Summary of a Recent
Judicial Development in
Bankruptcy

Taxes Arising from Postpetition Sale of Farm Assets
Are Not Incurred by the Chapter 12 Estate

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In the case of In re Hall, 376 B.R. 741 (Bankr. D. Ariz. 2007), the United States Bankruptcy Court for the District of Arizona held that a Chapter 12 estate cannot incur a federal capital gains tax liability arising from a postpetition sale of farm land because it is not a separate taxable entity; therefore, such liability cannot be treated as an unsecured claim that is not entitled to priority, pursuant to the Chapter 12 provisions of the Bankruptcy Code.

Background

The debtors filed their Chapter 12 petition on August 9, 2005. Id. at 742. The court granted their motion to sell their farm for $960,000, which generated capital gains tax of about $29,000. Id. The IRS filed Proofs of Claim for prepetition debt, but not for the postpetition capital gains tax. Id. at 742-43. The debtors amended their plan to include the tax liability as an unsecured claim in Class 6, to be paid in full to the extent funds were available, and otherwise paid pro rata with the rest of their Class 6 claims and the balance discharged. Id. at 743. The IRS objected, claiming that because a debtors' estate is not a separate taxable entity in a Chapter 12 case, the tax liability was not incurred by the estate, but rather was the responsibility of the debtors. Id.

Arguments

The IRS argued that because a debtors' estate is not a separate taxable entity in a Chapter 12 case, the tax liability resulting from the postpetition sale of property was not incurred by the estate; instead, it was the responsibility of the debtors. Id.

The debtors argued that postpetition taxes generated by the sale of farming assets were treated as unsecured debt of the estate and dischargeable under 11 U.S.C. § 1222(a)(2). Id.

Analysis and Holdings

The court examined § 1222(a)(2)(A) of the Bankruptcy Code, which states that a Chapter 12 plan shall provide for the full payment of all priority claims, except those owed to the government that arose from the sale of farm assets, in which case the claim shall be treated as unsecured and not entitled to priority status. Id. Priority claims are governed by § 507 of the Code. Id. Taxes fall under either administrative expenses (§ 507(a)(2)) or "allowed unsecured claims of governmental units" (§ 507(a)(8)). Id. at 743-44. The court noted, however, that § 507(a)(8) only covers prepetition taxes and so is not applicable here. Id. at 744. Section 507(a)(2) defines administrative expenses as those "allowed under § 503(b)," and § 503(b) defines the term as "any tax . . . incurred by the estate," except for those that fall under § 507(a)(8). Id. The issue then became whether taxes arising from the postpetition sale of farm assets are "incurred" by the Estate. Id.

The court considered the fact that the Internal Revenue Code treats Chapter 7 and 11 Estates as separate taxable entities, but not Chapter 12 or 13 Estates. Id. at 744-45. Furthermore, there is no provision for tax creditors to file a claim for postpetition taxes in Chapter 12 cases like there is for Chapter 13. Id. at 745. The court reasoned that because a Chapter 12 Estate does not exist as a separate taxable entity, it can not "incur" capital gains tax, therefore the debtors' tax liability does not qualify as an administrative expense. Id. at 746.

The court concluded that since the tax liability didn't fall under § 507(a)(8) or § 507(a)(2), it did not have priority status under § 507. Id. Thus the exception under § 1222(a)(2)(A) allowing priority claims to "be treated as an unsecured claim that is not entitled to priority" was not applicable, and the IRS's objection was sustained. Id. at 746-47.

The case was decided on October 2, 2007.