WASHINGTON (CN) – A California couple who filed for bankruptcy and then profited off the sale of their farm must pay a tax liability, the Supreme Court ruled Monday.
In a sharp dissent, Justice Stephen Breyer said the majority’s view risks causing the very ills Chapter 12 was designed to prevent.
For both sides of the 5-4 decision, the case hinged on the interpretation of the phrase “incurred by the estate” in federal tax liabilities.
Relying on “a plain and natural reading,” the majority said a Chapter 12 estate is not a separately taxable entity under the relevant provisions of the tax code.
“The debtor – not the trustee – is generally liable for taxes and files the only tax return,” Justice Sonia Sotomayor wrote for the court.
Therefore, “the post-petition income taxes are thus not “not incurred by the estate,” she added.
Breyer argued, however, that the majority embraced only the narrowest of many interpretations possible for “incurred by the estate.” Taking that reasoning to its logical conclusion could have the government collect a full tax debt outside of a bankruptcy proceeding and reduce a farmer’s assets and future income to the point where they would not be able to proceed under Chapter 12.
“Congress did not intend this result,” he wrote.
Brenda and Lynwood Hall filed for bankruptcy in 2005 and spelled out how they planned to pay off their debt through the sale of their 320-acre farm, as required by the Chapter 12 reorganization plan.
Under Chapter 12 of the bankruptcy code, farmer debtors may treat certain claims owed to a governmental unit resulting from the disposition of farm assets as dischargeable, unsecured liabilities.
The Halls’ situation became much more complicated when they sold the farm for $960,000, resulting in a capital-gains tax liability of $29,000.
A bankruptcy court refused to treat the tax debt as a dischargeable unsecured liability. The 9th Circuit ultimately took the same position, reversing the opinion of a federal judge.
The majority’s affirmation Monday resolves circuit conflict.
“It is clear that, pursuant to 26 U. S. C. §1398 and 1399, the standing Chapter 12 trustee neither files a return nor pays federal income tax,” Sotomayor wrote.
“These provisions suffice to resolve this case: Chapter 12 estates are not taxable entities,” she added. “Petitioners, not the estate itself, are required to file the tax return and are liable for the taxes resulting from their post-petition farm sale.”
“We hold that the federal income tax liability resulting from petitioners’ post-petition farm sale is not ‘incurred by the estate’ under §503(b) and thus is neither collectible nor dischargeable in the Chapter 12 plan,” the opinion States. “There may be compelling policy reasons for treating post petition income tax liabilities as dischargeable. But if Congress intended petitioners’ result, it did not so provide in the statute.”
The dissent, joined by Justices Anthony Kennedy, Ruth Bader Ginsburg and Elena Kagan, says that Chapter 12 aims to help family farmers in economic difficulty reorganize their debts without losing their farms.
“Congress amended §1222(a) of the Code to enable the debtor to treat certain capital gains tax claims as ordinary unsecured claims,” Breyer wrote.
“The court’s holding prevents the Amendment from carrying out this basic objective,” he added.
“If the government and the majority are right, then the capital gains tax falls outside the category of §507 priority claims – and therefore falls outside the scope of the amendment; in fact, it falls outside the bankruptcy proceeding altogether,” the dissent states later.
“If the resulting tax debt were treated as a §507 priority claim, then it might well absorb much of the money raised to the point where (depending upon the size of his other debts) the farmer might be unable to proceed under Chapter 12.
“The amendment accordingly seeks to place the tax authorities farther back in the creditor queue, requiring them, like ordinary unsecured creditors, to seek payment from the funds that remain after the §507 priority creditors(and secured claim holders) have been paid,” Breyer added.
“A broader interpretation of the word ‘claim’ may allow the plan to include certain post-petition debts,” Breyer wrote. “This, taken together with a broader interpretation of the phrase “incurred by the estate,” prevents the Government from collecting post-petition/pre-confirmation tax debts outside of Chapter 12, requiring it to assume a place in the creditor queue.”
“Together these broader interpretations permit the Amendment to take effect as intended. I find this last-mentioned consideration determinative,” Breyer wrote. “It seems to me unlikely that Congress, having worked on revisions of the Code for many years with the help of Bankruptcy experts, and having considered the Amendment several times over a period of years, would have made the drafting mistake that the Government and the majority necessarily imply that it made.”