Supreme Court to Decide Treatment of Post-Petition Tax Claims

The Supreme Court granted certiorari in Hall v. United States [2] to decide whether post-petition tax claims are administrative expenses under the Bankruptcy Code. [3] In Hall, the Debtors filed a petition under chapter 12 of the Bankruptcy Code and then moved the court to allow them to sell their farm for $960,000. The court approved, and the capital gain from the subsequent sale generated a $29,000 federal tax claim. The Debtors proposed in their amended chapter 12 plan to treat the $29,000 tax claim as a general unsecured liability by invoking § 1222(a)(2)(A) [4] of the Bankruptcy Code which provides:

The plan shall provide for the full payment in deferred cash payments of all claims entitled to priority under section 507, unless 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.

The IRS objected to the treatment of the tax claim as a general unsecured liability, and the bankruptcy court sustained the objection. [5] The district court reversed, but the Court of Appeals for the Ninth Circuit agreed with the bankruptcy judge. [6]

The circuit court reasoned that § 1222(a)(2)(A) applies only to “claims entitled to priority under section 507.” [7] The claim at issue involved a tax, but § 507 only has two classifications that involve taxes. One is § 507(a)(8) which deals with unsecured claims by government units. By its terms though, it applies only to pre-petition taxes and therefore does not apply to the tax from the post-petition sale of the Debtors’ farm.

The second classification is § 507(a)(2), which deals with administrative expenses allowed under § 503(b). Section 503(b)(1)(B)(i) provides that such administrative expenses include taxes “incurred by the estate.” Thus, if the estate (and not the Debtors) incurred the tax, the tax could be treated as an administrative expense, and § 1222(a)(2)(A) could be invoked to treat the tax claim as a general unsecured liability.

The court, however, used §§ 1398 and 1399 of the Internal Revenue Code to determine that the estate did not incur the tax and that it was therefore incurred by the Debtors. [8] Section 1399 provides that “except in any case to which section 1398 applies, no separate taxable entity shall result from the commencement of a case under title 11 of the United States Code.” Section 1398 applies only to cases under chapter 7 and chapter 11 in which the debtor is an individual. [9] Therefore, since the chapter 12 estate is not a separate taxable entity, the estate could not have incurred the tax, and the tax must have been incurred by the Debtors post-petition.

The court concluded that since the tax was incurred by the Debtors (and not the estate) post-petition, the claim was not an administrative expense, and § 1222(a)(2)(A) did not apply. [10] The result was that the tax claim could not be treated as a general unsecured liability and must be paid outside of the plan of reorganization.

The Circuits Split
The Eighth Circuit reached a different conclusion in Knudsen v. IRS. [11] In Knudsen, the court concluded that “postpetition income taxes are ‘administrative expenses’ ” incurred by the estate. [12] The court equated “incurred post-petition” with “incurred by the estate.” [13] Therefore, the tax claim that arose when the Debtors sold farm assets post-petition was an administrative expense which could be treated as a general unsecured liability under § 1222(a)(2)(A).

The court bolstered its conclusion that such a tax claim is an administrative expense by noting “the plain language of § 1222(a)(2)(A) does not restrict its application to post-petition sales.” [14] It also observed that while the Internal Revenue Code does not create a separate taxable entity in a chapter 12 case, an estate nevertheless exists and includes the farm property sold to incur the tax. [15]

In addition to resolving the narrow question of the application of § 1222(a)(2)(A) to post-petition tax claims, the decision of the Supreme Court will most likely have broader implications for bankruptcy estates and administrative expenses. The decision could affect the treatment of the post-petition tax claims under multiple chapters of the Bankruptcy Code.

1. I am grateful that Mr. Henry J. Riordan allowed me to read his insightful analysis of the cases discussed in this article.
2. United States v. Hall, 617 F.3d 1161 (9th Cir. Ariz. 2010), cert. granted (No. 875, 2010 Term).
3. The Question Presented as published on the Supreme Court’s website is:

After filing a Chapter 12 bankruptcy petition, Petitioners sold their family farm with the consent of their bankruptcy trustee and court approval, and with sale proceeds administered through the bankruptcy estate to pay creditors. Internal Revenue Code § 1399 provides that a bankruptcy filing other than an individual Chapter 7 or individual Chapter 11 does not give rise to a “separate taxable entity.” Does that IRC provision mean that the capital gains income tax incurred due to the sale of the farm is not a Bankruptcy Code administrative expense owed by the bankruptcy estate and payable under a bankruptcy reorganization plan? If so, Bankruptcy Code § 1222(a)(2), enacted to provide special treatment of such family farmer administrative expenses, would not apply or permit Petitioners to satisfy the tax as an unsecured claim that is not required to be paid in full. (search term: “10-875”).

4. All code references herein are to the Bankruptcy Code unless otherwise stated.
5. Hall, 617 F.3d at 1162.
6. Id.
6. Id. (quoting 11 U.S.C. § 1222(a)(2)(A)).
7. Id. at 1163-1164.
8. I.R.C. § 1398.
9. Hall, 617 F.3d at 1163. The Tenth Circuit recently agreed with the Ninth Circuit decision in Hall. See U.S. v. Dawes (In re Dawes), case no. 09-3129 (10th Cir. June 21, 2011) (post-petition tax claim is not an administrative expense of the estate because taxes were incurred by debtor).
10. Knudsen v. IRS, 581 F.3d 696 (8th Cir. Iowa 2009).
11. Id. at 708-709.
12. Id.
13. Id. at 709.
14. Id. at 709-710.