In re Hall

Page 741

376 B.R. 741

In re Lynwood D. HALL and Brenda Hall, Debtors.

No. 4-05-bk-04423-EWH.

United States Bankruptcy Court, D. Arizona.

October 2, 2007.

Clifford B. Altfeld, Altfeld Battaile & Goldman, P.C., Tucson, AZ, for Debtors.

MEMORANDUM DECISION

EILEEN W. HOLLOWELL, Bankruptcy Judge.

I. INTRODUCTION

The Debtors, relying on a provision added to Chapter 12 by The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), Pub.L. 109-8, 119 Stat. 23, seek to have the capital gains tax generated by the postpetition sale of their farm treated as a liability of their Chapter 12 Estate ("Estate"). However, the new provision, 11 U.S.C. § 1222(a)(2)(a),¹ only applies to prepetition taxes that are entitled to priority status under § 507. Because the capital gains tax in question was generated by a postpetition sale, it may not be paid through the Chapter 12 plan or included in the Debtors' Chapter 12 discharge. The reasons for this conclusion are explained in the balance of this decision.

II. FACTS AND PROCEDURAL HISTORY

The facts are not in dispute. The Debtors filed for Chapter 12 relief on August 9, 2005.² The Court granted Debtors' motion to sell their 320-acre farm for the sum of $960,000 on September 22, 2005. The sale of the farm land generated a capital gains tax of about $29,000. The Internal Revenue Service ("IRS") filed Proofs of Claim for prepetition debt, but it did not file a Proof of Claim against the Estate for the postpetition capital gains tax. The Debtors' First Amended Plan, however, proposes to include that tax liability as an unsecured claim in Class 6,³ which will be paid in full to the extent that funds are available, and otherwise will be paid pro rata with the other Class 6 claims and the balance discharged.

The IRS filed a timely objection. The IRS asserts that because the Estate is not a separate taxable entity in a Chapter 12 bankruptcy, the tax liability resulting from the postpetition sale was not incurred by the Estate, but is the responsibility of the Debtors. The Debtors argue that postpetition taxes generated by the sale of farming assets are treated as unsecured debt of the Estate and dischargeable under 11 U.S.C. § 1222(a)(2), as amended by BAPCPA. In support, Debtors cite In re Knudsen, 356 B.R. 480 (Bankr.N.D.Iowa 2006), the only published opinion on the application of amended § 1222(a)(2) to postpetition taxes.

III. ISSUE

Is the capital gains tax arising from the postpetition sale of farm land a priority claim under § 507, which can be denied full payment in a Chapter 12 plan and treated as an unsecured claim not entitled to priority pursuant to § 1222(a)(2)(A)?

IV. JURISDICTION

Jurisdiction is proper under 28 U.S.C. § 1334 and § 157(a) and (b)(2)(B), (J) and (L).

V. DISCUSSION

A. Statutory Framework

Chapter 12 was created as a remedy for a "family farmer with regular annual income." See § 101(19). It is modeled after Chapter 13 and allows eligible farmer debtors to adjust their debts in a similar manner. 8 Collier on Bankruptcy ¶ 1200.01[2], p. 1200-4 (15th ed. rev. 2006). The Chapter 12 debtor remains in possession and control of all the property and continues to operate the farm. § 1203. Upon confirmation of the Chapter 12 debt adjustment plan, all property of the estate vests in the debtor unless the plan provides otherwise. § 1227(b). Section 1222(a) prescribes the mandatory contents of a Chapter 12 plan. Under § 1222(a)(2)(A) — the provision at issue — a Chapter 12 plan shall:

(2) provide for the full payment, in deferred cash payments, of all claims entitled to priority under section 507, unless —

(A) the claim is a claim owed to a governmental unit that arises as a result of the sale, transfer, exchange, or other disposition of any farm asset used in the debtor's farming operation, in which case the claim shall be treated as an unsecured claim that is not entitled to priority under section 507, but the debt shall be treated in such manner only if the debtor receives a discharge; ...

Under the plain language of § 1222(a)(2), in order to qualify for treatment as an unsecured claim, the claim must fall within one of the priority categories in § 507. Only claims entitled to priority under § 507 and falling within the terms of § 1222(a)(2)(A) may "be treated as an unsecured claim that is not entitled to priority under section 507." There are two potential categories under which taxes may fall within § 507: administrative expenses (§ 507(a)(2))⁴ or allowed unsecured claims of governmental units (§ 507(a)(8)). Because § 507(a)(8) claims arise from taxes owed for prepetition years, 4 Collier on Bankruptcy ¶ 507.10[1], p. 507-61 (15th ed. rev.2006), the postpetition taxes in question here do not fall under that section. Consequently, the question is whether the taxes arising from the postpetition sale of the farm qualify as administrative expenses under § 507(a)(2).

The pertinent portion of § 507(a)(2) identifies as a priority "administrative expenses allowed under section 503(b)." In turn, § 503(b) provides, in relevant part:

(b) After notice and a hearing, there shall be allowed administrative expenses, ... including —

(1)(B)any tax —

(i) incurred by the estate, except a tax of a kind specified in section 507(a)(8) of this title;. ...⁵

In order for a tax to qualify as an administrative expense under § 503(b)(1)(B)(i), the tax milk: (1) be "incurred by the estate"; and (2) not be specified in § 507(a)(8). Towers v. United States (In re Pacific-Atlantic Trading Co.), 64 F.3d 1292, 1298 (9th Cir.1995) (referring to § 507(a)(7)⁶); Missouri Dept. of Revenue v. L.J. O'Neill Shoe Co. (In re O'Neill), 64 F.3d 1146, 1149 (8th Cir.1995) (§ 507(a)(7), now § 507(a)(8)) (citations omitted). "If either of these two requirements is not satisfied, then the claim is not entitled to administrative expense treatment." In re O'Neill, 64 F.3d at 1149. As discussed above, the second prong is met because postpetition taxes do not fall within § 507(a)(8),⁷ which applies to taxes owed for prepetition years.

B. Are Taxes Arising from the Postpetition Sale of Farm Assets Incurred by the Chapter 12 Estate?

The question, then, is whether the capital gains tax arising from the postpetition sale of the farm land is a tax "incurred" by the Estate. The IRS argues that the taxes cannot be incurred by the Estate because — unlike cases filed under Chapter 7 or 11 — a Chapter 12 estate is not a separate taxable entity. The Internal Revenue Code creates a separate taxable entity upon the filing of petitions by individuals under Chapters 7 and 11, but does not create a separate taxable entity in cases filed by individuals under Chapters 12 and 13. 26 U.S.C. §§ 1398, 1399. Chapter 12 debtors must file their own tax returns and pay any postpetition taxes, which are incurred by the debtors themselves. Because a Chapter 12 estate does not constitute a separate taxable entity, it cannot incur a tax liability constituting an administrative expense.

The IRS also points out that there is no provision for filing a claim for postpetition taxes in Chapter 12. A Chapter 13 tax creditor may file a claim for postpetition taxes under § 1305,⁸ but there is no corresponding provision in Chapter 12. The IRS argues that because it cannot file a claim for postpetition taxes against the Estate, the postpetition taxes cannot be claimed as an administrative expense of the Estate.

The Debtors counter that the court in Knudsen recognized that a Chapter 12 estate is not a separate taxable entity, but concluded that taxes incurred postpetition by the individual debtors can still be treated as administrative expenses under § 503(b)(1)(B) for purposes of payment under the plan. The Knudsen court specifically relied on O'Neill, 64 F.3d at 1152, in reaching this conclusion. 356 B.R. at 490.

However, the Knudsen court's reliance on O'Neill, a corporate Chapter 11 case, is misplaced. The primary issue before the Eighth Circuit in O'Neill was whether state taxes for prepetition corporate income qualified as administrative expenses. 64 F.3d at 1148. The Eighth Circuit did not decide whether the prepetition tax was "incurred by the estate" because the tax failed the second prong of the administrative expense' test — it was "a tax of a kind specified in § 507(a)(7)" (now § 507(a)(8)). 64 F.3d at 1149. Further, there was no dispute that the taxes on postpetition corporate income were administrative expenses. 64 F.3d at 1148. The state's argument pertaining to postpetition taxes was that when income taxes straddle the petition date, the tax claim cannot be split into prepetition and postpetition portions because that splits the tax year between the prepetition corporation and the postpetition estate, but the estate is not, a separate taxable entity under 26 U.S.C. § 1399. Id. at 1151-52. The Eighth Circuit dismissed that argument, explaining that the corporate debtor was not being taxed as two separate entities. Rather, it was being taxed as one continuous corporate entity, but the payment of the tax was being divided into separate components under bankruptcy law to determine the priority of payment. Id. at 1152. Thus, Knudsen is not persuasive because of its reliance on a corporate Chapter 11 case, which is inapposite to answering the precise question at issue here — whether a Chapter 12 estate can incur a federal capital gains tax liability that arises postpetition.

Instead, this Court agrees with the approach of the bankruptcy court in In re Brown, 2006 WL 3370867 (Bankr.D.Mass. Nov.20, 2006), which found that a Chapter 13 estate cannot be held liable for capital gains tax because it does not exist as a taxable entity.⁹ The Chapter 13 debtor argued that capital gains tax arising from the postpetition sale of his interest in rental property should be treated as an administrative claim for which the estate was liable. Since the debtor's interest in the property was property of the estate when it was...