On Appeal from the United States District Court for the Western District of Pennsylvania. (D.C. Civ. No. 93-0736).
Before: Stapleton and Greenberg, Circuit Judges, and Atkins, District Judge*fn*
GREENBERG, Circuit Judge.
This appeal involves a controversy over City of Farrell municipal income taxes that Sharon Steel Corporation withheld from its employees' wages. After withholding the amounts in dispute, Sharon Steel filed for protection under Chapter 11 of the Bankruptcy Code and thus did not remit the funds to the city. The City of Farrell subsequently initiated this action in the bankruptcy court to collect the unpaid taxes withheld. The bankruptcy court and the district court denied the City's request for an order requiring Sharon Steel to remit the withheld funds. We will reverse the district court's order, and we will remand the case to the district court for the proceedings we outline in this opinion.
II. FACTUAL BACKGROUND AND PROCEDURAL HISTORY
Sharon Steel has its main plant and principal place of business in the City of Farrell, Mercer County, Pennsylvania. In 1967 the city, pursuant to section 13 of the Pennsylvania Local Tax Enabling Act, as amended, Pa. Stat. Ann. tit. 53, § 6913 (1972), enacted a tax (Ordinance No. 0-17-66) on the earned income and net profits of all residents and non-residents employed or conducting business within the city. Under the ordinance and Pennsylvania law, Pa. Stat. Ann. tit. 53, § 6913 IV, employers located in the City of Farrell must withhold taxes on locally earned income from the wages of any employee subject to the city income tax and must remit those taxes in quarterly payments to the city.
For the fourth quarter of 1992, Sharon Steel withheld $56,831.99 in City of Farrell income tax. On November 30, 1992, Sharon Steel filed its petition under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Western District of Pennsylvania. After filing its petition, Sharon Steel remitted $7,944.97 in withholding taxes to the City of Farrell, which was the post-petition portion of the fourth-quarter wages it withheld for payment to the City of Farrell. But Sharon Steel retained the remainder of the withheld fourth-quarter taxes.
To obtain the remaining funds, the City of Farrell filed a motion in the bankruptcy court to lift the automatic stay and to compel the turnover of the funds. The bankruptcy court denied the motion in a written opinion dated April 9, 1993, rejecting the city's reliance on Begier v. IRS, 496 U.S. 53, 110 S. Ct. 2258, 110 L. Ed. 2d 46 (1990). In re Sharon Steel Corp., 152 B.R. 450 (Bankr. W.D. Pa. 1993). The city contends that Begier held that a trust is created for the benefit of the taxing authority whenever an employer withholds a portion of an employee's wages as income taxes. Thus, in the city's view, taxes withheld from an employee but not paid to the city do not become "property of the estate" when the employer files for bankruptcy even if the employer had not segregated the "trust" funds from its other assets. But the bankruptcy court distinguished Begier, primarily because Begier requires that the taxing authority show "some nexus between the trust and the assets sought to be applied to the debtor's trust fund tax obligations" and, in the court's view, the city could not "establish the required nexus with regard to the commingled funds in [Sharon Steel's] possession." Id. at 451-52. In other words, unlike in Begier, where the debtor had paid the taxes withheld to the Internal Revenue Service prior to filing its bankruptcy petition, thereby creating a segregated fund, Sharon Steel commingled the funds with its other assets and the funds remained commingled when Sharon Steel filed its Chapter 11 petition.
The city appealed but the district court affirmed the bankruptcy court's decision in a written opinion, agreeing with the bankruptcy court that "the facts of this case are distinguishable from [those in] Begier " and that the City "has failed to demonstrate the required nexus between the taxes and the commingled funds in the possession of the estate of Sharon Steel." In re Sharon Steel Corp., Civ. No. 93-0736, at 3-4 (W.D. Pa. Feb. 11, 1994). The district court also distinguished Begier on the basis that the statutory "language establishing a 'trust fund' in the withheld taxes in Begier is absent in the pertinent statute and ordinance governing withholding taxes for Farrell." Id. The district court entered its order on February 14, 1994, affirming the bankruptcy court's order. The city has appealed to us from that order.
The bankruptcy court had subject matter jurisdiction under 28 U.S.C. § 157(b) and 11 U.S.C. § 362(d) as the City of Farrell filed a motion to lift the automatic stay and compel turnover of the trust fund taxes. The district court had appellate jurisdiction under 28 U.S.C. § 158(a) over the bankruptcy court's denial of the City's motion, as the bankruptcy court's order denying the city relief was final. We have jurisdiction under 28 U.S.C. § 158 (d) over the district court's final order affirming the bankruptcy court's order.
The crux of this appeal is whether the remaining portion of the funds Sharon Steel withheld from its employees' wages for the fourth quarter of 1992 constitutes property of its bankruptcy estate or whether it is excluded from the estate by 11 U.S.C. § 541(d), which excludes equitable interests of third parties from a bankrupt's estate.*fn1 If the funds are property of the estate, then the bankruptcy court and district court correctly rejected the city's claim; but if the funds are not property of the estate, they should be paid to the city unless, as we discuss below, Sharon Steel's pre-petition lenders have a prior claim to the funds. The City of Farrell primarily contends that because Sharon Steel retained the funds withheld in trust for the city, the funds are not property of the estate, and that therefore we should reverse the district court's order. In considering this appeal we are ...