Oct. 24 (Westlaw Journals) - The U.S. Supreme Court is set to hear a dispute over whether a farmer who has filed a Chapter 12 petition may rely on a Bankruptcy Code provision making the capital gains tax from the bankruptcy sale of a farm dischargeable.
Hall et al. v. United States, No. 10-875, government’s brief filed (U.S. Sept. 16, 2011).
The 9th Circuit U.S. Court of Appeals ruled last year that the provision does not apply and Chapter 12 debtors must pay the tax out of their own pockets.
The petitioners are Lynwood and Brenda Hall. They filed a Chapter 12 petition in August 2005 in U.S. Bankruptcy Court for the District of Arizona, court records indicate.
Chapter 12 is a special provision of the Bankruptcy Code that applies to family farmers.
The Halls received Bankruptcy Court permission to sell their 320-acre farm in Willcox, Ariz., for $960,000, according to court records.
Their proposed reorganization plan sought to pay off their outstanding liabilities using the sale proceeds, court records say.
The IRS objected, claiming the Halls owed a $29,000 in capital gains tax from the sale of the farm.
The couple amended their plan to treat the $29,000 tax as an unsecured “administrative expense” of the estate under 11 U.S.C. § 1222(a)(2)(A) that could be discharged after less than full payment. Congress enacted the provision in April 2005 to allow a priority tax claim resulting from the sale of farm assets to be treated as a dischargeable, unsecured debt.
The IRS again objected on the ground a Chapter 12 bankruptcy estate is not considered a separate taxable entity under its internal regulations. It argued, therefore, that the capital gains tax was an obligation of the Halls, individually, that could not be included in the plan.
The Bankruptcy Court sustained the objection in 2007. However, the District Court reversed that decision following year on appeal by the Halls.
The IRS then appealed to the 9th Circuit. In August 2010 a 2-1 majority of the appeals panel ruled that because a Chapter 12 estate is not considered a separate taxable entity under Sections 1398 and 1399 of the Internal Revenue Code, the estate cannot incur taxes.
The majority acknowledged that its decision created a split with a prior ruling by the 8th Circuit in Knudsen v. IRS, 581 F.3d 696 (8th Cir. 2009). However, it disagreed with that court’s refusal to look to the Internal Revenue Code to determine if the tax was incurred by an estate.
After unsuccessfully seeking rehearing, the Halls filed a petition for writ of certiorari with the Supreme Court last December. The high court agreed in June to hear the case.
The Halls argue the 9th Circuit erred in not finding the capital gains tax is a dischargeable “administrative expense” of the estate.
They say that due to payments being made to other creditors, there are insufficient funds to satisfy the entire capital gains tax in full. They claim they will lose their house if forced to pay the capital gains tax outside their plan because tax liens are not subject to state-law homestead exemptions.
The IRS responds that payment of the tax cannot be included in the Halls’ plan.
The agency says because the filing of a Chapter 12 petition does not create a “separate taxable entity,” the estate cannot “incur” federal income taxes.
The agency says it has consistently taken the position that taxes incurred by a debtor post-petition cannot be collected in a Chapter 12 proceeding.
The Supreme Court’s docket indicates the case is set for argument Nov. 29.
Petitioners: Susan M. Freeman, Lewis & Roca LLP, Phoenix
Respondent: Donald B. Verrilli Jr., Justice Department, Washington
(Reporting by Chip Giambrone, Westlaw Journal Bankruptcy)