In re Dawes

Page 815

415 B.R. 815

In re Donald W. DAWES and Phyllis C. Dawes, Debtors United States of America, Appellant, v. Edward J. Nazar, Trustee; and Donald W. Dawes, Phyllis C. Dawes, Appellees.

No. 08-1054-WEB.

Bankruptcy No. 06-11237-12.

United States District Court, D. Kansas.

March 12, 2009.

COPYRIGHT MATERIAL OMITTED

Mark J. Lazzo, Wichita, KS, for Debtors.

Edward J. Nazar, Wichita, KS, pro se.

Memorandum and Order

WESLEY E. BROWN, District Judge.

This is an interlocutory appeal by the United States from a ruling by the Bankruptcy Court. The ruling concerns a construction of 11 U.S.C. § 1222(a)(2)(A), which carves out an exception to the general rule that a Chapter 12 plan must provide for full payment of priority claims, including administrative expenses in the form of taxes incurred by the bankruptcy estate. Section 1222(a)(2)(A) provides that a claim owed to the Government "that arises as a result of the sale, transfer, exchange, or other disposition of any farm asset used in the debtor's farming operation" shall be treated as an unsecured claim that is not entitled to priority under § 507, provided the debtor obtains a discharge. The Bankruptcy Court found this section applied to capital gains taxes owed by the debtors arising from a post-petition sale of real property used by the debtors for farming. As a result, the Court denied the United States' objection to the debtors' Chapter 12 plan treating the capital gain taxes as a general unsecured claim.

I. Background.

The debtors first came to the attention of the United States in the 1980s, when they failed to file income tax returns. In 1988, they were convicted of willfully failing to file income tax returns for the tax years 1981, 1982, and 1983. Doc. 2-6 at 91, United States v. Dawes, 88-10002 (D.Kan.1989), aff'd, 874 F.2d 746 (10th Cir. 1989). Each of them spent seven months in federal prison. Doc. 3 at 2. Additionally, they failed to pay income taxes for 1982, 1983, 1984, 1986, 1988, and 1990. Doc. 2-6 at 91. They were assessed a tax liability of $142,007. Doc. 3 at 2. The Dawes did not pay the tax, and by 2006 the debt had grown to $1,747,841.53. Doc. 3 at 2.

In 2003, the United States filed suit against the Dawes to reduce their income tax liabilities to judgment, to set aside conveyances of real property, to obtain a determination that Plainsman Property Trust was a nominee of the Dawes, and to foreclose federal tax liens against nine real properties. United States v. Dawes, 03-1132-JTM (D.Kan.2003), aff'd. 161 Fed. Appx. 742 (10th Cir.2005). Judge Marten found that in 1985 and 1986, after the federal tax liens had been assessed, the Dawes began moving their property into three trusts in which close family members or the Dawes served as trustees or agents. The court found the Dawes created the Plainsman Property Company to avoid tax judgments. Judge Marten found that the Dawes' conveyance of nine parcels of land to the Plainsman Property Company must be set aside as fraudulent, and that the property was subject to the federal tax liens. Id., 03-1132-JTM (D.Kan.2003), Doc. 33, filed Sept. 21, 2004. The District Court approved an order for the sale of the nine parcels of property.

The Dawes filed for bankruptcy on July 14, 2006. On October 11, 2007, the IRS filed the Report of Sale for the nine parcels of property. The IRS sold all but 80 acres of the Dawes' real estate. (Doc. 3, p. 2).

II. Case History.

On July 14, 2006, Debtors filed for bankruptcy relief under Chapter 7. Doc. 2-2 at 2. The Chapter 7 case was dismissed on August 2, 2006, but was reopened, and on August 17, 2006, was converted to Chapter 12. Doc. 2-2 at 3-4. The IRS, which holds a judgment against the Debtors for $1,541,604.08, plus interest, is the principal creditor.

On October 23, 2006, the IRS obtained relief from the automatic stay to enforce its judgment as to eight parcels of real property titled in the name of Plainsman Trust. Doc. 2-2 at 7. On November 13, 2006, Debtors filed their Chapter 12 plan. Doc. 2-2 at 7, Doc. 2-3. The plan proposed to pay that portion of the IRS claim secured by the eight parcels by surrender of the property to the IRS. Doc. 2-3 at 4. The plan further provided that "pursuant to 11 U.S.C. § 1222(a)(2)(A), all claims of the IRS or the Kansas Department of Revenue that arise post-petition as a result of the sale, transfer, exchange, or other disposition of the [nine parcels] shall be treated as a general unsecured claim not entitled to priority under § 507." Doc. 2-3 at 6. The United States objected to confirmation of the plan in numerous respects, including its treatment of taxes arising from the post-petition sale. Doc. 2-3 at 15. The parties did not immediately address this objection, proceeding instead with the sale of the property. The eight parcels were sold, and the sale proceeds exceeded $900,000. Both parties agree that the sale will result in the debtors owing a significant capital gains tax, although the exact amount was not specified in the pleadings.

On August 9, 2007, Debtors filed a motion for partial summary judgment, asking the court to find that "11 U.S.C. § 1222(a)(2)(A) allows the Debtors to provide in their Chapter 12 plan that the IRS' post-petition capital gains tax claim incurred as a result of the IRS' forced sale of Debtors' real estate is an unsecured claim." Doc. 2-2 at 17. On September 24, 2007, the United States filed a cross-Motion for Partial Summary Judgment asking the court to find that § 1222(a)(2)(A) does not apply to capital gains from post-petition sales. Doc. 2-2 at 20. The Bankruptcy Court granted the Debtors' Motion, noting that the purpose of Chapter 12 is to allow a farmer to reorganize and the purpose of § 1222 was to remove a major impediment to reorganization. Doc. 1-2. The court found that the Chapter 12 post-petition capital gains taxes qualified as "administrative expenses" entitled to priority because they were incurred by the estate. As such, it found the tax liability was within the § 1222(a)(2)(A) exception. The court concluded that the Debtors may treat the claim as an unsecured claim not entitled to priority under § 507, limited by the condition that such treatment is allowed only if the Debtors receive a discharge. Doc. 1-2.

III. Standard of Review

"On appeal from the bankruptcy court, the district court sits as an appellate court." In re Barber, 191 B.R. 879, 882 (D.Kan.1996). A district court reviews a bankruptcy court's factual findings for clear error, and reviews its conclusions of law de novo. Zions First Nat'l Bank, N.A. v. Christiansen Brothers, Inc., 66 F.3d 1560, 1563 (10th Cir.1995). The district court may affirm, modify, or reverse a bankruptcy judge's judgment, order, or decree or remand with instructions for further proceedings. Fed. R. Bankr.P. 8013.

IV. Summary of Arguments.

The United States contends that Section 1222(a) does not apply to any post-petition claims, including taxes. It argues that Chapter 12 plans deal only with the treatment of pre-petition claims and are only binding upon creditors holding such claims. Appellant contends this view is confirmed by reading sections 1226(b)(1), 1222, and 1227(a) together. Moreover, it argues that the Bankruptcy Court erred in finding that the capital gain taxes were "incurred by the estate." Appellant contends that in a Chapter 12 proceeding, the estate is not a separate taxable entity and the debtor remains personally responsible for the tax. This is in contrast to Chapter 7 and 11 cases, appellant says, where the tax code provides that the bankruptcy estate shall be treated as a separate taxable entity. Only in the latter cases may the tax be said to be incurred by the estate, appellant contends, and only then may the taxes be treated as an administrative expense of the estate. Citing 26 U.S.C. §§ 1398, 1399. Appellant thus argues it was error to treat the taxes as administrative expenses, and error to find that they fell within the exception of section 1222(a)(2)(A).

The Debtors' response urges the court to follow several recent decisions finding that post-petition capital gain taxes fall under § 1222(a)(2)(A), including the only decision by a district court to address the issue. Debtors argue that In re Knudsen, 389 B.R. 643 (N.D.Iowa 2008), is instructive as it addresses the precise issue and relies extensively on Judge Somers' analysis. Debtors argue the plain language of section 1222(a)(2)(A) does not restrict its applicability to pre-petition sales and that the legislative history behind the section supports the Bankruptcy Court's interpretation. They argue that appellant's interpretation, on the other hand, is flawed because it requires discriminatory treatment of similarly situated farmers, protecting only those who had the foresight to liquidate property before filing for bankruptcy protection. The debtors say post-petition tax claims have administrative priority status under section 503(b)—as the IRS has argued in other cases—and that such taxes are directly covered by § 1222(a)(2)(A). The Debtors have filed notice of supplemental authority, providing the court with two additional cases supporting their position.

V. Discussion.

a. Chapter 12 Bankruptcy and 11 U.S.C. § 1222(a)(2)(A)

Chapter 12 Bankruptcy was created for family farmers with regular annual income. 11 U.S.C. § 101(19). Chapter 12 allows eligible farmer debtors to adjust their debts while they remain in control and possession of their property, and they maintain the ability to operate the farm. 8 Collier on Bankruptcy § 1200.01[2], p. 1200-4 (15th ed. Rev.2006), 11 U.S.C. § 1227(b).

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was enacted on April 20, 2005. Pub.L. No. 109-8, 119 Stat. 23. The BAPCPA modified 11 U.S.C. § 1222(a)(2)(A) to read as follows: "The plan shall provide for the full payment, in deferred case payments, of all claims entitled to priority under section 507, unless the claim is a claim...