Executive of Bankrupt Airline Liable for Millions in Excise Tax

Originally Published on forbes.com on July 21st,2011

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Michael Conway was the founder and  CEO of National Airlines.  The mission of the airline was to bring tourists to Las Vegas, to visit their money I suppose.  The airline started service in 1999, but was never profitable.  In December 2000 it went into Chapter 11.  It continued to operate until November 6, 2002.  On May 7, 2003 the bankruptcy was converted to Chapter 7.  Now, as I was only vaguely aware, there is a federal excise tax on air transportation.  It is buried somewhere in the cost of your ticket.  The airline then writes a big check to the IRS.  That check to the IRS is special, though.  You see the portion of the ticket price that represented the excise is money that never really belonged to the airline.  It was your money that the airline was passing along to the federal government.  It is very similar to the money withheld from your pay for federal income tax. 

On November 30, 2000 National sent its quarterly excise tax return to the IRS in the amount of $1,832,521.01.  The IRS deposited the check on December 4.  On December 6, National went into Chapter 11 and “on the advice of counsel” closed its bank accounts to open new ones for the reorganization.  OOPS.  The check for the excise tax bounced and the company did nothing to clean it up in the early part of its reorganization.

National kept current on its excise tax payments for a while.  Then came September 11, 2001.  We all remember that.  Whenever I go back around my hometown (Fairview NJ) and look at the incomplete skyline across the river, I still get pissed off.  Among the less apparent outcomes of that day was the Air Transportation Safety & System Stabilization Act which among other things allowed airlines extended time to pay over the excise tax.  There was also direct infusion of money into the airlines.  National received $21,000,000.  National took advantage of the extension of time to pay the taxes.  It never quite got around to catching up on them though.

Now if you are in charge of a company that goes into bankruptcy, you will generally not be responsible for the company’s debts, trust funds are another matter. Like payroll withholdings, the excise tax was never the company’s money.  Because of that a “responsible person” who let the money that was collected for the tax go to pay other bills, can be liable for the unpaid tax.  That is why, with National totally gone, the IRS came knocking on Mr. Conway’sdoor for over $8,000,000.  He paid a small amount of the tax and sued for refund and abatement of the balance.  The district court turned him down and now he has lost on appeal to the Fifth Circuit.

The Court first addressed his responsibility for the pre-bankruptcy taxes:

The undisputed record shows that Conway was the founder, CEO, president, and chairman of the board of National during the periods in question; he was one of the largest individual stockholders; and he had the most individual authority, including the authority to hire and fire employees and to determine which creditors would get paid. Conway was also authorized to sign checks on each of National’s company accounts. No reasonable jury could find that Conway was not a responsible person before National’s bankruptcy, so Conway was a responsible person with regard to the pre-petition taxes.

Bankruptcy didn’t really change anything as far as the excise tax was concerned:

Furthermore, bankruptcy did not change Conway’s status as a responsible person with regard to the post-petition taxes. Notably, Conway acknowledges that during the bankruptcy, National continued to pay over the majority of its excise taxes without needing approval of the bankruptcy court and concedes that those excise taxes were paid in the normal course of business.

Mr. Conway tried to argue that he had not been “willful”.  That didn’t work:

Conway knew no later than January 19, 2001, when National filed a bankruptcy schedule reflecting the unpaid taxes, that the pre-petition excise taxes had not been paid. As to the post-petition taxes, Conway knew that they had not been paid no later than January 15, 2002, when he signed a request for an extension of time to pay over the taxes. National Airlines made payments in excess of $220 million to creditors between February 2002 and November 2002, far more than the approximately $8 million in unpaid excise taxes at issue in this case. Thus, in the absence of reasonable cause, Conway’s willfulness is established as a matter of law, and summary judgment on the issue is proper.

Mr. Conway tried to argue reliance on counsel, which did not get him anywhere.

With respect to the post 9/11 taxes.  Mr. Conway argued that Congress had contemplated that the airlines would use the unpaid taxes as working capital during the deferral period.  The Court did not buy that:

We disagree. Nothing in the plain language of the Act evinces an intent to allow the airlines to use the excise taxes as working capital. By the plain terms of the Stabilization Act, its effect was to allow airlines to defer paying over the collected excise taxes until January 15, 2002, as authorized by the IRS. Because these taxes are collected from passengers, and were not intended to become the property of National, more than a mere statutory deferral of payment would be required to evince an intent to allow the collected taxes to be used for operational purposes.

I have to say I have some sympathy for Mr. Conway on that one.  If the airlines were not supposed to use the money, what was the point of letting them delay paying it over?  It’s not as if the terrorists had hit their accounting departments.

The argument that when he left he thought tax payments had been arranged was also unavailing:

Conway also argues that he did not act willfully in regard to the pre-petition taxes because, at the time he left National, he believed he had arranged for those taxes to be paid. Noting that corporate officers have a duty to ensure that payment is made, we have repeatedly rejected the argument that a taxpayer’s good faith belief that payment for the taxes had been arranged is a defense to personal liability under § 6672.