Supreme Court Holds Post-Petition Tax Liabilities Non-Dischargeable for Chapter 12 Debtors

American Bankruptcy Institute Law Review Staff

 

 

Adopting a textualist approach, the U.S. Supreme Court, in Hall v. United States,[1] ruled that capital gains liability resulting from the debtors’ post-petition sale of their farm was not “incurred by the estate”[2] and therefore not dischargeable under chapter 12 of the Bankruptcy Code (“Code”).[3] After filing for chapter 12 bankruptcy protection, the debtors, Lynwood and Brenda Hall, sold their farm and incurred income tax liability as a result.[4] The Halls proposed a plan of reorganization under which they classified the resulting income tax liability as a dischargeable general unsecured claim and the IRS objected. The IRS argued that the taxes were the debtors’ independent responsibilities and were neither collectible nor dischargeable in bankruptcy.[5] The Court agreed with the IRS and held that the tax is neither a collectible nor dischargeable administrative expense under a chapter 12 plan of reorganization.[6]

 

Under chapter 12 of the Code, farmer debtors can treat certain governmental claims arising from the sale of farm assets as dischargeable general unsecured claims.[7] One such claim is for “administrative expenses allowed under section 503(b).”[8] Section 503(b) includes “any tax . . . incurred by the estate.”[9] The Court disagreed with the debtors’ position that the post-petition federal income tax liability resulting from the individual debtors’ farm sale was an administrative expense “incurred by the estate.”[10] The Court applied a “plain and natural reading” of the statute and concluded that “a tax ‘incurred by the estate’ is a tax for which the estate itself is liable.”[11] Looking to the Internal Revenue Code[12] (the “IRC”) and drawing support from section 346 of the Code, the Court reasoned that the chapter 12 estate is not a separate taxable entity. Therefore, it is the chapter 12 debtor, not the debtors’ estate, that is liable for income taxes that result from the sale.[13] As a result, the federal income tax liability was not collectible or dischargeable in the debtors’ chapter 12 plan and must be paid off independently by the debtors.[14]

 

The Court’s decision in Hall v. United States may potentially diminish the value of chapter 12 bankruptcy for debtors.[15] As noted by Justice Breyer in the dissent, the Court’s decision may produce the opposite result intended by Congress.[16] Section 1222(a)(2)(A) of the Code was enacted by Congress in 2005 in an attempt to free up capital for farmers and help farmers stay in the business of farming by allowing chapter 12 debtors to treat capital gain tax claims as ordinary unsecured claims, subject to discharge.[17] By allowing the IRS to collect its post-petition tax claims, the Court left chapter 12 debtors with fewer assets to devote to their chapter 12 plans, perhaps even to the point where they can no longer proceed under chapter 12.[18]

 

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