United States v. Richards

Wendy D. Brewer

FULTZ MADDOX DICKENS PLC

Laura M. Brymer

FULTZ MADDOX HOVIOUS & DICKENS PLC

Andrew M. Eberly

OFFICE OF JOSEPH M. BLACK, JR., STANDING CHAPTER 13 TRUSTEE

Samuel Patrick Jones

U.S. DEPARTMENT OF JUSTICE, TAX DIVISION

ORDER ON BANKRUPTCY APPEAL

SARAH EVANS BARKER, JUDGE United States District Court

The United States of America (the "United States"), on behalf of the Internal Revenue Service ("IRS"), appeals the Bankruptcy Court's July 13, 2020 Order establishing the amount of the IRS's general unsecured claim for the 2018 income tax year in the Chapter 12 bankruptcy of Robin S. and Marianna K. Richards. Specifically, the United States objects to the Bankruptcy Court's application of 11 U.S.C. § 1232, a provision of the Bankruptcy Code which governs the treatment of unsecured claims of the government arising "after the filing of the petition and before the debtor's discharge … as a result of the sale, transfer, exchange, or other disposition of any property used in the debtor's farming operation …." The Debtors rejoin that there is no error in the Bankruptcy Court's Order and that it should therefore be affirmed.

For the reasons detailed below, we AFFIRM the Bankruptcy Court's Order.^[1]

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Factual Background

I. Background on the Debtors

The Debtors, Robin S. ("Rob") and Marianna ("Marianna") K. Richards, submitted their voluntary petition for relief under Chapter 12 of the Bankruptcy Code on May 3, 2018. Their case was the lead case of three jointly administered Chapter 12 cases filed by members of the Richards family. Prior to their bankruptcy petition, the Debtors were involved in a family farming business with Rob's parents, Aaron and Angela Richards, and Rob's brother and sister-in-law, Eric and Cathy Richards, which took on significant debt as part of the family's efforts to expand the farm's operations. After uncontrollable weather conditions and market price declines caused their farming operation to suffer sustained financial losses from 2013 through 2015, the family's primary lender refused to renew their prior loan, forcing the liquidation of the farm's assets beginning in the spring of 2016.

In 2016, virtually all of the family's farm equipment, vehicles, and other personal property assets, including grain inventory, were liquidated, and the proceeds were paid over to the primary lender and to other lenders with specific purchase money security interests in the relevant assets. In 2018, after filing their bankruptcy petitions, the Richards family sold additional farmland to satisfy their final obligations to their lender. The liquidation of all these assets generated substantial income tax obligations for the Richards family members for the 2016, 2017, and 2018 tax years, which they were unable to pay. Thus, through their bankruptcy case, the Debtors sought relief from their tax liabilities generated from the asset liquidation.

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II. The Chapter 12 Plan

The Debtors submitted their "Chapter 12 Plan of Reorganization" (the "Plan"), on July 30, 2018, which was later confirmed without objection on October 22, 2018. Upon confirmation "all property of the Estate and property treated under the Plan … vest[ed] or re-vest[ed] in the Debtors," pursuant to the terms of their Plan. APPX 59 § 11.09. The Plan recognizes that the Debtors owed amounts to the United States for income taxes arising directly from the sale of farm assets in 2016, 2017, and 2018. Under the Plan, the Debtors' state and federal tax obligations were divided into two categories: (1) tax liabilities for income arising from the sale, transfer, exchange, or other disposition of any property used in the Debtors' farming operation ("Section 1232 Income"); and (2) tax liabilities arising from other income sources ("Traditional Income").

The Plan provides that tax liabilities arising from Traditional Income would retain priority status and that tax liabilities related to Section 1232 Income would be de-prioritized and treated as general unsecured claims dischargeable upon completion of the Plan if not fully paid. Specifically, the Plan provides that unpaid income tax obligations related to Traditional Income incurred prior to the bankruptcy petition date would retain priority status and be paid in full by the Chapter 12 Trustee within 28 days after confirmation of the Plans ("Priority Tax Liabilities"), while any obligations related to Traditional Income incurred after the petition date would be paid by the Debtors directly ("Direct Payment Liabilities"). APPX 51, 58.

Income tax obligations related to Section 1232 income, regardless of when incurred, would be de-prioritized and paid by the Chapter 12 Trustee as general

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unsecured claims that would be discharged if not fully paid upon completion of the Plan. APPX 50-52. According to the Plan, Section 1232 unsecured claims would be paid on a "pro rata basis" along with other general unsecured claims from a variety of sources. APPX 52, § 3.06. The Plan further provides that:

The means of payment described in this Plan are, absent an event of default of this Plan, the exclusive means of post-petition payment of any and all claims, and no creditor shall take action to collect on any claims, whether by offset or otherwise, unless specifically authorized by this Plan Any action taken on or between the Petition Date and Confirmation Date shall be reversed and refunded to the appropriate entity if such action is not specifically authorized by this Plan. This paragraph does not curtail the exercise of a valid right of setoff permitted under § 553

APPX 58.

The Plan describes the computation of claims amounts subject to Section 1232 treatment^[2] as follows: "These [Section 1232] tax claims shall be equal to that amount of tax resulting on the income tax returns of the Debtors as if the taxable income for the sale, exchange, transfer or other disposition of the arming assets was excluded from that tax return, and from the tax resulting had that taxable income been excluded on the Debtors' returns." APPX 51. With regard to the 2016 and 2017 tax years, the Plan further provides that the "computations under the [above] method are employed by a comparison of the Debtors' 2016 and 2017 income tax returns, and a pro forma income

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tax return for the same years."^[3] Id. Although the Plan does not state whether the computation of the claim amount for the 2018 tax year should apply this same method, we understand the Debtors to have used this same method for the 2018 calculation. The Plan is silent regarding how the Debtors' tax withholdings, payments, and credits for each tax year were to be applied or allocated between that year's income tax return and the corresponding pro forma tax return.

III. The Debtors' and the IRS's Proofs of Claim

The IRS timely filed its proof of claim in the Debtors' bankruptcy case on May 29, 2018, and thereafter amended its proof of claim three times. APPX 113, 117, 189, 193. The IRS filed its first amendment to its proof of claim for the 2016 and 2017 tax years prior to the Plan's confirmation. The amended claim identified the IRS's unsecured priority claim in the amount of $389, 083.97, and its total unsecured general claim in the amount of $20, 339.90. APPX 120. Subsequent to the Plan's confirmation, the Debtors objected to the IRS's first amended claim and sought to have a portion of the 2016 and 2017 tax claims related to Section 1232 Income reclassified as general unsecured claims, consistent with the Plan and Section 1232 of the Bankruptcy Code. APPX 121, 127. The IRS did not respond to the Debtors' objection, and, on March 21, 2019, the Bankruptcy Court sustained the objection, holding that $9, 879.00 of the IRS's claim would be entitled to unsecured priority status, and the remaining amount would be reclassified to unsecured general status. APPX 133.

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Shortly thereafter, in accordance with the terms of the Plan and 11 U.S.C. §§ 505 and 1232, the Debtors submitted their federal and state tax returns for the 2018 tax year. APPX 144-188, 217-241. As required by § 1232(d), the Debtors served notice of the filing on the IRS by letter dated March 29, 2019, along with a copy of their 2018 federal tax return (the "1080 Return"), which included income from the 2018 sale of farm assets and showed a tax liability of $100, 716, and their 2018 pro forma federal tax return (the "Pro Forma Return"), which excluded the income from the 2018 sale of farm assets and showed a tax liability of $33, 391. APPX 144-188, 217-271, 243-262. The Debtors' March 29 notice triggered the 180-day deadline under § 1232(d)(3) for the IRS to file its claim for 2018 taxes. The IRS did not file a proof of claim within that timeframe and, on October 28, 2019, pursuant to § 1232(d)(3), the Debtors filed a claim ("Claim No. 28") on the IRS's behalf for the 2018 Section 1232 Liabilities in the amount of $67, 325, reflecting the difference in tax liability between the 1080 Return and the Pro Forma Return. Notice of the filing of Claim No. 28 was issued by the Bankruptcy Court on October 29, 2019 and served on the IRS at multiple addresses. APPX 135-38.

Thereafter, in response to the Debtors' claim submitted on its behalf, the IRS amended its proof of claim for 2016 and 2017 tax liability, including, for the first time, tax liabilities for 2018. In that claim, as well as in the IRS's subsequent amendment of that claim (collectively, "Claim No. 3-4"), the IRS asserted a general unsecured claim of $61, 751 for the 2018 income tax year, excluding penalties and interests. Consistent with Section 1232, the IRS did not assert that any amount of its claim for the 2018 tax year was entitled to priority...