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SCOTUS: Chapter 12 Tax Theory on Selling the Farm Buys the Farm

By Robyn Hagan Cain on May 14, 2012 | Last updated on March 21, 2019

The Supreme Court ruled Monday that bankrupt farmers owe capital gains taxes from a bankruptcy sale, reports The Associated Press.

In a 5-4 opinion written by Justice Sonia Sotomayor, the Court held that the federal income tax liability resulting from a post-petition farm sale is not “incurred by the estate” under §503(b) of the Bankruptcy Code, and is neither collectible nor dischargeable in the Chapter 12 plan.

Farmers Lynwood and Brenda Hall petitioned for bankruptcy under Chapter 12 and sold their farm shortly thereafter for $960,000. The Halls proposed a plan of reorganization under which they would pay off outstanding liabilities with proceeds from the sale, but the Internal Revenue Service (IRS) objected, asserting a federal income tax of $29,000 on the capital gains from the farm sale.

The case hinged on how the Court interpreted the phrase "incurred by the estate" for federal tax purposes. The majority concluded that, since the debtor - not the trustee - is generally liable for taxes and files the only tax return, the post-petition income taxes are not incurred by the estate.

"These provisions suffice to resolve this case: Chapter 12 estates are not taxable entities," Sotomayor wrote. "Petitioners, not the estate itself, are required to file the tax return and are liable for the taxes resulting from their post-petition farm sale."

Justice Stephen Breyer, joined by Justices Anthony Kennedy, Ruth Bader Ginsburg and Elena Kagan, dissented from the majority, writing, "Chapter 12 of the Bankruptcy Code helps family farmers in economic difficulty reorganize their debts without losing their farms. Consistent with the chapter's purposes, Congress amended §1222(a) of the Code to enable the debtor to treat certain capital gains tax claims as ordinary unsecured claims. The Court's holding prevents the Amendment from carrying out this basic objective."

This was an unusual opinion: We didn't expect to see Justice Sotomayor aligned with Chief Justice Roberts and Justices Scalia, Thomas, and Alito in a tax decision ruling against struggling farmers. Are you surprised by the holding in this case?

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