Chapter 12 Bankruptcy and Tax Collection

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Rebecca Badgett

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Tax collectors are familiar with bankruptcy filings under Chapters 7, 11, and 13, but how many have seen a Chapter 12 bankruptcy?  That section of the Bankruptcy Code allows “family farmers” and “family fishermen” to restructure their debts when facing financial distress. A Chapter 12 plan is desirable because it is often less expensive than a Chapter 11 plan, which is primarily aimed at large corporate reorganizations, and more beneficial to the debtor than a Chapter 13, which is better suited for wage earners who have typically incurred fewer debts than family farmers and fishermen.

Happily for tax collectors, Chapter 12 is modeled on Chapter 13.  Many of Chapter 13’s tax friendly rules also exist under Chapter 12. The U.S. Supreme Court made clear in Hall v. U.S., 566 U.S. 506 (2012) that court decisions interpreting much-more-common Chapter 13 cases apply to Chapter 12 cases.  Both chapters generally prioritize the collection of taxes in the same manner.  There is one Chapter 12 nuance explained below, but that is not likely to affect property tax claims.

Who is Eligible for Chapter 12?

Under the Bankruptcy Code, “family farmers” and “family fishermen” debtors are either an individual (or married couple) or a corporation or partnership who meet the specific eligibility requirements set forth in 11 U.S.C. § 101 (18) or (19).  These requirements consider the amount of debt, the percentage of debt that is derived from the farming/fishing operation, and the percentage of income that is derived from such operations.  For a corporation or partnership, family ownership and control of the operation is necessary as well.

Some details: the aggregate debt (secured and unsecured) of an individual engaged in a farming operation may not exceed $4.1 million, and not less than 50 percent of that debt must arise from the farming operation (excluding a debt for the principal residence unless such debt arises out of the farming operation).  The debt limits are adjusted for inflation every three years.  In addition, more than 50 percent of the individual’s gross income for the preceding tax year, or each of the second and third taxable years preceding, must also arise from the farming operation.  The statutory debt and income requirements differ for family fisherman and for corporate filings.  Consult the Bankruptcy Code for the most up-to-date information.

How are Taxes Handled in a Chapter 12?

For a general overview of how taxes are prioritized in the other bankruptcy chapters, read this post.

As is true in most bankruptcies, property taxes that are incurred by the estate after a Chapter 12 petition is filed are administrative claims that have the highest priority of all tax claims. Taxes that were incurred before the petition was filed and that are secured by a lien on real property will generally qualify as a non-priority secured claim and be enforceable through foreclosure after discharge.  Property taxes that were incurred pre-petition, are unsecured, and were payable without interest or penalty at any point in the twelve months before the petition was filed are eighth-priority claims that have a fair chance of repayment during or after bankruptcy.  Taxes that arose pre-petition, are unsecured, and accrued interest or penalties more than a year prior to the filing are non-priority claims that usually will not be paid during bankruptcy and will not be enforceable after discharge.  All of these rules are consistent with how tax claims are treated in other types of bankruptcies.

There is one notable difference. Under 11 USC § 1222(a)(2)(A), a tax claim owed to a governmental unit that arises from the sale, transfer or disposition of any farm assets shall be treated as an unsecured claim that is not entitled to priority under § 507.  Importantly, this exception applies only to claims in the Chapter 12 plan that would have been entitled to priority under   § 507 in the first place, and the debtor must receive a discharge. For example, if a farmer sells a large piece of farming equipment and the sale created a capital gain, those taxes are treated as a general unsecured claim.  The IRS previously litigated the application of this exception to post-petition transactions.  However, in light of the Supreme Court’s holding in Hall v. United States post-petition income taxes are now exempt from the bankruptcy estate in both Chapter 12 and Chapter 13 filings.  Importantly, the Hall exception is aimed primarily at income taxes and will rarely if ever affect property tax claims.

Should the Tax Collector file a Proof-of-Claim?

As in Chapter 13, the type of claim held by the tax collector is also relevant to the proof-of-claim decision.  Once the type of claim is determined in flowchart 1 in this bankruptcy post, refer to flowchart 2 from that same post to decide whether it makes sense to file a proof-of -claim.

Because bankruptcy law contains countless complexities and exceptions, it’s wise to consult with an experienced bankruptcy attorney if your tax claims are substantial.  If you’ve confronted a Chapter 12 filing before and learned any valuable pointers I’ve missed, please share them in the comment section below.

Rebecca Badgett recently joined the UNC School of Government as a local government law research attorney.


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