Hall v. United States

Whether a debtor must pay federal income tax on capital gains from the sale of their farm during bankruptcy proceedings.

The Halls (“petitioners”) filed a petition under chapter 12 of the Bankruptcy Code and, after approval by the bankruptcy court, sold their family farm. The petitioners proposed a plan of reorganization in an attempt to pay off their outstanding debts using proceeds from the farm sale that included a proposal to treat $29,000 in capital gains tax as an unsecured claim. The Internal Revenue Service (“IRS”) objected to the proposal.

The Bankruptcy Court held that Chapter 12 estates cannot incur tax because it is not a separate taxable entity and therefore cannot be treated as an unsecured claim; sustaining the IRS’s objection. The District Court reversed holding that 11 U.S.C. § 1222 (a)(2) applied to the capital gains tax and could be treated as an unsecured claim. The Ninth Circuit reversed holding that because a Chapter 12 estate cannot incur tax it cannot be treated as an unsecured claim, is not dischargeable and must be paid in full.

The petitioners argue that the Ninth Circuit's holding is contrary to the plain language of 11 U.S.C. § 1222 (a)(2)(A) by holding that post-petition capital gains taxes are not administrative expenses and is therefore not entitled to be treated as an unsecured claim. Petitioners also argue that this is directly contrary to the statutory language. The petitioner argues that the legislative history shows that Congress intended § 1222 to apply to post petition sales of farm assets.