Old MacDonald Files Chapter 12 Bankruptcy: How Should the IRS Tax the Reorganization?
| Author | Daniel P. Fischer |
| Position | J.D. Candidate, The University of Iowa College of Law, 2012; B.S., Iowa State University, 2009 |
| Pages | 589-628 |
589
Old MacDonald Files Chapter 12
Bankruptcy: How Should the IRS Tax the
Reorganization?
Daniel P. Fischer
ABSTRACT: Before the BAPCPA amendments, many farm debtors
struggled to have bankruptcy plans confirmed due to significant tax claims
arising from proposed Chapter 12 reorganizations. Therefore, in 2005,
Congress amended the Bankruptcy Code, purporting to make “claims owed
to government units” unsecured. However, as debtors attempted to use this
provision to reduce tax liabilities in bankruptcy plans, the ambiguities and
shortcomings of the amendment came to light. The IRS objected to debtors’
classification of taxes arising from ordinary operations and postpetition
sales as unsecured, as well as the debtors’ method of allocation between
secured and unsecured claims. The legal battles over these objections have
created a split of authority between the Eighth Circuit on one side, and the
Ninth and Tenth Circuits on the other side. The debate of the proper
interpretation is based on how the Internal Revenue Code should influence
this bankruptcy provision, and how courts should use the Bankruptcy
Code’s plain language and Congress’s legislative history. The Supreme
Court has granted certiorari to address one of the three main issues.
However, Congress should go the extra step by clarifying the Bankruptcy
Code and effectuating the original legislative intent. Congress should do
this by classifying taxes arising from dispositions associated with
reorganization from both prepetition and postpetition sales as unsecured,
while officially adopting the “proration method” in allocating secured and
unsecured claims.
I. INTRODUCTION ...................................................................................... 591
II. CHAPTER 12 BACKGROUND ................................................................... 592
J.D. Candidate, The University of Iowa College of Law, 2012; B.S., Iowa State
University, 2009. Thank you to: Dr. Neil Harl, for feedback on this Note and other agricultural-
law topic ideas; Mr. Joe Peiffer, for feedback and an insider’s view on the history of this
provision; Professor Patrick Bauer, for advice on this bankruptcy topic as well as others; the
editors and student writers of the Iowa Law Review, for publishing and editing this Note; and
family and friends, for all the support.
590 IOWA LAW REVIEW [Vol. 97:589
A. DEVELOPMENT OF CHAPTER 12 BANKRUPTCY .................................... 592
B. CHAPTER 12 ELIGIBILITY AND MECHANICS ....................................... 594
C. THE STATUS OF AGRICULTURAL BANKRUPTCY: BACK TO THE
FUTURE? .......................................................................................... 596
III. CHAPTER 12 AFTER BANKRUPTCY REFORM ........................................... 599
A. BAPCPA CHANGES .......................................................................... 599
B. CASES INTERPRETING THE AMENDED CHAPTER 12 ............................. 600
1. Eighth Circuit ......................................................................... 601
2. Ninth Circuit .......................................................................... 604
3. Tenth Circuit .......................................................................... 605
IV. STATUTORY PRINCIPLES: WHAT METHODS OF INTERPRETATION CAN
THE COURTS EMPLOY, AND WILL COURTS EFFECTUATE THE
LEGISLATIVE INTENT? ............................................................................ 607
A. USE OF THE INTERNAL REVENUE CODE IN BANKRUPTCY DECISIONS ..... 607
1. Asset Classifications ................................................................ 608
2. Ordinary Income Versus Capital Gains ................................ 609
3. Postpetition Qualification ..................................................... 611
B. OTHER CANONS OF STATUTORY INTERPRETATION ............................. 613
1. Plain-Language Arguments ................................................... 614
2. Expressing Legislative Intent ................................................. 615
V. THE FUTURE OF TAX CLAIMS IN CHAPTER 12 ....................................... 618
A. THE SUPREME COURT’S DECISION ..................................................... 618
1. How the Court Will Decide ................................................... 618
2. How Lower Courts Should Decide the Issues Not
Addressed ................................................................................ 621
B. HOW CONGRESS SHOULD CLARIFY THE CODE .................................... 623
1. Make Both Ordinary and Capital Tax Liabilities
Unsecured ............................................................................... 623
2. Make Postpetition Taxes Unsecured .................................... 625
3. Incorporate the Proration Method into the Code .............. 626
VI. CONCLUSION ......................................................................................... 627
2012] TAXING CHAPTER 12 REORGANIZATIONS 591
I. INTRODUCTION
Chapter 12 Bankruptcy offers indebted farmers an opportunity to
reorganize their businesses.1 Since the enactment of Chapter 12 in 1985,
farm debtors have faced objections from the Internal Revenue Service
[“IRS”] to proposed bankruptcy plans due to the significant prospective
taxes generated by reorganization, thus preventing many plans from being
confirmed.2 Therefore, Congress amended the Bankruptcy Code,
specifically 11 U.S.C. § 1222, to treat “claim[s] owed to a governmental unit
that arise[] as a result of the sale . . . of any farm asset used in the debtor’s
farming operation” as unsecured claims, subject to eventual discharge.3
However, Congress was not sufficiently clear in its statutory language
regarding the treatment of taxes generated before and after bankruptcy.
Quickly after the amendments went into effect, the IRS was, once again,
objecting to debtors’ plans. Specifically, the IRS objected to debtors’
treatment of tax from ordinary income and postpetition dispositions as
unsecured, as well as the debtors’ liberal “marginal method” of allocating
tax liability between secured and unsecured claims.4
The Supreme Court recently granted certiorari to the debtors in the
Ninth Circuit case United States v. Hall to settle the split of authority between
the Eighth, Ninth, and Tenth Circuits regarding the treatment of taxes
arising from postpetition dispositions.5 Although this decision will resolve
one of the main issues, only the Eighth Circuit has addressed the issues of
ordinary income and the proper allocating method, holding for the
debtors.6 Under the IRS’s position adopted by the Ninth and Tenth Circuits,
the recent amendment to § 1222 becomes essentially futile to accomplish
the original legislative purpose.7 However, courts are limited by the proper
methods of statutory interpretation.8
1. See ROGER A. MCEOWEN & NEIL E. HARL, PRINCIPLES OF AGRICULTURAL LAW § 5.08, at
5-20 to -45 (Robert P. Achenbach, Jr. ed., Spring 2008 ed.) (discussing the process of
reorganization under Chapter 12).
2. ROGER A. MCEOWEN, IOWA STATE UNIV. CTR. FOR AGRIC. LAW & TAXATION, CHAPTER
12 BANKRUPTCY TAXATION: DID BAPCPA REALLY CHANGE TAX CLAIMS TO UNSECURED GENERAL
CREDITOR STATUS? 2 (2011), available at http://www.calt.iastate.edu/briefs/CALTLegalBrief-
BankruptcyTaxation.pdf.
3. 11 U.S.C. § 1222(a)(2)(A) (2006).
4. See, e.g., In re Knudsen, 356 B.R. 480 (Bankr. N.D. Iowa 2006), aff’d in part, rev’d in part,
(2011); see infra Part III.B (discussing the cases interpreting the Chapter 12 amendments).
6. See infra Part III.B.1 (discussing the Eighth Circuit’s interpretation of all three issues
presented in this Note).
7. See infra Part IV.B.2 (explaining the st atements made by proponents of the
legislation).
8. See infra Part IV (comparing methods of statutory interpretation and the extent that
these methods take legislative history and plain language into account).
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