The Supreme Court has handed down a decision in favor of the Internal Revenue Service collecting capital gains taxes from a couple who sold their family farm during bankruptcy.
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In a 5-4 decision Monday, the high court found that Lynwood and Brenda Hall owed capital gains taxes of $26,000 on the $960,000 sale of their 320-acre farm in Willcox, Ariz., which they were forced to sell during Chapter 12 bankruptcy proceedings.
The Halls proposed a plan under which they would pay off their outstanding liabilities with proceeds from the sale. The IRS objected, however, asserting they owed capital gains taxes from the sale. The Halls then proposed treating the tax as an unsecured claim to be paid to the extent that the funds were available, with the unpaid balance being discharged.
The Bankruptcy Court sustained an IRS objection, the District Court reversed that ruling, and the Ninth Circuit then reversed the District Court. The Ninth Circuit Court of Appeals in San Francisco held that because a Chapter 12 estate is not a separate taxable entity under the Tax Code, it does not “incur” post-petition federal income taxes. The Ninth Circuit concluded that because the tax was not “incurred by the estate,” it was not a priority claim eligible for the exception.
Chapter 12 of the Bankruptcy Code allows farmer debtors with regular annual income to adjust their debts subject to a reorganization plan. The plan must provide for full payment of priority claims. However, certain governmental claims arising from the disposition of farm assets are stripped of priority status and downgraded to general, unsecured claims that are dischargeable after less than a full payment.
The Supreme Court agreed with the appeals court and ruled in favor of the IRS. In the ruling, written by Justice Sonia Sotomayor, the high court noted that the federal income tax liability resulting from the Halls’ post-petition farm sale is not “incurred by the estate” under the Bankruptcy Code and “thus is neither collectible nor dischargeable in the Chapter 12 plan.”
“The phrase ‘incurred by the estate’ bears a plain and natural reading,” wrote Sotomayor. “A tax ‘incurred by the estate’ is a tax for which the estate itself is liable. Only certain estates are liable for federal income taxes.”
“None of the contrary arguments by petitioners and the dissent overcomes the statute’s plain language, context, and structure,” she added. “There is no textual basis for giving ‘incurred by the estate’ a temporal meaning, such that it refers to all taxes ‘incurred post-petition.’”
She noted that the Halls contend that the purpose of the statute is to provide debtors with robust relief from tax debts. “There may be compelling policy reasons for treating post-petition income tax liabilities as dischargeable,” she wrote. “But if Congress intended petitioners’ result, it did not so provide in the statute.”