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Divided U.S. Supreme Court: Debtors' Farm Sale Tax Liability Not Dischargeable

WASHINGTON, D.C. - (Mealey's) A divided U.S. Supreme Court ruled 5-4 Monday that the federal income tax liability that resulted from a debtor's post-petition farm sale is not "incurred by the estate" for the purposes of 11 U.S. Code Section 503(b); therefore, it is neither collectible nor dischargeable in a Chapter 12 bankruptcy proceeding (Hall v. United States, No. 10-875, Chapter 12, U.S. Sup.; See 12/07/2011) [an enhanced version of this opinion is available to subscribers].

Brenda and Lynwood Hall filed for Chapter 12 bankruptcy in the U.S. Bankruptcy Court for the District of Arizona.  They proposed a plan of reorganization under which they would pay off their outstanding liabilities using the proceeds from the sale of their farm.

Tax Liability

The IRS objected to the proposed plan, asserting a federal income tax of $29,000 on the capital gain the Halls received from the sale, which happened while the bankruptcy was pending.

The Bankruptcy Court sustained the IRS's objection, and the Halls appealed to the U.S. District Court for the District of Arizona, which reversed.  The IRS appealed to the Ninth Circuit U.S. Court of Appeals, where a divided court ruled that because a Chapter 12 estate is not a taxable entity, it cannot "incur" a tax.  The Halls then appealed to the Supreme Court

Justice Sonia Sotomayor wrote for a majority comprising Chief Justice John G. Roberts Jr. and Justices Antonin Scalia, Clarence Thomas and Samuel A.  Alito Jr. that a plain reading of the Bankruptcy Code means there is no textual basis for giving the phrase "incurred by the estate" a temporal meaning, such that it refers to all taxes "incurred postpetition."

11 U.S. Code Section 1222

The majority ruled that any cases suggesting that post-petition taxes were treated as administrative expenses are inapposite because they involve corporate debtors, which Congress has singled out for responsibilities paralleling those borne by a separate taxable entity's trustee.

The Halls contended that the purpose of 11 U.S. Code Section 1222(a)(2)(A) was to provide debtors with robust relief from tax debts, but the majority said  Congress did not provide such tax relief in the statute in question.

The majority added that given the plain language of 11 U.S. Code Section 1222(a), as well as the context and structure of the statute, it is "not for us to rewrite the statute."

Specifically, the majority said, the case at hand involved "complex terrain" of interconnected provisions and exceptions enacted over nearly three decades.  The position taken by the Halls "threatens ripple effects beyond this  case for debtors in Chapter 13 and the broader bankruptcy scheme that we need not invite," the majority said.


Justice Stephen G. Breyer wrote a dissent, which was joined by Justices Anthony M. Kennedy, Ruth Bader Ginsburg and Elena Kagan.

The dissenting justices said that in Chapter 12 bankruptcy, family farmers in economic difficulty may reorganize their debts without losing their farms.  Consistent with Chapter 12's purposes, Congress amended 11 U.S. Code Section 1222(a) to enable debtors to treat certain capital gains tax claims as ordinary unsecured claims.  The majority's holding prevents the amendment to 11 U.S. Code Section 1222(a) from carrying out this basic objective, they said.

The dissenting justices concluded that if the majority is correct, then capital gains taxes fall outside the category of priority claims, fall outside the scope of the amendment to 11 U.S. Code Section 1222(a) and, in fact, fall outside the bankruptcy proceeding altogether.


Under the majority's reading of the law, the IRS might well be able to collect the debt in full outside the bankruptcy proceeding - even if doing so would reduce the farmer's assets and future income to the point where the farmer would not be able to proceed under Chapter 12, the dissenting justices said.

Furthermore, the phrase tax "incurred by the estate" in 11 U.S. Code Section 503(b) and the word "claim" in 11 U.S. Code Section 1222(a) are open to different interpretations, the dissenting justices said.  Each of the narrower interpretations adopted by the majority would either exclude post-petition taxes from the phrase taxes "incurred by the estate" or exclude all post-petition debts, including administrative expenses, from the word "claim."

The Halls are represented by Susan Freeman of Lewis & Roca in Phoenix.  The U.S. government is represented by Pratik A. Shah of the U.S. Solicitor General's Office in Washington.

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