Debtors Must Pay Capital Gains Tax in Full, Supreme Court Holds

You can’t avoid paying taxes on assets you sell after a bankruptcy.  At least if you’re a farmer.  Sally P. Schrieber at the Journal of Accountancy reports The U.S. Supreme Court ruled Monday that farmers who sold farm assets during a bankruptcy reorganization under Chapter 12 of the Bankruptcy Code were liable for the full amount of the capital gains tax that resulted from the sale (Hall, Sup. Ct. Dkt. No. 10-875 (U.S. 5/14/12), aff’g 617 F.3d 1161 (9th Cir. 2010)).

In an opinion that affirmed a Ninth Circuit decision and resolved a split in the circuits, a divided Supreme Court (in an opinion by Justice Sonia Sotomayor joined by Chief Justice John Roberts and Justices Samuel Alito, Clarence Thomas, and Antonin Scalia) held that federal income tax liability resulting from the farmers’ post-petition farm sale is not “incurred by the [bankruptcy] estate” under Section 503(b) of the Bankruptcy Code and therefore not dischargeable in a Chapter 12 bankruptcy.

Chapter 12 of the Bankruptcy Code, which governs farm bankruptcies, allows farmer debtors to enter into a reorganization plan. The plan must provide for full payment of “priority claims,” but certain government claims, including “any tax . . . incurred by the [bankruptcy] estate” are downgraded to general, unsecured claims that are dischargeable without full payment (Bankruptcy Code §§503(b), 507(a)(2)).

The farmers in the case filed for Chapter 12 bankruptcy and then sold their farm. The IRS attempted to collect capital gains tax on the proceeds of the sale, but the farmers proposed to treat the tax as an unsecured claim that would be paid to the extent funds were available and the unpaid balance discharged. The case moved through Bankruptcy Court, federal district court, and then to the Ninth Circuit, which held that because a Chapter 12 bankruptcy estate is not a separate taxable entity under Secs. 1398 or 1399, the estate does not “incur” post-petition federal taxes. Because the tax was not “incurred by the estate” as required by Bankruptcy Code Section 503(b), the Ninth Circuit held that it was not eligible for discharge.

The Supreme Court’s majority agreed that “the statute’s plain language, context, and structure” support this conclusion and upheld the Ninth Circuit’s decision.

Breyer, Kagan, Ginsburg and Kennedy dissented.

Read the whole story here. 

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