Opinion analysis: When worlds collide, the IRS wins and bankrupts shudder
on May 16, 2012 at 11:44 am
Monday’s decision in Hall v. United States is emblematic of the Court’s long-standing skepticism of the Bankruptcy Code as an important institution for mitigating the long-term costs of financial distress. As a jurisprudential matter, the case is a classic conflict of wholly separate worlds: the world of the IRS and the Internal Revenue Code on the one hand, and the world of financial distress and the Bankruptcy Code on the other. Each world has its own title of the United States Code (Title 26 for tax and Title 11 for bankruptcy), and each has its own set of institutions, legal experts, and – most importantly – foundational habits of mind and practice.
The case is as simple a fact pattern as you can imagine: a family that owns a farm cannot make ends meet. In response, they seek relief under Chapter 12 of the Bankruptcy Code (a special set of provisions for family farmers). To resolve their outstanding debts, they proposed to sell the family farm and use the proceeds to pay their creditors. The IRS objected, claiming a right to take much of the sales proceeds as a tax on the capital gains from the sale; as is commonly the case, even in a depressed real-estate market, a farm that has been owned for many years will sell for far more than its original price.
The family argued that the IRS claim is a general unsecured claim (paid after all priority creditors, and discharged even if unpaid), relying on a recent amendment of the Bankruptcy Code that treats certain claims “that aris[e] as a result of the sale * * * of any farm” as “an unsecured claim that is not entitled to priority.” The IRS countered that the provision has no application here, because it applies only to sales that took place before the bankruptcy proceeding began.
The dispute turned specifically on the question whether this particular type of tax claim would have been a priority claim under Section 507 before the amendment, which is true only if the tax claim was “incurred by the [bankrupt’s] estate,” as opposed to the family in its individual capacity. The family contended that this is obviously true, pointing to the fact that the sale happened after bankruptcy and to the acknowledged regularity that tax claims for post-petition financial activity have always had priority in individual bankruptcy proceedings. The IRS, weaving a masterful web of tax technicalities, argued that the tax is not actually “incurred by the estate,” because in fact there happens to be no separate taxable estate in Chapter 12 proceedings; the IRS stood firmly on an obscure provision of Title 26 that, it is safe to say, has never received close scrutiny from a bankruptcy lawyer or judge.
The family also pointed, quite persuasively, to the legislative history of the provision. This is, of course, of no moment to many of the Justices, but it is compelling in its specificity and plausibility. All agree that the provision was drafted, proposed, and more or less forced through Congress at the instance of Senator Grassley of Iowa, who made numerous speeches during the years it took him to get the proposal adopted in which he highlighted this specific scenario: an effort to sell a farm during bankruptcy scuttled by the IRS’s insistence on the payment of capital gains taxes from the sales proceeds.
Faced with the dueling institutional perspectives, on Monday the Court wholeheartedly embraced the view of the IRS. Writing for a five-Justice majority, Justice Sotomayor tracks the analysis of the Solicitor General’s brief directly: because there has never been a separate taxable estate in a Chapter 12 proceeding, she explains, the amendment is ineffective to accomplish its stated purpose. Justice Breyer’s dissent predictably points to the unambiguous intention of the amendment’s drafter and decries the Court’s ready willingness to accept the government’s reading of the complex interplay of Codes.
I have no quarrel with the Court’s statutory analysis. Indeed, the IRS’s statutory argument is compelling, at least as long as you consider it in a vacuum unimpeded by the Bankruptcy Code. What I do find interesting, though, is the blithe lack of concern about the systemic effect of the decision. No decision in this case could have any serious effect on the IRS’s administration or the public fisc. The amounts at stake are, from the perspective of the IRS, less than trivial. And if the decision produced administrative difficulty or fiscal inequity, who would doubt the ability of the IRS to obtain prompt rectification from Capitol Hill?
From the perspective of the bankrupts, however, the matter is far different. The facts of this case underscore precisely why Senator Grassley wanted this amendment, and effectively scuttle the value of Chapter 12 for one of the most salient scenarios of farm distress: high debt burdens coupled with ownership of a farm that is worth far less than it was only a few years ago. We can be absolutely sure that the decision of the Court produces exactly the opposite of the result intended by the amendment, as expressed by Senator Grassley; the Court is almost explicit in telling Congress that it simply didn’t express its intentions clearly enough to force the Justices to obey them. Unfortunately for the bankruptcy system, it is most unlikely that Congress will find time to take the Justices up on that invitation any time soon. It is not a coincidence, I think, that the bankruptcy process has done so little for individual consumers during our seemingly endless recession and that the Court has hewed, so consistently, to such a niggardly interpretation of the Bankruptcy Code.
IN PLAIN ENGLISH: At issue in Hall v. United States was whether farmers who sell their farm while in bankruptcy have to pay capital gains tax to the IRS. The farmers argued that they could sell the farm and give the proceeds to their other creditors. However, the Court agreed with the IRS that the IRS must be paid before the other creditors.
