U.S.A v. Hall

617 F.3d 1161

UNITED STATES of America, Appellant,v.Brenda HALL; Lynwood D. Hall, Appellees.

No. 08-17267.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Feb. 10, 2010.

Filed Aug. 16, 2010.

Patrick J. Urda, Tax Division, Department of Justice, filed the briefs and argued the cause for the appellant. John A. DiCicco, Acting Assistant Attorney General, and Bruce R. Ellisen, Tax Division, Department of Justice, were on the briefs. Diane J. Humetewa, United States Attorney, served as Of Counsel.

Clifford B. Altfeld, Altfeld Battaile & Goldman, P.C., Tuscon, AZ, filed the brief and argued the cause for the appellees. Eugene Vamos, Altfeld Battaile & Goldman, P.C., Tuscon, AZ, was on the brief.

Appeal from the United States District Court for the District of Arizona, David C. Bury, District Judge, Presiding. D.C. No. 4:07-cv-00679-DCB.

Before DIARMUID F. O'SCANNLAIN, STEPHEN S. TROTT and RICHARD A. PAEZ, Circuit Judges.

Opinion by Judge O'SCANNLAIN; Dissent by Judge PAEZ.

OPINION

O'SCANNLAIN, Circuit Judge:

We must decide whether and to what extent debtors must pay federal income tax on the gain from the sale of their farm during bankruptcy proceedings.

I

A

Lynwood and Brenda Hall filed a petition under chapter 12 of the Bankruptcy Code, which governs family farmer bankruptcies, in August 2005. Shortly thereafter, the Halls moved to sell their farm for $960,000, which the bankruptcy court approved.

In December 2005, the Halls proposed a plan of reorganization, under which they sought to pay off their outstanding liabilities using the proceeds from the sale. The Internal Revenue Service (“IRS”) objected to the proposed plan, asserting a federal income tax of $29,000 on the capital gain from the sale. The Halls then amended their proposed plan to treat the $29,000 tax as an unsecured claim to be paid “to the extent funds are available,” with “the balance discharged.” The IRS again objected.

B

The bankruptcy court sustained the IRS's objection. In re Hall, 376 B.R. 741 (Bankr.D.Ariz.2007). The district court reversed. Hall v. United States ( In re Hall ), 393 B.R. 857 (D.Ariz.2008). The United States timely appealed.

II

The United States contends that the district court erred by reversing the bankruptcy court's decision to sustain the IRS's objection, asserting that the tax on the gain from the sale of a farm during bankruptcy is not dischargeable.

A

We begin, as always, with the text of the applicable statute. Chapter 12 of the Bankruptcy Code, 11 U.S.C. §§ 1201-31, allows family farmers and fishermen to reorganize their business affairs while keeping creditors at bay. But the benefits of this arrangement come with responsibilities. In chapter 12 bankruptcy cases, the debtor must file a plan of reorganization id. § 1221, and the contents of that plan are prescribed in section 1222(a)(1)-(4). In particular, section 1222(a)(2)(A) states:

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....

Thus debtors may well treat certain claims owed to a governmental unit arising from the sale of farm realty as payable in less than full, and dischargeable.

But, by its terms, subsection (2)(A) applies only to “claims entitled to priority under section 507[of the Bankruptcy Code].” Section 507, in turn, lists numerous categories of claims that receive special treatment in bankruptcy. Id. § 507(a)(1)-(10). Two of the categories include taxes. The first such category, section 507(a)(8), includes various taxes incurred “on or before the date of the filing of the petition,” i.e., “prepetition.” E.g., id. § 507(a)(8)(A) (involving prepetition income taxes).¹ Indeed, there is no dispute that section 1222(a)(2)(A) allows chapter 12 debtors to treat taxes incurred by selling farm assets before the filing of a bankruptcy petition as payable in less than full and dischargeable: a tax incurred prepetition is a claim “entitled to priority under section 507” by way of section 507(a)(8). Here, by contrast, the tax was incurred after the filing of the petition i.e., “post-petition.”

The second category that includes taxes, section 507(a)(2), consists of “administrative expenses allowed under section 503(b).” Id. § 507(a)(2). This provision arguably includes the tax on the gain from the sale of the farm because section 503(b), which is cross-referenced by section 507(a)(2), allows for “administrative expenses ... including ... any tax ... incurred by the estate.” Id. § 503(b)(1)(B)(i) (emphasis added).

Which, of course, raises the question whether the post-petition tax on the sale of the farm at issue in this case was “incurred by the estate.” We are satisfied that the answer is no. The Internal Revenue Code provides that a chapter 12 estate cannot incur taxes. Title 26 U.S.C. § 1399 states that “no separate taxable entity shall result from the commencement of a case under title 11 of the United States Code”-the bankruptcy title-“[e]xcept in any case to which section 1398 applies.” Section 1398 applies only to “any case under chapter 7 (relating to liquidations) or chapter 11 (relation to reorganizations) of title 11 of the United States Code in which the debtor is an individual.” 26 U.S.C. § 1398. It follows that a chapter 12 estate is not a taxable entity.

Since the chapter 12 estate is not a taxable entity, the chapter 12 estate cannot “incur” a tax. We agree with those courts that have reached the same conclusion for the same reason with respect to chapter 13 estates, which are treated identically to chapter 12 estates by sections 1398 and 1399. In re Whall, 391 B.R. 1, 5-6 (Bankr.D.Mass.2008); In re Brown, 2006 WL 3370867, *3 (Bankr.D.Mass. Nov.20, 2006); In re Gyulafia, 65 B.R. 913, 916 (Bankr.D.Kan.1986). Because a chapter 12 estate cannot “incur” a tax, it cannot get the benefit of section 1222(a)(2)(A), which provides that the tax on the gain from the sale of a farm during bankruptcy is dischargeable and payable in less than full.

We recognize that our conclusion that the chapter 12 estate cannot “incur” a tax necessarily implies that the debtor is responsible for any taxes incurred after the bankruptcy petition is filed in a chapter 12 case because the chapter 12 trustee, the only other potentially responsible party, is not liable for the tax. Section 1398 provides that in chapter 7 and individual chapter 11 cases, where there can be “taxable income of the estate,” any “tax ... shall be paid by the trustee.” 26 U.S.C. § 1398(c)(1). The omission of any provision in the U.S.Code requiring the trustee to pay taxes in cases to which section 1398 does not apply, such as chapter 12 cases, implies that the trustee does not pay taxes in such cases. In re Lindsey, 142 B.R. 447, 448 (Bankr.D.Okla.1992) (“It is clear that, pursuant to 26 U.S.C. § 1398 and 1399, the standing Chapter 12 trustee neither files a return nor pays federal income tax....”). That makes sense: since the chapter 12 estate is not a taxable entity and thus there cannot be “taxable income of the estate,” 26 U.S.C. § 1398(c)(1), and the debtor remains in possession in chapter 12 bankruptcy absent extraordinary circumstances, 11 U.S.C. § 1203, the trustee is not associated with any taxes. See Holywell Corp. v. Smith, 503 U.S. 47, 112 S.Ct. 1021, 117 L.Ed.2d 196 (1992) (shifting tax burden to trustee in corporate chapter 11 case because chapter 11 bankruptcy created a separate entity overseen by the trustee). ²

B

The Halls primarily rely on Knudsen v. IRS, 581 F.3d 696 (8th Cir.2009), in which chapter 12 debtors proposed a plan to sell farmland and farm equipment to fund their reorganization. Like the case before us, the plan treated the income taxes arising from these postpetition sales as unsecured claims under section 1222(a)(2)(A) and thus dischargeable. Id. at 701. The IRS objected there as well. Id. But the Eighth Circuit ruled for the debtors, holding that “ § 1222(a)(2)(A) applies to the postpetition sale of farm assets,” so that the taxes arising from such sale could be treated as unsecured claims and dischargeable. Id. at 710 (emphasis added). In its view, the taxes arising from the postpetition sale met the requirement in section 1222(a)(2)(A) that they be a “claim[ ] entitled to priority under section 507.” Id. at 708-09. Specifically, the court held that the taxes fell under section 507(a)(2) as administrative expenses because they satisfied the relevant definition of administrative expenses in section 503(b)-“tax incurred by the estate”-which means merely “tax ... incurred postpetition.” Id. at 708-09. The court expressly declined to give weight to Internal Revenue Code sections 1398 and 1399 when interpreting the phrase “tax ... incurred by the estate,” and took comfort in the fact that the Bankruptcy Code did not indicate that a chapter 12 estate could not incur taxes. Id. at 708-10.³ We are not persuaded.

The Halls first argue, relying on the cases collected by Knudsen, 581 F.3d at 709, that “incurred by the estate” in section 503(b) means “incurred postpetition.” In their view, it does not matter whether the estate can incur a tax because the key is when the tax was incurred.

It is true that the cases the Halls and Knudsen cite state that all taxes “incurred by the estate” are “incurred postpetition.” They must: because an estate does not exist until after a bankruptcy petition is filed, any taxes an estate incurs are necessarily incurred postpetition. But just because all apples are fruits does not mean all fruits are apples. Likewise, although all taxes “incurred by the...