May 14, 2012

Supreme Court Decides Hall v. United States

On May 14, 2012, the Supreme Court decided Hall v. United States, No. 10-875, holding that a federal income tax liability resulting from the postpetition sale of an individual debtor's farm during the pendency of a Chapter 12 bankruptcy is not "incurred by the estate" within the meaning of 11 U.S.C. § 503(b)(B)(i) and therefore is not dischargeable in the bankruptcy.

Lynwood and Brenda Hall petitioned for Chapter 12 bankruptcy and later sold their farm. The Halls initially proposed a reorganization plan under which they would pay outstanding liabilities from the farm sale proceeds. The Internal Revenue Service objected, asserting that the Halls owed the IRS $29,000 in federal income tax on the capital gains from the farm sale. The Halls amended their proposed plan to treat the income tax as a general, unsecured claim to be paid to the extent that funds were available, with the unpaid balance to be discharged. The IRS objected again, arguing that the federal income tax liability was not dischargeable. The Bankruptcy Court sustained the IRS's objection on the ground that the Chapter 12 estate was not a separate taxable entity under the Internal Revenue Code ("IRC") that was capable of incurring taxes. The District Court reversed, doubting that the IRC provisions were relevant. In a split decision, the Ninth Circuit reversed the District Court.

Granting certiorari to resolve a circuit split, the U.S. Supreme Court affirmed the Ninth Circuit. The parties agreed that § 1222(a)(2)(A), which downgrades "certain governmental claims resulting from the disposition of farm assets" to "general, unsecured claims that are dischargeable after less than full payment," applies only to priority claims collectible in the bankruptcy plan, and that postpetition federal income taxes qualify under that section only if they constitute a "tax ... incurred by the estate" under  § 503(b)(B)(i). The case thus turned on whether the tax was "incurred by the estate."

Applying a "plain and natural reading" of the statute, the Supreme Court noted that because the debtor in a Chapter 12 bankruptcy is generally liable for taxes and files the only tax return, the Chapter 12 estate is not a separately taxable entity. As a result, the Court held, the postpetition federal income tax liability is not "incurred by the estate" and thus is neither collectible nor dischargeable in the Chapter 12 plan. The Court also found support in additional provisions of the Bankruptcy Code and the Bankruptcy Tax Act of 1980 that specify "on a chapter-by-chapter basis which estates are separately taxable and therefore liable for taxes."  The Court noted that Chapter 12 was modeled on and shares many provisions with Chapter 13, and bankruptcy courts and commentators have concluded that postpetition income taxes are not incurred by a Chapter 13 estate. Finally, the Court acknowledged that there may be "compelling policy reasons for treating postpetition income tax liabilities as dischargeable" and echoed the Ninth Circuit's observation that "Congress is entirely free to change the law by amending the text."

Justice Sotomayor delivered the opinion of the Court, in which Chief Justice Roberts and Justices Scalia, Thomas, and Alito joined. Justice Breyer filed a dissenting opinion, in which Justices Kennedy, Ginsburg, and Kagan joined.

Download Opinion of the Court

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