Academic journal article Journal of Business and Accounting

The High Court Rules That Post-Petition Income Taxes on the Sale of Farm Assets Are Not Discharged in Chapter 12 Bankruptcy Cases

Academic journal article Journal of Business and Accounting

The High Court Rules That Post-Petition Income Taxes on the Sale of Farm Assets Are Not Discharged in Chapter 12 Bankruptcy Cases

Article excerpt


In Hall v. U.S., 132 S. Ct. 1882 (2012), the Supreme Court ruled that federal income tax liabilities due to individual debtors' sales of farm assets during the pendency of a Chapter 12 bankruptcy reorganization are not subject to collection or discharge in the debtors' plan. The Court opined that the post-petition income taxes are not unsecured claims under Bankruptcy Code § 1222(a)(2)(A) as they were not "incurred by the estate" under Bankruptcy Code §503(b) and thus not entitled to priority under Code §507. Under Code § 1222(a)(2)(A), a Chapter 12 plan must provide for full payment of all claims entitled to priority under Code §507 unless the claim is owed to a governmental unit arising from the sale of any farm asset used in the debtor's farming operation, in which case it will be treated as an unsecured claim. Code §507(a)(8) gives priority to certain pre-petition taxes while Code §507(a)(2) gives priority to administrative expenses allowed under Code §503(b). Code §503(b)(1)(B)(i) allows for any tax "incurred by the estate" to be treated as an administrative expense. The Court gave the phrase "incurred by the estate" its plain meaning and applied IRC §§1398 and 1399, reasoning that the Chapter 12 estate was not a separate taxable entity and the debtor was individually responsible for the tax.


While the country last summer was focused on the Supreme Court's ruling on the constitutionality of Obamacare and the battle in the Supreme Court between the competing philosophies of interpreting the Constitution, the Supreme Court issued a 5^1 ruling in Hall v. U.S., 132 S. Ct. 1882 (2012) (Hall), where the justices were divided based upon the competing interpretive methodologies.

In Hall, the majority employed the "originalist" or strict constructionist approach giving the statutory words at issue their plain meaning, viewing them in context and within the structure of the U.S. Code. The dissent employed the "purposiveness" approach reading the statute to reach the result it believed Congress intended. Hall involved an issue related to the attempt to aid family farms by amending Title 11 of the United States Code (Bankruptcy Code or Code) and adding Chapter 12, 11 U.S.C. §§1201-31, which allows family farmers to reorganize their business affairs while holding off creditors and continuing the farming enterprise by allowing farmer debtors with regular annual income to adjust their debts.

Chapter 12 was modeled after Chapter 13, which allows individual debtors with regular annual income to preserve existing assets pursuant to a court-approved plan whereby creditors are paid out of their future income. Chapter 12 requires the debtor to petition the court and file a plan of reorganization which must be confirmed by the court. The filing of the petition creates a bankruptcy estate. Generally, unless the debtor has sufficient assets or future income to satisfy the statutory criteria regarding the minimum amounts to be paid to secured creditors, Code §507 priority creditors, and unsecured creditors, and the debtor will be able to comply with the plan, the court will not confirm the plan. Each secured creditor must either accept the plan, receive payment, or retain a lien securing its claim. Generally, upon confirmation Code § 1227(b) provides that all property of the bankruptcy estate vests in the debtor. Under Code §1203, a debtor remains in possession and control of the farm assets and continues to operate the farm.

Chapter 12, as originally enacted in 1986, was flawed: when there was a sale of farm assets as part of the plan to make the farm viable and/or to raise funds to satisfy creditors, taxable gains remained a priority claim which had to be paid in full for a plan to be confirmed. Thus, the Internal Revenue Service (1RS) could veto the plan, or the debtor's inability to make all plan payments due to the tax liability might prevent confirmation. This would thwart Congress's intent in enacting Chapter 12 and prevent family farmers from making business decisions necessary to save the farm without being hindered by the tax consequences of the sales or exchanges of the farm assets. …

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