In re Gene R. Smith And Charleen J. Smith

447 B.R. 435

107 A.F.T.R.2d 2011-1298

2011-1 USTC P 50,288

In re Gene R. SMITH and Charleen J. Smith, Debtors.Gene R. Smith and Charleen J. Smith, Movants,

v.United States of America, Internal Revenue Service, Pennsylvania Department of Revenue, and Ronda J. Winnecour, Chapter 12 Trustee, Respondents.

No. 06–10692–TPA.

United States Bankruptcy Court, W.D. Pennsylvania.

March 10, 2011.As Amended March 14, 2011.

Gary V. Skiba, Esq., Erie, PA, for the Movants.Ari David Kunofsky, Esq., Washington, DC, for Respondent, Internal Revenue Service.Jana Pail, Esq., for Respondent, Ronda J. Winnecour.

MEMORANDUM OPINION

THOMAS P. AGRESTI, Chief Judge.

Currently before this Court is a Motion for Determination of Tax Liability (“Tax Motion”), filed by the Chapter 12 Debtors, Gene and Charleen Smith (“Debtors”). The Debtors seek a determination that the capital gains tax obligation resulting from the postconfirmation sale of their farm assets may be treated as a general unsecured claim. As authority for their request, the Smiths reference 11 U.S.C. § 1222(a)(2)(A).¹

The Internal Revenue Service (“IRS”) objects to this treatment. It argues that Section 1222(a)(2)(A) does not apply to taxes that arise from a postpetition and/or a postconfirmation sale of a Chapter 12 debtor's farm assets. The IRS further asserts that the doctrine of sovereign immunity shields it from the Debtors' efforts to have the Court determine the Debtors' capital gains tax liability resulting from the postconfirmation sale of their farm assets.

The Court first finds that the IRS is not shielded by sovereign immunity from the relief sought by the Debtors. Nevertheless, the Court finds in favor of the IRS because the confirmed plan, which was in place before any sale was even contemplated, does not bind the IRS as to a postconfirmation tax obligation and the Debtor may not now modify the plan to change that result. Even if the Debtors were somehow able to overcome that obstacle, the Court finds that Debtors are not entitled to treat a capital gains tax obligation that arises from the Debtors' postconfirmation sale of farm assets as a general unsecured claim. Therefore, the Debtors' Tax Motion will be denied.

FACTS AND PROCEDURAL HISTORY

The Debtors were dairy farmers who conducted their farming operations in Union City, Pennsylvania. On June 20, 2006, they filed their Petition under Chapter 12 of the Bankruptcy Code. The Debtors' Amended Chapter 12 Plan (the “Plan”) was confirmed on an interim basis on December 19, 2006, and after being further amended to increase the monthly payment, was finally confirmed on November 30, 2007. The Plan called for a continuation of the Debtors' farming operations and provided that “title to the debtors' property shall remain with the debtors.” It provided for monthly payments of $3,370 to the Chapter 12 Trustee, funded by proceeds received from a “milk attachment,” i.e., an assignment from a milk producers cooperative. Unsecured creditors were to receive no distribution. There was no provision for a sale of farm assets in the Plan and the IRS was neither listed as a creditor nor notified of the Plan.

Initially, the Debtors were able to meet their Plan obligations, completing payment of $100,873.17 out of a Plan base of $196,918.77. By late 2008, however, due to what the Debtors call a “dramatic” decline in milk prices, they were unable to continue making the required Plan payments. The Debtors ceased making all Plan payments after February, 2009. On March 12, 2009, the Debtors proposed a third amended plan (“Proposed 3rd Amended Plan” ²) under which their monthly payments would be reduced to $1,050 for a six month period before increasing to $3,500. Other than this change in monthly payments, the Proposed 3rd Amended Plan, was substantially the same as the Plan, with funding to come from continuing farm operations and not a sale of farm assets. Both the Plan and the Proposed 3rd Amended Plan provided that “[t]he title to the debtors' property shall remain with debtors.”

Despite the lower payment provided for in the Proposed 3rd Amended Plan, the Debtors were still unable to make their payments. On August 13, 2009, the Debtors filed a Motion for Public Sale of Personal Property Free and Divested of Liens (“Sale Motion”) seeking authority to sell all of their farm equipment and their entire herd of cattle at auction. Although such a sale was not part of either the confirmed Plan or the Proposed 3rd Amended Plan, on August 21, 2009, the Court approved the sale in an Order Authorizing Public Auction Sale of Personal Property Free and Divested of Liens (“ Sale Order ”). The Sale Order directed that all of the proceeds of the sale, net of expenses, be turned over to the Chapter 12 Trustee. As of that time, the Debtors, effectively, were out of the farming business.

The IRS was not given notice of the Sale Motion, the hearing on it, or the Sale Order.³ The first notice to the IRS came on August 25, 2009, when the Debtors filed the Tax Motion. In it they stated that their accountant had advised them that whatever amount was received at the sale to be held pursuant to the Sale Order would be subject to capital gains tax. The Tax Motion further asserted Debtor's contention that, pursuant to Section 1222(a)(2)(A), they had a right to treat such capital gain tax as an unsecured claim, not entitled to priority, because the sale involved assets involved in their farming operation.⁴ Debtors asked for a declaratory judgment to that effect.

On September 7, 2009, prior to any response from the IRS or hearing on the Tax Motion, an auction was held pursuant to the Sale Order. Gross proceeds in the amount of $113,845 were realized from the sale with net proceeds of $96,255.63 remitted to the Chapter 12 Trustee. The Parties apparently agree that capital gains tax did become due as a result of the sale, although the amount has not been determined.⁵ Calculation of the amount of tax is not relevant to the Court's decision here.

On September 24, 2009, the Debtors filed another sale motion, this one seeking authority to auction five of their six parcels of real estate, retaining only the lot which contains their primary residence. The Debtors sought to delay the proposed sale of the real property when it became clear that the issue regarding the capital gains tax would be disputed. That second sale motion was eventually denied on November 18, 2009.

On a parallel track, the IRS filed its response to the Tax Motion on September 30, 2009, disputing among other things, the Debtors' right to treat the capital gain tax as an unsecured claim. The Debtors filed a brief in support of their position on October 7, 2009. On that same date, a hearing on the Tax Motion was held. At the suggestion of the IRS, with agreement from the Debtors, the Tax Motion was “converted” into one to determine priority of claim.⁶ The Parties further agreed that the matter involved strictly a legal issue. As such, the Court directed that they submit a stipulation of facts, which was filed on November 6, 2009. Also at the Court's direction, the Debtors and the IRS filed additional briefs. On December 7, 2009, the Chapter 12 Trustee filed her brief supporting the Debtors' position.

After the Parties further supplemented the record, another argument on the Tax Motion was heard on April 19, 2010, at which time the IRS raised the issue of sovereign immunity for the first time.⁷ Based on that occurrence and an additional issue arising at this hearing as to whether the property sold and/or the proceeds from the sale constituted property of the estate or property of the Debtors, the Court ordered further briefing. The final such brief was filed on June 18, 2010. Shortly before that, on June 2, 2010, and somewhat inexplicably belated in the Court's view, the Debtors filed yet another proposed, amended plan (“Proposed 4th Amended Plan”) that would finally provide for the farming asset sale, add the IRS as a creditor, and address the IRS tax claim under Section 1222(a)(2)(A).⁸

While the Court was in the process of deciding this matter, the Court of Appeals for the Ninth Circuit rendered a decision in United States v. Hall, 617 F.3d 1161 (9th Cir.2010) ⁹ which the Parties believed to involve much the same issue currently before this Court. In sharp contrast to previously decided cases on the issue which had found in favor of the Debtors' position, such as Knudsen v. IRS, 581 F.3d 696 (8th Cir.2009), Hall adopted a “plain meaning” approach to application of the statutory language and ruled in favor of the United States. The Court found the issuance of the Hall opinion significant enough to warrant comment by the Parties, so it afforded them an opportunity to file additional briefs. On October 4, 2010, the Court heard yet further argument on the outstanding issues. The matter is now ripe for disposition.

SOVEREIGN IMMUNITY

Before it can even consider the substantive issues raised by the Tax Motion, the Court must first address the assertion by the IRS that the doctrine of sovereign immunity prevents the Court from ruling on the matter. As indicated above, the sovereign immunity issue was a relatively late entrant into the case, having been first raised by the IRS at the second oral argument held on April 19, 2010. Nevertheless, a defense of sovereign immunity implicates the Court's subject matter jurisdiction, and as such, may be raised at any time. See, e.g., In re Hechinger Inv. Co. of Del., Inc. 335 F.3d 243 (3d Cir.2003). The Court would naturally prefer that a question of sovereign immunity be raised “front and center” at the first opportunity so as to avoid wasted effort, but even in the absence of that happening, the matter must be faced and resolved before the outstanding substantive issues can be addressed.

The IRS' position on sovereign immunity is simple and direct. It notes that waivers of sovereign immunity must be clear and explicit and points to the...