra, 2a-3a (citing 721 F.2d at 1098)). The court further concluded that the Commissioner's "failure to provide (respondent) with the Section 6303(a) notice bars the present suit" (App., infra, 3a). REASONS FOR GRANTING THE PETITION The court of appeals has decided an important question of federal tax law in a way that squarely conflicts with a recent decision of the Third Circuit. The decision below would produce an irrational result, for it would require the IRS, when making an assessment against a taxpayer, to notify a group of third parties whose identifies the IRS typically would not know at the time. The notice required by the court of appeals would take the form of a tax bill that those third parties would not then be expected to pay, and that bill would be in an amount that would rarely if ever correspond to any future liability that the government might seek to establish against them in a civil suit under Section 3505. The question presented has considerable administrative importance, for the practical effect of the decision below would be to nullify what Congress intended to be an important part of the tax-collection scheme. Review by this Court is therefore appropriate. 1. The decision below is in direct conflict with the Third Circuit's decision in United States v. Jersey Shore State Bank, 781 F.2d 974 (1986) (reprinted in App., infra, 15a-36a). That case, like this one, involved a suit by the United States to collect a bank's personal liability for an employer's unpaid withholding taxes. The government's complaint there, as here, alleged that the bank had incurred personal liability both under Section 3505(a), by paying wages directly to employees, and under Section 3505(b), by supplying funds to the employer for the specific purpose of paying wages, with knowledge that the employer did not intend, or would not be able, to pay over the required withholding taxes (App., infra, 16a). The bank there contended, as respondent contended below, that Section 6303(a) required the IRS to notify it of the assessment against the employer within 60 days of making that assessment (App., infra, 16a). And the bank there moved for summary judgment, as respondent did below, on the theory that the Commissioner's failure to give it the notice specified in Section 6303(a) barred the United States from bringing suit to collect the bank's liability under Section 3505 (App., infra, 16a-17a). The Third Circuit squarely rejected the bank's argument, explicitly declining to follow the decisions of the Eleventh Circuit below and of the Seventh Circuit in Associates Commercial. See App., infra, 20a & n.2, 21a-27a, 30a-31a, 32a. The Third Circuit pointed out that the "plain language" of Section 6303(a), contrary to the view of those courts, does not unambiguously require notice to lenders at the time the employer's taxes are assessed (App., infra, 21a-22a). The statute speaks of "notice to each person liable for the unpaid tax"; at the time of the assessment against the employer, the Third Circuit observed, the employer's lenders (as contrasted with the employer himself) have not a present but only a "potential liability" to pay the unpaid tax (id. at 23a). The statute, moreover, as the Third Circuit observed, "requires notice of a particular kind: i.e., one 'stating the amount (of the tax) and demanding payment thereof'" (id. at 22a (emphasis in original), quoting I.R.C. Section 6303(a)). Upon making an assessment against the employer, the Third Circuit pointed out, the IRS has no authority to "demand payment" from lenders, for their liability can be collected only by the Department of Justice in a civil suit instituted for that purpose. App., infra, 22a, 25a & n.5. See I.R.C. Sections 7401, 7402. And the tax bill that Section 6303(a) requires the IRS to send the employer, the Third Circuit observed, would rarely if ever "state() the amount" (I.R.C. Section 6303(a)) of a lender's potential liability, since that bill would include the employer's own share of the payroll taxes, for which lenders are not liable, and since that bill would include the employer's own share of the payroll taxes, for which lenders are not liable, and since the amount of a lender's liability could be affected both by the timing of its loans and by a statutorily-specified "cap" under Section 3505(b) (See App., infra, 22a-23a). For all these reasons, the Third Circuit concluded, "the more natural and logical reading" of the statutory language was that urged by the government and rejected by the court of appeals below -- that "section 6303(a) requires notice only to those individuals against whom the taxes have been assessed" (App., infra, 23a). Even if Section 6303(a) were construed to require notice to lenders, the Third Circuit continued (App., infra, 24a-29a), it would by no means follow that the Commissioner's failure to provide such notice would foreclose the United States from bringing a civil suit to collect the lender's liability under Section 3505. It has been "long settled that the government's failure to assess its taxes (does) not preclude it from exercising its common-law right to sue for the taxes" (App., infra, 24a (citing authority)). Indeed, the Code explicitly recognizes that the United States may timely bring a "proceeding in court without assessment for the collection of (a) tax" (I.R.C. Section 6501(a) (emphasis added); see I.R.C. Sections 7401, 7402). And it is "equally well settled that where the government ha(s) assessed the taxes but failed to provide the taxpayer with notice of that assessment, it c(an) still proceed by suit to collect the taxes owed" (App., infra, 24a (citing cases)). The rationale for this well-settled rule, the Third Circuit observed (App., infra, 24a-25a), is that notice and demand under Section 6303(a) are chiefly designed to protect the taxpayer from surprise collection activity, something that cannot happen in the case of a civil suit. Once a tax has been assessed, the IRS is empowered to collect the tax from any person against whom it has been assessed by a variety of summary devices, such as levy, seizure, and sale of property (App., infra, 25a). Notice under Section 6303(a) enables a taxpayer to avoid such enforced collection by promptly paying the tax bill tendered to him. In order to protect the taxpayer, therefore, the Code explicitly requires the Commissioner to provide notice and demand under Section 6303(a) before seeking to collect a tax administratively. E.g., I.R.C. Sections 6321, 6322 (tax liens), 6331 (levy and seizure). Where the government seeks to collect a liability by civil suit, on the other hand, not only does the Code not require notice and demand under Section 6303(a), but, as the Third Circuit observed, "the need for (such) notice * * * is not nearly so self-evident" (App., infra, 25a). The government in such a case cannot "employ its summary collection methods" against the defendant, who is thus "in no danger of having his property immediately seized or attached to satisfy the obligation" (id. at 26a). "In a civil action," therefore, "service of the government's complaint provides the (defendant) with all the notice and protection required" (ibid.). Relying on these considerations, the Third Circuit concluded that the Commissioner's failure to notify a bank under Section 6303(a) "does not bar (the government's) suit to collect the (b)ank's liability under section 3505" (App., infra, 29a). Since the IRS cannot summarily collect a Section 3505 liability, the notice and demand specified in Section 6303(a), if directed to a lender, would be deprived of its usual function. And since a lender cannot be held liable in a civil suit unless the government proves either that the lender itself paid wages without paying the required withholding taxes (I.R.C. Section 3505(a)) or that the lender supplied funds to the employer with "actual * * * knowledge" that the employer would not pay over those taxes (I.R.C. Section 3505(b)), formal notification from the IRS of the assessment against the employer would rarely tell a potentially-liable lender anything that it did not already know. The Third Circuit thus concluded (App., infra, 30a-31a) that the notice mandated by the Seventh Circuit and by the court of appeals below "serves no useful purpose," but "simply adds an additional formalistic requirement for the imposition of section 3505 liability." 2. In declining to follow the decision below, the Third Circuit reached a result that accords with the statutory language, with the overall statutory scheme, and with Congress's purpose in enacting Section 3505. Congress enacted that provision in 1966 (Federal Tax Lien Act of 1966, Pub. L. No. 89-719, Section 105(a), 80 Stat. 1138) in response to a practice generally known as "net payroll financing," which was especially common in the case of employers experiencing financial difficulties. See H.R. Rep. 1884, 89th Cong., 2d Sess. 20 (1966). Under that practice, a third party -- typically a surety, bank, or general contractor -- would supply funds for the payment of wages, thus keeping the employer afloat. However, in order to limit its own exposure, the lender would supply an amount equal only to the "net," or after-tax, wages due the employees, without paying, "either to the employees or to the Government, the withholding taxes due the Government" (ibid.). Although employers in such circumstances remained liable for the unpaid withholding taxes, Congress found that they "were likely to be without financial resources and, as a result (that) recourse against them (might) well be fruitless." S. Rep. 1708, 89th Cong., 2d Sess. 21 (1966). Under pre-1966 law, moreover, recourse could not be had against the lender either, since the lender was not an "employer," as defined by statute, with respect to the withholding taxes (ibid.). To stem this loss of revenue, Congress in Section 3505 imposed liability on third parties who engaged in net payroll financing, concluding that such lenders "sit in essentially the same position vis-a-vis control over payroll funds and access to information as the employer itself." Jersey Shore State Bank (App., infra, 19a). See H.R. Rep. 1884, supra, at 20; S. Rep. 1708, supra, at 22. Nothing in the language or legislative history of Section 3505 suggests that Congress intended a lender's liability thereunder to hinge on whether it had received notice and demand of the sort described in Section 6303(a). Indeed, the mechanism that Congress prescribed for collecting the lender's liability, which differs significantly from the mechanism prescribed for collecting certain other third-party liabilities under the Code, clearly suggests the reverse. Congress has provided, for example, that the liability of certain transferees (I.R.C. Section 6901(a)) and of responsible officers (I.R.C. Section 6672(a)) "shall be assessed and collected in the same manner as (the) taxes" of the taxpayer itself. I.R.C. Section 6671(a); see I.R.C. Section 6901(a). The Commissioner is thus empowered to collect such third-party liabilities by levy and other summary devices, and, before such administrative collection steps can be taken, "notice and demand" (I.R.C. Section 6671(a)) to the third party are necessarily required under Section 6303(a). In the case of a lender's liability under Section 3505, by contrast, Congress stated that collection could be effectuated only by "the United States (in an) appropriate civil proceeding." H.R. Rep. 1884, supra, at 65-66. Since it was well established in 1966 that the United States could bring a civil proceeding to collect taxes from the taxpayer himself without prior Section 6303(a) notification (see, e.g., Jenkins v. Smith, 99 F.2d 827 (2d Cir. 1938)), Congress in enacting Section 3505 is unlikely to have contemplated any requirement of prior Section 6303(a) notice to third parties. In requiring such notice, the court of appeals has opted for an unworkable enforcement scheme that, in practical effect, would larely nullify what Congress intended to be an important part of the tax-collection scheme. When the Commissioner makes an assessment of unpaid payroll taxes, he ordinarily will have no way of knowing whether the delinquent employer has borrowed money from a third party under circumstances that might render the latter liable under Section 3505. There is no indication on the face of a payroll tax return who the employer's creditors might be, much less any indication whether such creditors might themselves have paid net wages (I.R.C. Section 3505(a)) or have "actual * * * knowledge" (I.R.C. Section 3505(b)) of the employer's withholding tax delinquency. Nor could the Commissioner reasonably be expected, at the time he makes the assessment against the employer, to undertake to identify such lenders. The IRS during 1984 received about 19 million quarterly withholding tax returns, almost six million of which were accompanied by only partial payment or by no payment at all. /3/ In order to protect the revenue, the Commissioner typically assesses such delinquent taxes against the employer within a month or two of receiving the return. As the Third Circuit observed in Jersey Shore State Bank (App., infra, 32a), it would obviously "impose a prohibitory investigative burden on the government" to require the IRS, within 60 days of making those six million assessments, to identify and notify all lenders who might have potential personal liability for the taxes thus assessed. Even if such investigations were realistically possible, moreover, they would entail a tremendous waste of resources. Like any creditor, the Commissioner naturally tries to collect delinquent payroll taxes first from the employer itself by sending the employer a series of tax bills. If collection efforts against the employer fail, it is the Commissioner's usual practice to try to collect from the employer's responsible persons under Section 6672. Only after those avenues have been investigated does the Commissioner normally explore the possibility of collection from lenders. Indeed, the IRS estimates that Section 3505 comes into play in only about one case for every 5,000 withholding tax delinquencies. Since lenders in the vast majority of cases will never be called upon to pay the delinquent taxes, it would be pointless for the IRS to go to the expense of identifying and notifying them at the very outset of the collection process -- a step that would needlessly embarrass employers and convey no useful information to lenders in any event. For these reasons, the Third Circuit in Jersey Shore State Bank concluded without exaggeration that "liability under section 3505 would be rendered a substantial nullity if, as an absolute prerequisite for collection, the government (were) forced to give third parties such as (respondent) notice of its assessment against the taxpayer within sixty days" (App., infra, 33a). Properly construed, the court reasoned, the phrase "each person liable for the unpaid tax" in Section 6303(a) refers, not to lenders who might face potential liability in a future civil suit, but "only to those parties against whom the taxes have been assessed, and against whom the government can proceed administratively" (App., infra, 26a). "(C)onstruing section 6303(a) as the Seventh Circuit did," the Third Circuit held, interposes a meaningless formal requirement "upon which parties liable under section 3505 can rely, thereby thwarting Congress' intent to recover the unpaid withholding taxes from such persons" (App., infra, 30a-31a). 3. The question presented has considerable importance to the administration of the tax laws. Following the Seventh Circuit's decision in Associates Commercial, lenders rapidly realized that they had been afforded a near-absolute defense to liability, since the Commissioner has never provided, and would find it virtually impossible to provide, notice of the sort that the court there ordered. In the two years since Associates Commercial was decided, litigation concerning the question presented has accordingly multiplied. Besides the three cases that have already reached decision in the courts of appeals, appeals are now pending in the Third, /4/ Eighth, /5/ and Ninth Circuits, /6/ and the Tax Division informs us that at least a dozen cases are now pending in the district courts. Litigation concerning this question will necessarily continue until the existing conflict in the circuits is resolved by this Court. Perhaps the most troubling aspect of the rule adopted by the Seventh Circuit and by the court of appeals below is the effect it would have on Section 3505's central deterrent purpose. A principal reason for the comparative paucity of litigation concerning Section 3505 prior to the Seventh Circuit's decision in Associates Commercial was that lenders refrained from engaging in net payroll financing for fear of incurring personal liability. By converting Section 3505 virtually into a dead letter, the rule adopted by the Seventh Circuit and by the court below will encourage lenders to return to the very practice that Congress in 1966 determined to stop. CONCLUSION The petition for a writ of certiorari should be granted. Respectfully submitted. CHARLES FRIED Solicitor General ROGER M. OLSEN Acting Assistant Attorney General ALBERT G. LAUBER, JR. Assistant to the Solicitor General WYNETTE J. HEWETT BRUCE R. ELLISEN Attorneys MARCH 1986 /1/ Unless otherwise noted, all statutory references are to the Internal Revenue Code of 1954 (26 U.S.C.), as amended (the Code or I.R.C.). /2/ Respondent had also filed a previous motion for summary judgment, arguing inter alia that the undisputed facts showed it to be unaware that Dri-Mix was delinquent in its employment taxes, and contending that the government could not recover for that reason. See R. 345-346. The district court denied that motion. On respondent's cross-appeal, the court of appeals affirmed the district court, noting that respondent's counsel had "all but conceded at oral argument" that the cross-appeal was "without merit." App., infra, 2a, 3a. We have no occasion to address that aspect of the decision below. /3/ These statistics are based on information in IRS files and have been provided to us by the Service. /4/ United States v. American Bank & Trust Co., No. 85-1615. /5/ United States v. Messina Builders & Contractors Co., No. 85-2505. /6/ United States v. Harvis Construction Co., No. 86-1540; United States v. United California Bank, No. 85-1873; United States v. Hunter Engineers & Constructors, Inc., No. 84-2652, (argued Nov. 20, 1985). APPENDIX