Chapter 12 bankruptcy, a provision of the law written for farmers who are trying to reorganize debts, was weakened by a Supreme Court ruling Monday that requires an Arizona farm couple to pay full capital gains taxes on land sold after they had entered into a reorganization plan.
Senator Chuck Grassley (R-IA) said Tuesday that he will introduce legislation to keep the law more farmer-friendly.
“I’m definitely going to do a bill to clarify the law,” Grassley told Agriculture.com.
Grassley has defended his view that bankrupt farmers should be protected from full tax liability previously in Congress. “I remember telling my colleagues you can’t get blood out of a turnip,” he said Tuesday.
“Although Chapter 12 remains a farm-friendly alternative to other bankruptcy plans, this decision does diminish the ability of famers to structure a viable Chapter 12 plan,” says Gary Maydew, a retired professor of accounting at Iowa State University who writes for Successful Farming magazine. “Often a sale of the farmer’s appreciated farm land may represent the best vehicle to use to execute a payment plan. By asserting the capital gains tax on the sale, the IRS will hinder the ability of farmers to successfully implement a reorganization.”
The case decided by the Supreme Court Monday dealt with the farm bankruptcy of Lynwood and Brenda Hall.
The Supreme Court, in a narrow 5-4 decision denied the Halls the ability to have federal income taxes discharged on a post-petition sale of farmland. In Hall v. United States the farm couple sold their farm shortly after petitioning for bankruptcy under Chapter 12.
Here is Maydew’s analysis of the case:
“Chapter 12 bankruptcy plans require full payment of priority claims. However, taxes incurred by the estate in a Chapter 12 bankruptcy are stripped of priority status (i.e., thrown in with other general unsecured claims that may be discharged with partial payment).
"After filing for Chapter 12 bankruptcy and selling their farm, the Halls proposed a plan under which they would pay their liabilities with proceeds from the sale. However, the IRS objected to the plan, asserting a claim of capital gains tax of $29,000 on the sale. The Halls then proposed treating the tax as an unsecured claim to be partially paid, with the remainder to be discharged.
"The case wound though the Bankruptcy Court and a U.S. District Court, before the Ninth Circuit ruled against the Halls. The Supreme Court agreed to hear the case because the Eighth Circuit had ruled in favor of a taxpayer in that circuit.
"The case hinged on whether the federal income tax liability was incurred by the bankruptcy estate or the farmer (the Halls). If deemed incurred by the estate, then the relevant provisions of Chapter 12 provide for the federal tax to be downgraded from priority to a general, unsecured claim. However if the taxes were incurred by the Halls, then the taxes would remain a priority, not dischargeable under a Chapter 12 plan.
"Unfortunately for farmers, the Supreme Court agreed with the Ninth Circuit that a Chapter 12 estate is not a separate taxable entity. Therefore, the Halls, and not the Chapter 12 estate incurred the tax liability in a post- petition sale.
"Three justices joined Justice Breyer in dissenting. The minority believed that Congress intended government claims to be dischargeable in a Chapter 12 bankruptcy, and that the bankruptcy law should be interpreted as such.
"Fortunately, Congress seems likely to amend Chapter 12. It does appear from the statements of Senator Grassley of Iowa that the law was intended to make federal taxes dischargeable. Farmers can hope that Congress crafts a more precise version of Chapter 12 in the near future.”
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