In re Hall

393 B.R. 857

In re Lynwood D. HALL and Brenda A. Hall, Debtors Lynwood D. Hall, Brenda Hall, Appellants, v. United States of America, Appellee.

No. CV-07-679-TUC-DCB.

Bankruptcy No. 05-4423-TUC-EWH.

BAP No. 07-1441.

United States District Court, D. Arizona.

August 6, 2008.

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

Alan R. Costello, Costello Law Firm, Phoenix, AZ, for trustee.

ORDER

David C. BURY, District Judge.

This is an appeal from a bankruptcy decision, pursuant to 28 U.S.C. § 158(a)(1), entered in In re Hall, BK-05-4423-TUE-EWH.

FACTUAL AND PROCEDURAL BACKGROUND

The Bankruptcy Court in In re Hall, 376 B.R. 741 (Bankr.D.Ariz.2007), held that because a Chapter 12 estate is not a separate taxable entity, it cannot incur a federal capital gains tax liability arising from the postpetition sale of farm assets and, therefore, such liability is not a claim entitled to priority which may be denied full payment under a Chapter 12 plan and treated as an unsecured claim that is not entitled to priority.

The Debtors are family farmers whose bankruptcy filing was governed by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) and 11 U.S.C. § 1222(a)(2)(A). After the filing, the Bankruptcy Court granted Debtors' motion to sell their 320-acre farm for the sum of $960,000. The sale of the farmland generated a capital gains tax of about $29,000. Debtors' plan proposed to include that tax liability as an unsecured claim, which would be paid in full to the extent that funds were available; otherwise it would be paid pro rata with the other similarly situated claims, and the balance discharged. Relying on In re Knudsen, 356 B.R. 480 (Bankr.N.D.Iowa 2006), aff'd in part and rev'd in part, 389 B.R. 643 (N.D.Iowa 2008), the Debtors argued that, under § 1222(a)(2)(A), taxes generated by the sale of farming assets are treated as unsecured debt and are not entitled to priority if the debtor receives a discharge.

The Bankruptcy Court rejected the conclusion in Knudsen and agreed with the Bankruptcy Court in In re Brown, 2006 WL 3370867 (Bankr.D.Mass.2006). The Bankruptcy Court noted that, under § 1222(a)(2)(A), a Chapter 12 plan must provide for the full payment, in deferred cash payments, of all claims entitled to priority under 11 U.S.C. § 507 unless the claim is owed to a governmental unit and arises out of the disposition of any farm asset used in the debtor's farming operation, in which case the claim must be treated as a nonpriority unsecured claim. This provision applies only if a debtor receives a discharge. The Bankruptcy Court said that, 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. The only two potential categories under which taxes on a postpetition sale might fall are if the tax is an administrative expense (§ 507(a)(2)) or is an allowed unsecured claim of a governmental unit (§ 507(a)(8)).

The Bankruptcy Court went on to find that Section 507(a)(8) did not apply because that section applies exclusively to claims that arise from taxes owed prepetition. Further, § 507(a)(2) did not apply because it identifies as a priority administrative expenses allowed under section 503(b). In order for a tax to qualify as an administrative expense under § 503(b)(1)(B)(i), the tax must be incurred by the estate and not be a tax of a kind specified in § 507(a)(8). The question was whether the capital gains tax arising from the postpetition sale of the farmland is a tax "incurred" by the estate. The Bankruptcy Court agreed with the Internal Revenue Service (IRS) that the taxes in this case were not incurred by the estate because a Chapter 12 estate is not a separate taxable entity, and it cannot incur a tax liability constituting an administrative expense. See 26 U.S.C.A. §§ 1398, 1399.

Further, the Bankruptcy Court found that there is no provision for filing a claim for postpetition taxes in a Chapter 12 bankruptcy. The Court read Section 503(b)(1)(B)(i)in conjunction with §§ 1398 and 1399 of the Internal Revenue Code and resolved that there is no separate taxable entity created when an individual commences a case under Chapter 12. Consequently, the capital gains tax arising from the postpetition sale of the farmland cannot be a tax incurred by the Chapter 12 estate under § 503(b)(1)(B)(i). Because the postpetition capital gains tax is not entitled to priority under § 507, it does not fall within the exception carved out by § 1222(a)(2)(A), which creates an exception for priority claims arising from the prepetition sale, transfer, or exchange of farm assets. Because the taxes did not qualify as an administrative expense under § 503(b) and were not entitled to priority under § 507, they did not fall within the purview of the § 1222(a)(2)(A) exception and could not be treated as an unsecured claim that is not entitled to priority. The Bankruptcy Court sustained the IRS's objection to the Debtors' Chapter 12 plan.

On December 21, 2007, the Debtors filed an appeal from the Bankruptcy Court's decisions entered October 3, 2007 and November 20, 2007. On February 21, 2008, Debtors/Appellants' opening brief was filed. On February 21, 2008, Appellee USA's brief was filed. On March 5, 2008, Appellee State of Arizona's brief was filed. On March 7, 2008, Debtors/Appellants' reply brief was filed. On May 12, 2008, oral argument was presented to the Court by the parties and the matter was taken under advisement.

STANDARD OF REVIEW

There are no questions of fact. The issue on appeal is an issue of law and is subject to de novo review by the District Court. See In re Olshan, 356 F.3d 1078, 1083 (9th Cir.2004); In re Price, 353 F.3d 1135, 1138 (9th Cir.2004); In re Summers, 332 F.3d 1240, 1242 (9th Cir.2003). The Bankruptcy Court's interpretation of the bankruptcy code is reviewed de novo by the District Court. See In re DeVille, 361 F.3d 539, 547 (9th Cir.2004).

ISSUE

The issue to be resolved is whether or not, in a Chapter 12 bankruptcy, "the taxes incurred from the post-petition sale of a debtor's real property that is used in farming may be treated as a liability of the estate and discharged under 11 U.S.C. 1222(a)(2)(A) or whether the debtor in a Chapter 12 bankruptcy is personally liable for taxes incurred from the post-petition sale of farming real property." (Debtor's Opening Brief at 2.)

DISCUSSION

As indicated by the Court during oral argument, the Court continues to be inclined in favor of the Debtors' position and does find that, as in In re Knudsen, 389 B.R. 643 (N.D.Iowa 2008), In re Dawes, 382 B.R. 509 (Bankr.D.Kan.2008), and In re Schilke, 379 B.R. 899 (Bankr. D.Neb.2007) (all Chapter 12 family farmer bankruptcies addressing the same issue as presented herein), the Halls may treat post-petition income taxes incurred from the post-petition sale of their farm as a liability of the estate, dischargeable under § 1222, and the plan may propose payment of such expenses by the estate. This Court is not persuaded by an application of the analysis and holding in In re Brown, 2006 WL 3370867 (Bankr.D.Mass.2006), a chapter 13 bankruptcy which did not address § 1222 and applied an IRS interpretation of bankruptcy policies.

Appellants contend that the Congress intended to offer relief to the farmer by the amendment and inclusion of § 1222(a)(2)(A), which is supported by a reading of the legislative history of this amendment, as follows:

Chapter 12. Adjustment of Debts of a Family Farmer or Fisherman with Regular Annual Income

§ 1222. Contents of plan

(a) The 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.

Claims entitled to priority as described in Section 507, are as follows:

(a) The following expenses and claims have priority in the following order:

* * *

(2) Second, administrative expenses allowed under section 503(b) of this title, and any fees and charges assessed against the estate under chapter 123 of title 28.

* * *

(8) Eighth, allowed unsecured claims of governmental units, only to the extent that such claims are for—

(A) a tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition—

The Hall decision specifically found, as follows,

Perhaps Congress meant to provide relief for postpetition taxes, but that is not what the statute provides. "It is well established that "when the statute's language is plain, the sole function of the courts-at least where the disposition required by the text is not absurd-is to enforce it according to its terms.'" Lamie v. United States Trustee, 540 U.S. at 534 (quoting Hartford Underwriters Ins. Co. v. Union Planters Bank, 530 U.S. 1, 6, 120 S.Ct. 1942, 147 L.Ed.2d 1 (2000)) (other citations omitted). In this case, the disposition of the text is not absurd: as written, § 1222(a)(2)(A) creates an exception for priority claims arising from the prepetition sale, transfer or exchange of farm assets. That is what § 1222(a)(2)(A) provides and no more. It is beyond the province of this Court to provide "what we might think ... is the preferred result." Id. at 542 (quoting United States v. Granderson, 511 U.S. 39, 68[, 114 S.Ct. 1259, 127 L.Ed.2d 611] (1994)).

Because the taxes arising from the postpetition sale of the farm do not qualify as an administrative expense under § 503(b) and are not entitled to priority under § 507, they do not fall within the purview of § 1222(a...