8:00 a.m. 9:00 a.m. Presented by Joseph Peiffer Peiffer Law Office, P.C. PO Box Cedar Rapids, IA Phone:

Transcription

1 Wednesday, June 21, 2017 Commercial and Bankruptcy Law Rooms: Chapter 12 Family Farm Bankruptcy and Bankruptcy Venue Reform: Keeping Cases Near the Business 8:00 a.m. 9:00 a.m. Presented by Joseph Peiffer Peiffer Law Office, P.C. PO Box Cedar Rapids, IA Phone:

2 Part 1: Dealing with Tax Claims Pre- Petition Sales - Section 1222(a)(2)(A) Hall v. U.S., 132 S.Ct (2012) Part 2: Venue for Bankruptcy Cases Should be Where the Principal Assets or the Headquarters of the Business are Located The Case for Change of 28 U.S.C Presented at: Iowa State Bar Association Annual Meeting June 21, 2017 Des Moines, Iowa Joseph A. Peiffer Peiffer Law Office, P.C. PO Box Cedar Rapids, IA (319) C (319) joep@peifferlaw.com

3 Table of Contents Part 1: Dealing with Tax Claims Pre-Petition Sales Section 1222(a)(2)(A) Hall v. U.S., 132 S.CT (2012)...1 Congress and Practitioners Tackle the Supreme Court s Decision in Hall v. United States...1 The Statute Reviewed...1 How Does the Issue Arise?...2 The Facts of Hall...2 Post-Petition Sale of Ranch Leads to Significant Taxes...3 IRS Objects to Chapter 12 Plan...3 Decisions in Hall...3 Prior Decisions Interpreting 1222 (a)(2)(a)...4 Congressional Action in Response to Hall...7 Problems Caused by Lack of Action to Correct Hall...8 Feasibility is a Current Problem for Many Chapter 12 Debtors...9 Other Questions Lurking for Practitioners and Courts in Interpretation of 1222 (a)(2)(a)...9 1) Which Farm Asset Sales Qualify for Special Tax Treatment Under 1222 (a)(2)(a)? ) How is the Amount of Tax Treatable as an Unsecured Claim Pursuant to 1222 (a)(2)(a) Calculated?...11 A. The Debtors Methodology-The Marginal Approach...11 B. The IRS Methodology-The Proportional Approach ) Is the Tax Treated Under 1222 (a)(2)(a) Discharged When the Debtor Receives a Discharge? ) Is the Sale of AN Individual s Interest in a Farm Partnership the Sale of a Farm Asset Used in the Farming Business? ) Must the Family Farmer be Engaged in Farming at the Time of Filing the Chapter 12 to be Eligible for the Benefits of Chapter 12? ) Can a Farmer Change Tax Years to Avail Himself of the Provisions of 1222 (a)(2)(a)? ) After Hall, Can Any Post-Petition Taxes be Paid from Post-Petition Earnings as They Are Property of the Bankruptcy Estate? ) Can Farmers Whose Debts Exceed the Debt Limits of Chapter 12 Downsize to the Extend that They Qualify for Chapter 12?...18

4 Part 1 Closing Observations...19 Part 2: Venue for Bankruptcy Cases Should be Where the Principal Assets or the Headquarters of the Business Are Located The Case for Change of 28 U.S.C Proposal...20 Background...20 Why Venue Reform is Necessary...21 Exhibit Exhibit Exhibit Exhibit Exhibit Exhibit

5 Part 1: Dealing with Tax Claims Pre-Petition Sales - Section 1222(a)(2)(A) Hall v. U.S., 132 S.Ct (2012) Congress and Practitioners Tackle the Supreme Court s Decision in Hall v. United States The Supreme Court decided Hall v. United States, 132 S.Ct (2012) on May 14, It resolved the conflict between the Eighth, Ninth, and Tenth Circuits regarding whether 11 U.S.C. 1222(a)(2)(A) applied to post-petition income taxes incurred because of the sale of farm assets used in the Debtor s farming operation. The decision does not allow post-petition taxes to be deprioritized and treated as pre-petition unsecured claims. The Eighth Circuit held that the taxes incurred post-petition did qualify for de-prioritization and treatment as pre-petition unsecured claims 1, while the Ninth and Tenth Circuits held that the post-petition taxes did not qualify for deprioritization and treatment as pre-petition unsecured claims. 2 This paper will examine the background of the circuit court split, then focus on the Congressional response to the decision, and finally focus on unanswered questions for practitioners to consider as they represent Chapter 12 Debtors and their creditors. The background of the split is examined below. The Statute Reviewed The Supreme Court considered the unique BAPCPA provision applicable only in Chapter 12 3 that de-prioritizes priority claims of governmental units that arise as a result of the sale or transfer of farm assets utilized in the farmer s farming operation. 11 U.S.C. 1222(a)(2)(A) stipulates that: The plan shall (2) provide for the full payment, in deferred cash payments, of all claims entitled to priority under section 507, unless (A) the claim is a claim owed to a governmental unit that arises as a result of the sale, transfer, exchange, or other disposition of any farm asset used in the debtor s farming operations in which case the claim shall be treated as an unsecured claim that is not entitled to priority under section 507, but the debt shall be treated in such a manner only if the debtor receives a discharge The question presented to the Supreme Court was whether Section 1222(a)(2)(A) s reference to claims entitled to priority under section 507 means all tax claims described in Section 507, including taxes on post-petition sales, or whether, instead, the Ninth Circuit was correct that Congress meant for an entirely separate section of the IRC to impliedly remove one of the key 1 Knudsen v. IRS, 581 F.3d 696 (8th Cir. 2009). 2 United States v. Hall, 617 F.3d 1161 (9 th Cir. 2010); Dawes v. United States, 652 F.3d 1236 (10 th Cir. 2011). 3 Chapter 12 bankruptcy was enacted on October 27, 1986, effective November 26, 1986, in response to the farm crisis. Public Law Title III Sec. 302 (a) & (c). As part of BAPCPA, Chapter 12 was expanded to include family fishermen. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No , 1007, 119 Stat. 23,

6 portions of Section 507 from Section 1222(a)(2)(A) s special protections. 4 The key question referred to was the applicability of Section 1222(a)(2)(A) to post-petition taxes incurred by a family farmer when farm assets are sold post-petition. 5 How Does the Issue Arise? The issue arises in Chapter 12 bankruptcies when the family farmer sells or transfers farm assets used in its farming operation and a priority claim arises in favor of a governmental unit. Generally, the priority claim is an income tax claim due to gain realized on the sale of the farm asset. It can also arise in the context of the breach of an assumed pre-petition or post-petition contract 6 between the family farmer and the Farm Service Agency (FSA) that the purchasing farmer refuses to assume. Each of these contracts contains a liquidated damages provision in case of breach. 7 The refusal to assume the contract with FSA results in a priority claim 8 treatable under 1222(a)(2)(A). The Facts of Hall The Halls owned and operated a 320-acre farm in Wilcox, Arizona. They filed their Chapter 12 bankruptcy petition on August 9, Before filing their petition, the Halls had contracted to sell their farm for $960, Unfortunately, the sale was complicated by the fact that their farm secured a disputed claim of Brenda Hall s father, his wife, and their family trust (the Osborns ). The Osborns had filed a state court foreclosure action that would have enabled them to recover the whole value of the Halls farm. After filing their Chapter 12 petition, the sale of the farm for $900, was approved by the Bankruptcy Court. As a result, the Osborns received $400, The Osborns claims and the Halls counterclaims were to be resolved after the sale by the Bankruptcy Court. After the sale, the Chapter 12 trustee held $422, After substantial litigation and mediation, the Halls and Osborns agreed to a settlement through which the Osborns received an additional $215, Pre-petition secured claims owed to the IRS and Cochise County, AZ for pre-petition taxes were also paid from the sale proceeds. 4 Appellant s brief Hall v. United States, No at i. 5 Interestingly, 1222(a)(2)(A) does not apply to family fishermen. 6 Examples of these contracts include the Direct and Countercyclical Program (DCP) that provides subsidies for twenty-three crops grown in all fifty states; and the Conservation Reserve Program (CRP) that pays participating farmers to keep highly erodible land out of production for ten to fifteen years. A discussion of CRP is found in U.S. Through Agr. Stabilization and Conservation Service v. Gerth, 991 F.2d 1428 (8 th Cir. 1993). Farmer participation in CRP is extensive throughout the United States. In the 2010 signup for the Conservation Reserve Program, farmers from 39 states offered to participate in the program offering 4,343,452 acres to be placed in the reserve. FSA accepted 91.6% of the offers of land made by farmers. RS21613 Conservation Reserve Program: Status and Current Issues, 15- Sep-2010; Tadlock Cowan, published by the Congressional Research Service. 7 The DCP liquidated damage provision provides that all of the funds paid to the producer shall be repaid to FSA upon breach. The CRP liquidated damage provision provides that all of the payments made under the CRP contract from inception through breach be repaid to FSA, which can be quite expensive given the ten to fifteen year term of the CRP contracts. 8 Each of these governmental claims arising through a post-petition breach will constitute an administrative claim under 503(b)(1)(A) and 507(a)(2). 2

7 Post-Petition Sale of Ranch Leads to Significant Taxes The sale price of the Halls farm exceeded the adjusted tax basis of the farm, resulting in taxable capital gains which led to income taxes of $29, Relying on 1222(a)(2)(A), the Halls Chapter 12 Plan provided that the taxes arising as a result of their post-petition sale would be treated as an unsecured claim and paid pro rata to the extent funds were available after satisfying higher priority claims. IRS Objects to Chapter 12 Plan The IRS objected to the Halls Plan based on IRC 1399 which states that no separate taxable entity results from the commencement of a bankruptcy case under any chapter of the Bankruptcy Code, except for Chapter 7 liquidation or Chapter 11 reorganization cases of individual debtors. The IRS argued that the post-petition capital gains tax incurred as a result of the Halls sale of their ranch was not an administrative expense under Bankruptcy Code 507(a)(2) and 503(b). Since it was not an administrative expense, it was not covered by Section 1222(a)(2)(A), because it was not incurred by the estate as required to qualify as an administrative expense claim in the Halls bankruptcy case. The IRS argued, instead, that postpetition capital gains tax was an obligation of the Halls individually to be paid from nonbankruptcy estate assets, and could not be discharged under their Chapter 12 reorganization plan. Without administrative expense status, the IRS claimed, Bankruptcy Code 1222(a)(2)(A) is simply inapplicable to post-petition tax claims due to sale of bankruptcy estate assets, so debtors like the Halls have to pay the entire capital gains tax as though it arose outside the bankruptcy. The Halls argued that the Bankruptcy Court should follow the Bankruptcy Court Decision In re Knudsen, 356 B.R. 480, (Bankr. N.D. Iowa 2006) which held that 1222(a)(2)(A) applied to post-petition taxes, which could be treated for distribution purposes as administrative expenses under 11 U.S.C. 503(b)(1)(B). Decisions in Hall The Bankruptcy Court agreed with the IRS and sustained the Government s objection. In re Hall, 376 B.R. 741 (Bankr. D. Arizona 2007). On appeal, the District Court reversed the Bankruptcy Court. United States v. Hall, 393 B.R. 857 (D. Arizona 2008). The Ninth Circuit, in a 2-1 decision, agreed with the Bankruptcy Court, and reversed the District Court. United States v. Hall, 617 F.3d 1161 (9th Cir. 2010) cert. granted, June 13, 2011, 131 S.Ct. 2989, 180 L.Ed.2d 820, 79 USLW 3693, 79 USLW 3696 (2011). The Ninth Circuit recognized that its decision created a circuit split with the Eighth Circuit s decision in Knudsen v. IRS, 581 F.3d 696 (8th Cir. 2009), which reached the opposite conclusion regarding the applicability of 1222(a)(2)(A) to 9 While $29, might seem like a significant tax, it is far smaller than the taxes faced by numerous other farmers dealing with post-petition sales of farm assets. E.g. Anders and Cynthia Knudsen, N.D. Iowa Case No Doc. No. 287 p. 1, Federal taxes $72, State taxes $896.00; Jason and Jodi LeGassick, N.D. Iowa Case No Doc. No. 67 p. 6, $81, est.; Kent and Glenda Ficken, D. Colorado Case No Doc. 29 pg. 11, $38, The author s last Chapter 12 plan seeks to discharge Federal taxes of $207, and State taxes of $55,

8 post-petition taxes. The Eighth Circuit held that 1222(a)(2)(A) applied to post-petition taxes because it found that they were administrative expenses under 503(b)(1)(B). 10 The Eighth Circuit also held that the language of 1222(a)(2)(A) did not restrict it to pre-petition creditors but also applied to post-petition claims of governmental units. 11 Prior Decisions Interpreting 1222(a)(2)(A) This provision was first interpreted by the Bankruptcy Court for the Northern District of Iowa, in which Judge Edmonds held that the existence of a separate taxable entity was not necessary in order to apply 1222(a)(2)(A) to the taxes arising from the post-petition dispositions of farm assets used in the debtor s farming operation. 12 Judge Edmonds relied on the Eighth Circuit decision In re L.J. O'Neill Shoe Co. 13 stating that, [i]n a bankruptcy case, the payment of the tax imposed against a debtor may still be divided into separate components in accordance with the bankruptcy laws determining the priority of payment of those claims. 14 Judge Edmonds analogized that Knudsen was like O Neill since neither O Neill nor Knudsen had separate taxable entities. O Neill was a corporate Chapter 11 case while Knudsen was a Chapter 12 individual case. Judge Edmonds held that the Plan in Knudsen could provide for the payment of post-petition taxes from income earned after the filing of the petition, and such taxes may be treated for distribution purposes as administrative expenses under 11 U.S.C. 503(b)(1)(B). Judge Edmonds continued stating, [m]oreover, the plan may provide for treatment of a portion of these taxes as unsecured debt under 1222(a)(2)(A), and upon entry of a discharge order, such taxes, including penalties and interest, would be discharged under 11 U.S.C. 1228(a) to the extent they are treated as unsecured. 15 Judge Edmonds decision on the applicability of 1222(a)(2)(A) to post-petition taxes was affirmed by the District Court decision by Judge Mark Bennett. 16 Judge Bennett observed that Chapter 12 expressly contemplates that a plan may provide for the sale of property of the estate. 11 U.S.C. 1222(b)(8). He continued stating, [s]o construed, much of the benefit of 1222(a)(2)(A) in stripping priority from claims of governmental units, at least to the extent that such claims are tax claims, would be frittered away. 17 Judge Bennett cited with approval the Bankruptcy Court s decision In re Dawes, 18 stating, [c]onstruing 1222(a)(2)(A) to apply to postpetition sales provides debtors and their counsel when formulating a plan the flexibility intended by Congress to make decisions driven by farming and business factors, rather than potential adverse tax consequences, and noting, [t]he entire purpose of Chapter 12 is to allow a farmer to reorganize, and the specific purpose of the amendment to 1222 was to remove a major impediment to reorganization F.3d Id. at In re Knudsen, 356 B.R. 480, (Bankr. N.D. Iowa 2006) F.3d 1146, 1152 (8th Cir.1995) B.R. at B.R. at In re Knudsen, 389 B.R. 643, 677 (N.D. Iowa 2008). 17 Id at B.R. 509, 519 (Bankr. D. Kansas 2008) B.R. at

9 In determining that 1222(a)(2)(A) applies to post-petition taxes, Judge Bennett reviewed the meanings of Bankruptcy Code 503, 507 and 1222(a)(2) as well as principles of bankruptcy law. He quoted In re Dawes, which states, [t]axes are therefore accorded administrative expenses priority [under 507] if they are (1) incurred by the estate and (2) not of a kind specified in section 507(a)(8). 20 Judge Bennett concluded that 507(a)(8) applies only to pre-petition taxes; therefore, post-petition taxes, which were at issue in Knudsen, are not of a kind specified in section 507(a)(8). 21 Thus, whether post-petition taxes can be paid through the bankruptcy estate turned on whether those taxes are incurred by the estate. 22 The term incurred by the estate is not clear under the Bankruptcy Code. The phrase could refer to the time liability for a tax accrues did the liability arise before or after the creation of the estate under 541, but it could instead refer to the entity liable for the tax is the bankruptcy estate created under 541 liable for the tax? 23 To determine whether the taxes on capital gains are administrative expenses, Judge Bennett considered a Senate report accompanying the 1978 Bankruptcy Code. The Senate report contained a discussion of 503(b)(2) which stated: In general, administrative expenses include taxes which the trustee incurs in administering the debtor's estate, including taxes on capital gains from sales of property by the trustee and taxes on income earned by the estate during the case. Interest on tax liabilities and certain tax penalties incurred by the trustee are also included in this first priority. 24 [S.Rep. No , 95th Cong., 2d Sess. 66 (1978), U.S.Code Cong. & Admin.News 1978, p (italics supplied), reprinted in D Collier on Bankruptcy App. Pt ] The Report of the Recommendations of the Senate Finance Committee, to which the tax-related provisions of the proposed Code had been referred, stated in part as follows concerning tax priorities: Administrative expenses-taxes incurred during the administration of the estate share the first priority 25 given to administrative expenses generally. [S.Rep. No , 95th Cong., 2d Sess. 13 (1978) (as reported by the Senate Judiciary Committee and the Senate Finance Committee) (italics supplied), reprinted in D Collier on Bankruptcy App. Pt ] Hence, the legislative history of 503(b)(2)(B) evidences that Congress intended incurred by the estate to have reference to when the tax liability was incurred, not to the entity having liability for the tax. 26 Judge Bennett cited the bankruptcy decision In re Dawes, that analyzed the legislative history behind IRC 1398 and 1399 which addressed matters of tax filing, reporting, and B.R. at B.R. at B.R. at B.R. at In light of changes made to 11 U.S.C. 507 in BAPCPA taxes incurred during the administration of the estate are now second priority 507(a)(2). 25 Id B.R. at

10 payment obligations, not the definition of administrative claims in the Bankruptcy Code. The court in Dawes concluded that the phrase incurred by the estate in the definition of administrative expenses in 503(b)(1)(B)(i) has reference to the time when the tax liability is incurred and not to whether the estate is a separate taxable entity. 27 The Bankruptcy Court decision in Knudsen was followed by the Bankruptcy Court in In re Schilke, 379 B.R. 899 (Bankr. D. Neb. 2007) wherein Bankruptcy Judge Thomas L. Saladino stated: Faced with the choice of following the result in Knudsen or the result in Hall, I feel that Knudsen produces the more appropriate result when considering the apparent intent of the statute -- that is, to help farmers reorganize. The legislative history quoted above relating to an earlier bill to amend 1222(a)(2) in an identical manner clearly shows that the language used was intended to allow the debtor to use the amendments to 1222(a)(2) for taxes generated during the bankruptcy reorganization from the sale of assets used in a farming operation. 28 The Bankruptcy Court s decision in Dawes was affirmed by the District Court in Kansas. 29 In affirming the Bankruptcy Court, the District Court held that 1222(a)(2)(A) is not limited to creditors, but instead applies to governmental units holding a claim against a Chapter 12 debtor. 30 It further held that the post-petition capital gains taxes were incurred by the estate and thus, were administrative expenses even though the Chapter 12 estate was not a separate taxable entity. 31 The Ninth Circuit in Hall v. the United States criticized and did not follow the Bankruptcy Court s decision in Dawes. 32 The Ninth Circuit reasoned that since the Internal Revenue Code provides that a Chapter 12 estate cannot incur taxes, it follows that a Chapter 12 estate is not a taxable entity. Therefore, it cannot incur a tax. 33 The Ninth Circuit concluded that because a Chapter 12 estate cannot incur a tax, it cannot get the benefit of 1222(a)(2)(A), which provides that the tax on the gain from the sale of a farm during bankruptcy is dischargeable and payable in less than full. 34 The analysis by the Ninth Circuit relies upon 1398 and 1399 of the Internal Revenue Code that deal with the creation of a separate taxable estate upon the filing of individual Chapter 7 and 11 bankruptcies. Eight days after the Supreme Court granted certiorari in Hall, the Tenth Circuit reversed the District Court decision in Dawes. 35 The Tenth Circuit adopted the reasoning of the Ninth Circuit in Hall that was based upon the interpretation of the phrase incurred by the estate through the lens of the Internal Revenue Code 1398 and 1399 and rejected the reasoning of the Eighth Circuit in Knudsen that was based on a consideration of the Bankruptcy Code. In Knudsen, the 27 Id. at B.R. at B.R. 815 (D. Kansas 2009) B.R. at Id F.3d 1161 (9 th Cir. 2010) F. 3d at Id. at Dawes v. United States, 652 F.3d 1236 (10 th Cir. 2011), petition for certiorari filed 2011 WL

11 interpretation of the phrase incurred by the estate was based upon the timing of the event that caused the tax to be incurred, not a consideration of whether a separate taxable estate was created upon the filing of the Chapter 12 bankruptcy. The Eighth Circuit did not rely upon the Internal Revenue Code, but rather interpreted 1222(a)(2)(A) through the lens of the Bankruptcy Code. It analyzed whether the sale was the sale of property of the estate as defined by Thus, a classic split of the circuits existed regarding whether 1222(a)(2)(A) can be used to de-prioritize tax claims of governmental units for post-petition sales of farm assets used in the debtor s farming operation. The Eighth Circuit held that 1222(a)(2)(A) can be used to deprioritize these claims while the Ninth and Tenth Circuits held that 1222(a)(2)(A) cannot be used for that purpose. The Supreme Court resolved the split, holding that the 1222(a)(2)(A) does not apply to the post-petition sale of farm assets utilized in the debtor s farming operation because no separate taxable estate was created upon the filing of the Chapter 12 bankruptcy. Therefore, the tax is neither collectible nor dischargeable in the Chapter 12 plan. Hall v. United States, 132 S.Ct. 1882, 1893 (2012). Congressional Action in Response to Hall Suggestions to amend the Bankruptcy Code to rectify the effect of Hall were presented to Senator Grassley (R-IA) the afternoon that Hall was decided. Beginning in June of 2012, Senate Staffers, Susan Freeman (the attorney who argued Hall), and your speaker had extensive discussions regarding drafting a bill to address the holding in Hall. The suggested legislation forwarded to Senator Grassley would have dealt with the holding in Hall as well as many other unanswered questions that arise from the ambiguity of 1222(a)(2)(A). Ultimately, Senator Grassley chose to only address Hall in corrective legislation as it was viewed as being less controversial than dealing with the whole gambit of unclear issues that had not been addressed by Hall. On September 13, 2012, Senators Grassley and Franken (D-MN) introduced S.3545, which was referred to the Senate Finance Committee where it died when the 112 th Congress was adjourned. A copy of S.3545 is attached as Exhibit 1. In December of 2012, the National Bankruptcy Conference sent its comments regarding S.3545 to Senator Grassley. Those comments are attached as Exhibit 2. The comments of the National Bankruptcy Conference were very insightful and assisted the drafters in revising S.3545 and crafting a better bill for introduction in the 113 th Congress. On August 1, 2013, Senators Grassley and Franken introduced S.1427, the Family Farmer Bankruptcy Clarification Act of This bill was not merely a reintroduction of S Rather, it was a redrafted bill designed to avoid the death that S.3545 experienced in the Senate Finance Committee. Its goal, like S.3545 before it, was to provide a legislative basis to allow family farmers to utilize Chapter 12 bankruptcy to de-prioritize taxes incurred on the sale or other disposition of farm assets and treat them as pre-petition general unsecured claims. S.1427 was initially assigned to the Senate Finance Committee. On September 10, 2013, it was removed from the Senate Finance Committee and assigned to the Senate Judiciary Committee. This is the same committee that passed the initial version of 1222(a)(2)(A) in 1999 that became law as part of BAPCPA in April of After assignment to the Senate Judiciary Committee, S.1427 did not move forward in the 113 rd Congress. On January 20, 2015 Senators Grassley and Franken F.3d at

12 introduced S.194, titled Family Farmer Bankruptcy Clarification Act of S.194 is the reintroduction of S.1427 with the exception of the change in title from 2013 to On May 25, 2017, Senators Grassley and Franken introduced S.1237, titled Family Farmer Bankruptcy Clarification Act of Just as its predecessor in 2015, S.1237 is the reintroduction of S.1427 except for the change in title to reflect introduction to the Senate in A copy of S.1237 is attached as Exhibit 3. The redlined version of the portions of the Bankruptcy Code amended by S.1237 is attached hereto as Exhibit 4. It appears that no relief will be forthcoming from Congress this year unless farmers and their representatives press Congress for action. Another approach to satisfy the problems created by Hall would be to allow Chapter 12 debtors to utilize the short year tax provisions of 26 U.S.C. 1398(d). A copy of a proposal I have made to allow Chapter 12 debtors to use the short year tax provisions of 1398 is attached as Exhibit 5. Problems Caused by Lack of Action to Correct Hall In In re O Farrell, 74 B.R. 421 (Bkrtcy. N.D. Fla. 1987) the Court held that it is not the creditor s prerogative to select which or how much of the Chapter 12 debtor s property is to be disposed of under Bankruptcy Code provision permitting plan to provide for sale of all or any part of property of the estate. 37 In O Farrell, the debtor proposed to surrender dairy improvements to Federal Land Bank. Land Bank objected, asserting that it would effect (sic.) a limitation on use and a resultant diminution in value of the surrendered parcel and improvements. The Bankruptcy Court disagreed and allowed the family farmer to dictate the terms of its reorganization plan. Five years after Hall was decided by the Supreme Court, creditors now understand the usefulness of 1222(a)(2)(A) in dealing with taxes incurred when farm assets used in the farming operation are sold. Unfortunately, due to the requirement that the sale of the farm assets occur in the tax year prior to the filing of the bankruptcy, some creditors are now dictating the terms of the farmer s pre-petition liquidation plans. Recently, a farmer visited my office. The farmer owned 240 acres that had been in his family for over 150 years. Given the circumstances surrounding his current indebtedness, the farmer understood that it was imperative that he sell some land to decrease the debt load. He had recently found an off-farm job to supplement his income and his wife s offfarm income. With their combined off-farm income, they had determined that they would only need to sell 80 acres of land, some machinery and cattle, then file a Chapter 12 in 2018 to deal with the taxes. The bank insisted that they sell 180 acres. Since the debt to the bank exceeds the value of the collateral, the bank does not need to consent to the sale of only 80 acres. Indeed, without the bank s consent, the farmer could not limit the sale to 80 acres and was required to sell 180 acres to gain the bank s consent. Filing a Chapter 12 bankruptcy is supposed to give the farmer a break so a feasible plan of reorganization can be proposed to deal with the debt and taxes. Since Hall, the secured creditors again control the liquidations of farmers if there will be tax problems as the sales need to be concluded in the year before filing. This is not what Congress envisioned when it enacted Chapter 12 in It must be remedied U.S.C. 1222(b)(8) and 1225(a)(5)(B). An excellent discussion of this is found in In re Sharon E. Kerwin-White, 129 B.R. 375 n.9 (Bankr. D. Vernont 1991). 8

13 Feasibility is a Current Problem for Many Chapter 12 Debtors Falling farm prices have led many farmers to be faced with virtually impossible scenarios to produce corn and soybeans at a profit. Many publications noted expected losses of $50.00 to $ per acre of corn and soybeans produced. The cash losses would be less for those farmers that owned their land, provided they did not consider a rent equivalent for their owned ground as a cost of production. Such a cost is known as an opportunity cost in economic circles. Many farmers coming to my office are facing loss scenarios on the crops they are producing. With losses being projected, it is impossible to demonstrate feasibility for a plan. Feasibility is required by 11 U.S.C. 1225(a)(6). Recently, an Iowa egg producer with nearly 300,000 hens sought assistance. The cost of production of a dozen eggs for this producer was $0.52 to $0.55. The price per dozen eggs on the breaker market, the best market available to him, was $0.37 per dozen, resulting in a monthly cash loss of $150, No plan could be proposed for this farmer that would satisfy the staggering debt owed by the farm when even the costs of operation cannot be covered. Fortunately, feasibility is not considered strictly on current conditions. To determine whether a plan is feasible, the Court analyzes the debtor s projected income and expenses in relation to actual past performance. The feasibility standard requires the Court to determine whether the plan offers a reasonable prospect of success and is workable. In re Monnier Bros., 755 F.2d 1336, 1341 (8 th Cir. 1985); In re Foertsch, 167 B.R. 555, 565 (Bankr. D.N.D. 1994); In re Weber, 297 B.R. 567, 571 (Bankr. N.D. Iowa 2003). A review of the past 5 years of production records for yields and tax returns to see costs along with projections for the upcoming years should be provided to the Court. Where the projections differ from the past performance, the differences should be explained. If the operation is being changed to increase profitability, what is being changed and how the changes will improve profitability must be explained. Unfortunately, not all family farmers can propose confirmable plans. That inconvenient truth is the bad news that must be delivered to many family farmers. In many family farm cases, partial or nearly total liquidation will be required. This liquidation generally leads to significant income taxes, which can be dealt with through Chapter 12, which, while an imperfect solution, is the best solution available for most struggling family farmers. Other Questions Lurking for Practitioners and Courts in Interpretation of 1222(a)(2)(A) 1) Which farm assets qualify for special tax treatment under 1222(a)(2)(A)? 2) How is the amount of tax to be treated under 1222(a)(2)(A) calculated? 3) Is the unpaid portion of the tax treated under 1222(a)(2)(A) discharged when the Chapter 12 discharge is entered? 4) Is the sale of an individual s interest in a farm partnership the sale of a farm asset used in the farming business? 5) Does the family farmer need to be engaged in farming at the time of filing to qualify for Chapter 12? 6) Can a farmer change tax years to avail himself of the provisions of 1222(a)(2)(A)? 7) After Hall, can any post-petition taxes be paid from post-petition earnings as they are property of the bankruptcy estate? 8) Can farmers whose debts exceed the debt limits of Chapter 12 downsize to the extent that they qualify for Chapter 12? 9

14 1) Which Farm Asset Sales Qualify for Special Tax Treatment Under 1222(a)(2)(A)? In re Knudsen, 356 B.R. 480 (Bankr. N.D. Iowa 2006) was the first case to address the issue which assets lead to governmental claims treatable under 1222(a)(2)(A)? The Bankruptcy Court held that slaughter hogs sold in order to convert the Knudsens farrow-to-finish hog operation into a custom hog-raising operation did not qualify as farm assets used in the debtors farming operation, within the meaning of 1222(a)(2)(A). The Bankruptcy Court determined that the term used in was to be determined based upon language in the Internal Revenue Code 26 U.S.C That limited the farm assets that could be sold and qualify for de-prioritization to what are generally referred to as capital assets under the Internal Revenue Code. Knudsen, 389 B.R. at 664. The Bankruptcy Court was reversed with the District Court holding that the sale of slaughter hogs qualified for treatment under 1222(a)(2)(A). In re Knudsen, 389 B.R. 643 (N.D. Iowa 2008) affirmed 581 F.3d 696 (8th Cir. 2009). Knudsen was followed in In re Ficken, 430 B.R. 663, (10th Cir. B.A.P. Colo. 2010). In Knudsen, the District Court held that the phrase used in the debtor s farming operation required analysis of the meaning of three separate phrases within the longer phrase. Those phrases are: any farm assets, used in, and the debtor s farming operation. In re Knudsen, 389 B.R. at 664. The District Court held that the phrase any farm asset included the Knudsen s slaughter hogs. It rejected the IRS contention that farm assets could not include products of the farming operation. Knudsen, 389 B.R. at 664. The District Court held that the phrase the debtor s farming operation means the farming operation under the reorganization plan, not the farming operation as it existed before the farmer s attempt to reorganize. Knudsen, 389 B.R. at The District Court adopted a liberal reading of the phrase used in and avoided the narrow and formalistic constraints imposed by the IRS s importation of a tax code construction, which would fritter [ ] away the benefits of 1222(a)(2)(A) in stripping priority from claims of governmental units, including tax and non-tax claims. In adopting its liberal reading of the phrase used in, the District Court cited Wright v. Union Central Life Ins. Co., 311 U.S. 273, 279 (1940) for the proposition that the [Bankruptcy] Act must be liberally construed to give the debtor the full measure of the relief afforded by Congress, lest its benefits be frittered away by narrow formalistic interpretations which disregard the spirit and letter of the Act. Knudsen, 389 B.R. at In re Knudsen, 389 B.R. 643, 664 (N.D. Iowa 2008). The term farming operation is also defined in 11 U.S.C. 101(21). It includes farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, or livestock, and production of poultry or livestock products in an unmanufactured state. See In re Miller, 122 B.R. 360 (Bankr. N.D. Iowa 1990) (debtor s purchase of timber ground and harvest of trees, processing into kiln dried planed boards held not to be a farming operation.); In re Watford, 898 F.2d 1525 (11th Cir. 1985) (whether debtor is engaged in a farming operation is determined by a review of the totality of the circumstances, the list included in the definition section is not all inclusive); In re Marke, 77 B.R. 832 (Bankr. D. Kan. 1987) (farming operations are to be broadly construed and debtor s game farm and kennel constituted a farming operation); In re Swanson, 289 B.R. 372 (Bankr. C.D. Ill. 2003) (income from cash rent is not income from a farming operation); In re Armstrong, 812 F.2d 1024 (7th Cir. 1987) (the sale of debtor s farm machinery considered income from the farming operation); compare Federal Land Bank v. McNeal, 77 B.R. 315 (S.D. GA. 1987) aff d. 848 F.2d 170 (11th Cir. 1988) (debtor s trucking for neighbors tied directly to efficiency of debtor s farming operation constitutes farming operation), with In re Faber, 78 B.R. 934 (Bankr. S.D. Iowa 1987) (debtor s trucking operation considered as a separate business, not part of the debtor s farming operation). 10

15 The appellate decision in Knudsen provides direction to determine whether the taxes occasioned by the sale of farm assets by a farmer qualify for treatment as an unsecured claim. Three yeses in the chart below are required for 1222(a)(2)(A) treatment: Asset Sold Any Farm Asset Used in Debtor s Farming Operation Yes No Yes No Yes No Sow Herd X X X Farrowing Equipment X X X Livestock Trailer X X X 500 Shares Iowa Premium Select X X X Soybeans not fed X X X Corn fed to hogs X X X Farmland X X X Remainder Interest??? 2) How is the Amount of Tax Treatable as an Unsecured Claim Pursuant to 1222(a)(2)(A) Calculated? Two methods have been suggested to calculate the amount of tax that qualifies for deprioritization under 1222(a)(2)(A). Debtors favor the marginal approach while governmental units favor use of the proportional approach. The courts in Knudsen and Ficken are the only courts that have published opinions examining the methods of calculating the amount of tax that is to be de-prioritized under 1222(a)(2)(A). 39 A. The Debtors Methodology The Marginal Approach: In Knudsen, the Debtors urged the Court to adopt a marginal approach to determine the amount of tax subject to 1222(a)(2)(A) treatment. The Bankruptcy Court rejected the marginal methodology. 40 The marginal methodology was approved by the District Court in Knudsen, 389 B.R. 643, 665 (N.D. Iowa 2008) affirmed 581 F.3d 696 (8th Cir. 2009). The marginal approach is described below: Step 1: Calculate the tax due if all income is reported as being taxable (Traditional Return). Step 2: Calculate the tax due if income from sale of farm assets used in debtor s farming operation is excluded (Pro-Forma Return). Step 3: Subtract the tax due as found under Step 2 from the tax due under Step 1. The difference between the tax shown on the Traditional Return and the Pro-Forma Return is the tax treatable under 1222(a)(2)(A). The tax shown on the Pro-Forma Return is the priority tax that must be paid by the debtor. In Knudsen, the calculations of tax due under the marginal 39 In re Knudsen, 389 B.R. 643, (N.D. Iowa 2008) affirmed 581 F. 3d 696 (8th Cir. 2009); In re Ficken, 430 B.R. 648, (Bankr. D. Colo. 2009) affirmed 430 B.R. 663 (10th Cir. BAP 2010) rev d on other grounds 433 Fed. Appx. 682 (10th Cir. 2011). 40 In re Knudsen, 356 B.R. 480, 487 (Bankr. N.D. Iowa 2007). 11

16 methodology on the assets that the Knudsens believed qualified for 1222(a)(2)(A) treatment were as follows: Traditional Return $55, (less) Pro-Forma Return (Priority Tax) (12,701.00) Tax Treatable Under 1222(a)(2)(A) $43, B. The IRS Methodology The Proportional Approach: In Knudsen, the Internal Revenue Service argued for a proportional approach to determine the amount of the tax to be treated under 1222(a)(2)(A). Under the proportional approach the IRS argued that each dollar of income is treated identically so that all tax rates are applied to it from the first dollar to the last dollar. Utilizing the IRS interpretation of the assets to which 1222(a)(2)(A) applies, even self-employment taxes retained the taint of priority. The proportional approach urged by the IRS in Knudsen is illustrated below 41 : IRS Proportional Approach Non-Gain (Priority Claim) Gain (General Claim) Subject to 1222(a)(2)(A) Total Income $225,833 $169, % $56, % - ½ SE Tax (7,588) - Health Ins. (6,780) AGI 211,465 -Std. Deduction (9,700) -Exemptions (18,600) Taxable Income $183,165 Income Tax $40,666 $30, % $10, % SE Tax 15,176 15, % 0 0.0% Total Tax $55,842 $45, % 10, % Tax Withheld (282) (282) 100.0% 0 0.0% Fuels Credit (238) (238) 100.0% 0 0.0% Net Tax Due $55,322 $45,156 $10,166 Payment (8,000) (6,530) 82.0% (1,470) 18.0% Tax Balance $47,322 $38,626 $8,696 Interest $ % % Total $39,167 $8, Govt. Exhibit A Anders & Cynthia Knudsen United States Bankruptcy Court Northern District of Iowa Case No The allocation between Priority Claims and General Unsecured Claims is determined by comparing the amount of income derived from the sale of farming assets with the total income shown on the tax return. In this instance, the total income shown on the Knudsens 2004 Income Tax Return was $225,833 while the amount of the farm assets sold that qualified for 1222(a)(2)(A) treatment in the eyes of the IRS was $56,236, which is 25.0% of the total income reported on the tax return. Since the Self Employment tax was incurred as a result of the income reported on Schedule F and not as a result of the sale of capital assets, the IRS argued that the Self Employment tax would be a priority claim, not a general unsecured claim. 12

17 3) Is the Tax Treated Under 1222(a)(2)(A) Discharged When the Debtor Receives a Discharge? In Knudsen, the IRS argued that it would be able to collect any tax unpaid by the Debtors when the discharge was entered pursuant to 11 U.S.C. 1228(a). The Knudsens argued that when the tax claim was reclassified as an unsecured claim, it would be discharged when they received their discharge. The Bankruptcy Court determined that when the Knudsens received their discharge, all taxes treated under 1222(a)(2)(A) would be discharged. In making that determination, the Bankruptcy Court stated: IRS argues that if Congress did not intend a reclassification, then Knudsens' plan is not confirmable because it proposes discharge of a portion of the prepetition priority tax claim. IRS says such discharge is not permissible under 11 U.S.C. 1228(a)(2). That section excepts from discharge any debt of a kind specified in 523(a) of the Code, and such debts include debts for taxes of the kind and for the periods specified in section (a)(8). 11 U.S.C. 523(a)(1)(A). IRS's argument is clever, but I think it depends on a too narrow reading of 1222(a)(2)(A) and 1228(a). Section 1222(a)(2)(A) permits debtors to treat government tax claims as unsecured to the extent they arise from the sale or other disposition of any farm asset used in the debtor's farming operation. A chapter 12 plan may provide such treatment, so long as a debtor's plan complies with all other confirmation requirements. Knudsens' plan provides for 1222(a)(2)(A) treatment of the IRS's prepetition priority tax claim. Section 1228 permits discharge of all debts permissibly provided for by the plan. Section 1222(a)(2)(A) allows debtors to treat certain tax claims as unsecured rather than as priority tax claims regardless of their normal status under 507(a)(8). The exception for debts of the kind specified in 523(a)(1)(A) is, therefore, not applicable. Because of 1222(a)(2)(A) treatment, a portion of the IRS's prepetition priority claim is not, for confirmation purposes, a debt of a kind specified in 507(a)(8). The plan does not impermissibly seek to discharge debts excepted from discharge under 1228(a)(2). 42 This issue, while initially designated in the IRS statement of issues on appeal was withdrawn by the IRS when it filed its Appellee s brief. Thus, the District Court did not address the issue of the discharge of the 1222(a)(2)(A) taxes. 4) Is the Sale of an Individual s Interest in a Farm Partnership the Sale of a Farm Asset Used in the Farming Business? Judge Collins faced this question in In re Hemann, 2013 Bankr. LEXIS 1385, 2013 WL , 69 Collier Bankr. Cas. 2d (MB) 638, 2013 WL (Bankr. N.D. Iowa 2013). In Hemann, the individual debtor, Norbert Hemann, had been in a farm partnership with his brother for many years. He sold his interest in the farming partnership to his brother in October of B.R. at

18 and filed his Chapter 12 bankruptcy petition in February of The IRS filed its Proof of Claim showing taxes owed totaling $97,457.39, which included some pre-petition interest. The Iowa Department of Revenue filed its Proof of Claim showing taxes owed totaling $27, The Debtor utilized the marginal methodology to calculate the taxes that would be due after the applicability of 1222(a)(2)(A). It showed that the following taxes were due: Priority Taxes 1222(a)(2)(A) Taxes Total Taxes Federal $10,766 $86,510 $97,276 State 3,864 23,732 27,596 Total $14,630 $110,242 $124,872 A partnership is a pass-through entity like a Subchapter S corporation, a Limited Liability Company, or a Limited Liability Partnership. The IRS and the IDR each argued that Mr. Hemann was not a farmer as the farming was done through the partnership, Hemann Brothers Partnership, not Norbert Hemann individually. Therefore, Norbert Hemann was not qualified to avail himself of the beneficial provisions of 1222(a)(2)(A). The Debtor argued that he qualified as a family farmer as he met the requirements set forth in 101(18)(A) and 109(f). The Debtor included the tax claims in his calculation of his total debt and asserted that the tax claims were farm debt. Therefore, his total debt met the greater than 50% threshold required for Chapter 12 eligibility. The tax authorities argued that when Mr. Hemann sold his interest in the partnership, he stopped farming through the partnership and therefore, he did not qualify to file Chapter 12 as he had a new farming operation. The Debtor was only farming on a very small scale in 2011, farming approximately 31 acres instead of farming in partnership with his brother and farming over 300 acres and having a livestock operation. Judge Collins held that Norbert Hemann was engaged in a farming operation. Hemann, 2013 Bankr. LEXIS 1385, *14, 2013 WL , *6. Judge Collins followed Knudsen, 581 F. 3d 696, 714 (8th Cir. 2009) finding that courts construe the definition of farmer liberally in order to further Congress purpose of helping family farmers to continue farming. Judge Collins also opined that the other holdings of Knudsen continue to be good law and its interpretations of Chapter 12 in general and 1222(a)(2)(A) in particular are controlling. Hemann, 2013 Bankr. LEXIS 1385, *25, 2013 WL , *5. Judge Collins dismissed the tax authorities position that the income needed to arise out of the farming operation that the Debtor was farming when the Chapter 12 petition was filed, citing Knudsen, 581 F.3d at 714 n.3 in which the Eighth Circuit rejected the IRS s assertion that the eligibility language of 101(18)(A) must be the same farming operation under the Chapter 12 plan. In Knudsen, the Debtor changed his farming operation from a farrow-to-finish hog operation to an operation that custom finished hogs for another owner. Hemann, 2013 Bankr. LEXIS 1385, *18, 19. Hemann changed his farming operation from one in which he farmed in partnership with his brother to one in which he farmed on his own. Thus, Judge Collins held that the tax claims related to the previous disposition of the Debtor s interest in the farm partnership should be included as 14

19 farm debt in calculating whether 50% of Debtor s aggregate debts were incurred in the farming operation. Hemann, 2013 Bankr. LEXIS 1385, *21, 2013 WL , *7. Judge Collins reviewed the three-fold test for treatment of taxes under 1222(a)(2)(A): that the asset being sold be a farm asset used in the debtor s farming operation. With respect to the first test, that the asset sold be a farm asset, he concluded that the disposition of Norbert Hemann s interest in Hemann Brothers Partnership was a disposition of his only farm asset - the partnership interest. Hemann, 2013 Bankr. LEXIS 1385, *41, 42, 2013 WL , *15, 16. With respect to the second test, the used in test, he followed the Eighth Circuit in holding that the Debtor s partnership interest was used in his farming operation. Hemann, 2013 Bankr. LEXIS 1385, *43, 2013 WL , *16. With respect to the third test, the the Debtor s farming operation test, Judge Collins rejected the tax authorities argument that the term debtor s farming operation needed to be the same operation that the Debtor was seeking to reorganize in the Chapter 12 bankruptcy. He found that if the taxing authorities argument were to be recognized, 1222(a)(2)(A) would never have any application where a reorganized entity differs in any way from the previous entity which is most, if not all, cases. To do so would be to construe the statue to be a nullity. Hemann, 2013 Bankr. LEXIS 1385, *45, 2013 WL , *17. 5) Must the Family Farmer be Engaged in Farming at the Time of Filing the Chapter 12 to be Eligible for the Benefits of Chapter 12? On April 22, 2016, Judge Joan Lloyd held that a famer not currently actively engaged in farming and not intending to return to farming can be a Chapter 12 debtor. In re Williams, 2016 WL (Bkrtcy. W.D. KY 2016). This decision was rendered despite the fact that 11 U.S.C. 101(18) provides that the term family farmer means an individual and spouse engaged in a farming operation whose aggregate debts do not exceed $4,031,575, * * * and such individual or such individual and spouse receive from such farming operation more than 50% of such individual s or such individual and spouse s gross income for (i) the taxable year preceding; or (ii) each of the 2nd and 3rd taxable years preceding the taxable year in which the case concerning such individual or such individual and spouse was filed. In re Williams, 2016 WL , *2. The Court also examined 101(19) that states, The term family farmer with regular income means a family farmer whose annual income is sufficiently stable and regular to enable such family farmer to make payments under a plan under Chapter 12 of this Title. It also examined 101(21), stating that the term farming operation includes farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, or livestock, and production of poultry or livestock products in an unmanufactured state. The Chapter 12 case was filed on October 12, At the meeting of creditors, the Debtors testified that the last time they were actively involved in farming was They further testified that they had no intention of ever returning to active farming. They farmed in Arkansas by having their son plant and harvest their crops. The Chapter 12 Trustee contended that since the Debtors were not actively engaged in farming when the bankruptcy petition was filed and testified that they did not intend to return to farming, they did not qualify for relief under Chapter 12. The Debtors countered that since 11 U.S.C. 1222(8) contemplates a complete liquidation of the farming operation, it would make little sense to block a debtor from the relief provided by Congress under Chapter 12 simply because the Debtors made a reasonable financial decision to end a non-profitable farming operation which 15

20 would cause the Debtors to fall deeper into debt. This seems to be contrary to the goal of a Chapter 12. Congressional history of Chapter 12 cited in In re Mikkelsen Farms, Inc., 74 B.R. 280, 285 (Bkrtcy. D. Ore. 1987) provides as follows: It is clear from the legislative history that Congress was extremely concerned with the economic plight of families who had lived on the farm and had an established way of life in raising crops and livestock. It had recognized the provisions of Chapter 11 and Chapter 13 simply did not meet the needs of many farmers. H.R. 5316, 99th Cong., 2d Sess., 132 Cong.Rec. H8986, 8998 (daily ed. Oct. 2, 1986). In discussions of P.L , Sen. Grassley, a Conference Committee member, stated the provisions ensure that only family farmers not tax shelters or large corporate entities will benefit. Id., 132 Cong.Rec. at S15076 (daily ed. Oct. 3, 1986). Chapter 12 allows for a partial or complete liquidation of the debtor's property. 11 U.S.C. 1222(a)(8) (1986). This provision reflects a recognition by Congress that many family farm reorganizations, to be successful, will involve a scaling down of the farm operation. Id., 132 Cong. Rec. at H8999 (daily ed. Oct. 2, 1986). Judge Lloyd concluded that the omission of a requirement that the regular income to fund the plan come from farming in both sections 101(18 and 1222(a)(1) was deliberate, meaning that for purposes of funding the plank the regular income could come from whatever source that was sufficiently stable and regular. Thus, it follows that the Debtors need not be actively engaging in the farm operation on the date of the Petition to be eligible under Chapter 12. 6) Can a Farmer Change Tax Years to Avail Himself of the Provisions of 1222(a)(2)(A)? Since 1222(a)(2)(A) applies only to the taxes from farm asset sales arising in tax years prior to the filing of the Chapter 12 filing, could a clever debtor change his tax year so that it ended prior to filing the Chapter 12 petition and thus utilize 1222(a)(2)(A) to de-prioritize the taxes occasioned by the sale of the farm assets? Taxpayers are allowed to change tax years. Query: If a taxpayer cited its reason for changing its tax year to allow it to avail itself of 11 U.S.C. 1222(a)(2)(A), would it be allowed to change its tax year, file a short year return including the income from the sale of its farm assets used in its farming operation, and then file the Chapter 12 to de-prioritize its pre-petition tax liabilities arising from the sale of its farm assets? I do not have the answer to this conundrum; however, I believe it should be considered by those family farmers who are not able to make it to the next tax year before they must file their Chapter 12 bankruptcies. Unfortunately, 26 U.S.C. 1398(d) only allows individual Chapter 7 or 11 debtors to file a short year tax return, which would then allow the tax incurred after the beginning of a tax year and before the filing of the Chapter 12 to qualify for the provisions of 11 U.S.C. 1222(a)(2)(A). Since the Chapter 12 debtor could not use the provisions of 1398 to procure a short tax year, thereby complying with the requirement that the tax debt be incurred in the tax year before filing, could a family farmer liquidate the unnecessary assets thereby incurring taxes, then file a Chapter 7, make the election to utilize a short tax year, reaffirm debt with the farm creditors essential to its operation, then file the Chapter 12 to deal with the taxes? 16

21 7) After Hall, Can Any Post-Petition Taxes be Paid from Post-Petition Earnings as They are Property of the Bankruptcy Estate? In Hall, the Supreme Court cited with approval an opinion from the Bankruptcy Court for the District of Massachusetts, which held that to hold the Chapter 13 estate liable for [a] tax when it does not exist as a taxable entity defies common sense as well as Congress intent. Hall v. United States, 132 S.Ct. 1882, 1890 (2012) (quoting In re Whall,391 B.R. 1, 4 (Bankrtcy. Ct. Mass. 2008)). The same holds true for a Chapter 12 estate. Id. In making its holding, the Supreme Court reasoned that since a separate estate was not created by the filing of a Chapter 13 bankruptcy, it is clear that post-petition income taxes are not automatically collectible in a Chapter 13 plan and, a fortiori, are not administrative expenses under 503(b). Id. The same logic applies in Chapter 12 cases. Property of the bankruptcy estate is generally described in 11 U.S.C. 541(a). That section provides in relevant part: (a) The commencement of a case under section 301, 302, or 303 of this title [11 USCS 301, 302, or 303] creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held: (1) Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case. (2) All interests of the debtor and the debtor's spouse in community property as of the commencement of the case that is-- (A) under the sole, equal, or joint management and control of the debtor; or (B) liable for an allowable claim against the debtor, or for both an allowable claim against the debtor and an allowable claim against the debtor's spouse, to the extent that such interest is so liable. (3) Any interest in property that the trustee recovers under section 329(b), 363(n), 543, 550, 553, or 723 of this title [11 USCS 329(b), 363(n), 543, 550, 553, or 723]. (4) Any interest in property preserved for the benefit of or ordered transferred to the estate under section 510(c) or 551 of this title [11 USCS 510(c) or 551]. (5) Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date-- (A) by bequest, devise, or inheritance; (B) as a result of a property settlement agreement with the debtor's spouse, or of an interlocutory or final divorce decree; or (C) as a beneficiary of a life insurance policy or of a death benefit plan. (6) Proceeds, product, offspring, rents, or profits of or from property of the estate, except such as are earnings from services performed by an individual debtor after the commencement of the case. (7) Any interest in property that the estate acquires after the commencement of the case. In Chapter 12 cases, property of the estate also includes property in addition to that set forth in provides the additional property of the estate setting forth the following: 17

22 (a) Property of the estate includes, in addition to the property specified in section 541 of this title [11 USCS 541]-- (1) all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7 of this title [11 USCS 701 et seq.], whichever occurs first; and (2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7 of this title [11 USCS 701 et seq.], whichever occurs first. (b) Except as provided in section 1204 [11 USCS 1204], a confirmed plan, or an order confirming a plan, the debtor shall remain in possession of all property of the estate. Since under Hall property of the estate cannot be utilized to pay post-petition taxes, can any Chapter 12 plan that proposes to pay post-petition taxes utilizing the debtor s post-petition earnings that are property of the Chapter 12 bankruptcy estate be confirmed? In reality, if Hall means what it appears to say, a court should not confirm a Chapter 12 plan that provides for the use of property of the estate, post-petition earnings, to pay the taxes. Rather, the post-petition earnings should be used to pay pre-petition debt. Can this be what Congress intended when it chose not to establish separate taxable estates in Chapter 12 and Chapter 13 cases? I doubt it. 8) Can Farmers Whose Debts Exceed the Debt Limits of Chapter 12 Downsize to the Extent that They Qualify for Chapter 12? Effective April 1, 2016, the debt limit for family farmers seeking relief under Chapter 12 was increased to $4,153, Indexing of the debt limit was part of BAPCPA enacted in Unfortunately, the debt limit has only kept pace with inflation, while the business of farming has expanded in size and debt significantly faster than the pace of inflation. In the week before finalizing this outline the author was contacted by two farmers whose debts greatly exceeded the debt limits for Chapter 12. In addition, regional variations in farming indicate that fewer farmers are eligible for Chapter 12 relief due to capital requirements. Examples include dairy farms in Wisconsin, California, Arizona and other states; seed stock production in the Pacific Northwest; cattle farms in Texas; crop farms in the Midwest. It is time for Congress to recognize the realities of the situation and dramatically increase the debt limits for Chapter 12 Debtors. The author has advocated a debt limit increase to at least $10,000, for the past five years. Part 1 Closing Observations 1) Farm debt restructuring and bankruptcy will continue to be fascinating areas of practice for the foreseeable future. 2) Realistic client expectations are essential to a successful restructuring or bankruptcy. 43 Dollar amount as adjusted by the Judicial Conference of the United States. See Adjustment of Dollar Amounts notes set out under this section and 11 U.S.C.A

23 3) Accurate cash flows based upon realistic yields and prices are an essential element of a successful restructuring or bankruptcy. 4) Chapter 12 can provide a strong lever in negotiating a debt settlement with creditors as they know what they can expect in Chapter 12. 5) Chapter 12 may provide the only graceful exit for a farmer with low basis assets to rightsize the operation and avoid payment of significant income taxes. 6) Unless Congress remedies the problems caused by its poor draftsmanship, the timing of filing a Chapter 12 to take advantage of the tax savings afforded by 1222(a)(2)(A) must be in the tax year after the disposition of the farm assets as was held in Hall v. United States, 132 S. Ct (2012). 19

24 Part 2: Venue for Bankruptcy Cases Should be Where the Principal Assets or the Headquarters of the Business are Located The Case for Change of 28 U.S.C The Commercial Law League of America has been pressing for a change in the venue provisions of the Bankruptcy Code for many years. On February 26-28, 2017, the CLLA made a proposal for venue reform to members of Congress. The position paper prepared for those meetings on Capitol Hill is set forth below. Proposal Eliminate the state of incorporation, restrict affiliate filings and establish the debtor's principal place of business as the proper venue for commencing a chapter 11 business bankruptcy case. Retired Bankruptcy Judge Steven Rhodes (Bankr. E. D. Michigan) recently commented in the Wall Street Journal that the current venue law is "the single most significant source of injustice in chapter 11 bankruptcy cases." The National Association of Credit Managers recently asserted that venue shopping in bankruptcy cases "creates significant obstacles for trade creditors...and increases the cost of participation." The proposed amendment to 28 U.S.C attempts to put an end to the rampant forum shopping permitted under the current statutory regime. Although substantively the same as the bipartisan Chapter 11 Bankruptcy Venue Reform Act of 2011 (H.R. 2533) introduced by Representative Lamar Smith (R-TX) and co-sponsored by Representatives John Conyers (D-MI), Howard Coble (R-NC) and Steve Cohen (R-TN), the proposed amendment simplifies the language by using terms defined in the Bankruptcy Code and eliminates critical loopholes. Our proposed changes to the bankruptcy venue statute are attached as Exhibit 6. Background Forum shopping in bankruptcy has reached epidemic levels. A 2015 GAO Report on Corporate Bankruptcy - Stakeholders Have Mixed Views on Attorneys; Fee Guidelines and Venue Selection/or Large Chapter 11 Cases (GA ) confirmed that since 2009 nearly 2/3 of large companies (assets and liabilities of $50 million or more) filed their Chapter 11 cases in venues outside of the district where their principal place of business or principal assets are located. Approximately 90 percent of those companies filed in the District of Delaware or the Southern District of New York. (Id., p.3). Our research tracked these same trends for the years from 2004 through 2016, where 735 Chapter 11 bankruptcy cases were filed in the District of Delaware and another 125 Chapter 11 bankruptcy cases were filed in the Southern District of New York, each involving a business debtor headquartered in a different state. These cases involved approximately $1 trillion in assets, over $2 trillion in debt, 6.3 million creditors and more than 2 million employees, all having their rights administered by courts having no meaningful connection with the subject debtors. This trend is not limited to large public companies. Almost half of the Delaware cases involved smaller businesses with less than $15 million in assets at the time of filing. The full report of the research and findings, along with other articles on venue reform can be found at: 20

25 Why Venue Reform is Necessary When troubled companies flee their home states and seek bankruptcy protection in remote jurisdictions, trade creditors, employees, retirees and other parties are disenfranchised, public confidence in the bankruptcy system erodes and local interests are ignored. The 1997 National Bankruptcy Review Commission recognized that forum shopping and the concentration of cases in Delaware made it more difficult for small creditors and employees to actively participate in a bankruptcy case. The mass concentration of Chapter 11 cases far from a debtor's home state deprives local constituents of their due process and tilts the playing field toward financially sophisticated parties who regularly appear in large bankruptcy cases. The situation has continued to deteriorate over time, leading to a growing level of indifference among creditor, employee and retiree constituents unable to participate actively in a process that directly affects their interests. When a disproportionately high number of large and middle ' market companies flee to Delaware or New York to seek refuge from their creditors, the process appears to be subject to manipulation by large moneyed interests. In the Patriot Coal case, it was noted by the press that "[l]enders and lawyers who get the big cases like taking their troubles to courts in New York and Delaware, which are convenient to their homes and offices and attuned to their concerns." Forum shopping to achieve desired outcomes directly threatens the integrity of the bankruptcy system by eroding public confidence and calling into question the fairness of a bankruptcy system that can be so easily manipulated. The consequences of a business bankruptcy are often most profound in the region and community in which the debtor' s principal place of business or principal assets are located. The location of the bankruptcy case can have a tremendous impact on the local economy since the reorganization of a distressed company will impact local jobs and wages for years to come. Trade creditors, employees and retirees' ability to participate in the bankruptcy is limited when the venue of the case is located thousands of miles away in a remote courtroom. In contrast, when a company stays home to reorganize, all parties can participate and the local economy can retain the more immediate economic benefits of remaining in the debtor's headquarter city. Based on estimates from Bloomberg Businessweek (February 12, 2012), the flood of companies fleeing their home jurisdictions over the past 13 years has drained nearly $4 billion from local economies. For further information please contact: Peter C. Califano, Esq. President Commercial Law League of America pcalifano@cwclaw.com Douglas B. Rosner, Esq. DRosner@GOULSTONSTORRS.com Joseph A. Peiffer, Esq. joe@peifferlaw.com 21

26 S Family Farmer Bankruptcy Tax Clarification Act of 2012 (Introduced in Senate - IS) S 3545 IS 112th CONGRESS 2d Session S To amend title 11 of the United States Code to clarify the rule allowing discharge as a nonpriority claim of governmental claims arising from the disposition of farm assets under chapter 12 bankruptcies. IN THE SENATE OF THE UNITED STATES September 13, 2012 Mr. GRASSLEY (for himself and Mr. FRANKEN) introduced the following bill; which was read twice and referred to the Committee on Finance A BILL To amend title 11 of the United States Code to clarify the rule allowing discharge as a nonpriority claim of governmental claims arising from the disposition of farm assets under chapter 12 bankruptcies. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE. This Act may be cited as the `Family Farmer Bankruptcy Tax Clarification Act of 2012'. SEC. 2. CLARIFICATION OF RULE ALLOWING DISCHARGE TO GOVERNMENTAL CLAIMS ARISING FROM THE DISPOSITION OF FARM ASSETS UNDER CHAPTER 12 BANKRUPTCIES. (a) In General- Section 1222(a) of title 11, United States Code, is amended-- (1) in paragraph (2), by striking `unless--' and all that follows through `the holder' and inserting `unless the holder'; (2) in paragraph (3), by striking `and' at the end; (3) in paragraph (4), by striking the period at the end and inserting `; and'; and (4) by adding at the end the following: 22 Exhibit "1" Page 1 of 3

27 `(5) notwithstanding the application of the rules under subchapter V of chapter 1 of the Internal Revenue Code of 1986, and without regard to whether the claim arose before or after the filing of the petition, provide for the treatment and payment of any unsecured claim owed to a governmental unit by the debtor or the estate that arises as a result of the sale, transfer, exchange, or other disposition of any farm asset used in the debtor's farming operation as an unsecured claim that is not entitled to priority under section 507.'. (b) Postpetition Claims Relating to Sale, Transfer, Exchange, or Other Disposition of Farm Assets- (1) IN GENERAL- Section 1222 of title 11, United States Code, is amended by adding at the end the following: `(e)(1) A governmental unit may file a proof of claim for a claim described in subsection (a)(5) that arises after the date on which the petition is filed. `(2)(A) Except as provided in subparagraph (B), if a governmental unit has not filed a proof of claim under paragraph (1) for a claim described in subsection (a)(5), after the date that is 120 days after the date on which the claim arises, the trustee or the debtor may file proof of such claim. `(B)(i) For a claim described in subsection (a)(5) that is a tax for which a return is due, if the debtor or trustee has provided notice as described in clause (ii) and the governmental unit has not filed a proof of claim under paragraph (1), after the date that is 180 days after the date on which the debtor or trustee provides the notice, the debtor or the trustee may file proof of such claim. `(ii) Notice as described in this clause is notice by the debtor or the trustee-- `(I) indicating the intent to file the applicable claim; `(II) setting forth the amount of the claim; `(III) that includes a copy of the filed return relating to the claim; and `(IV) that is delivered to the governmental unit at the address designated for requests made under section 505(b)(1)(A). `(3) A claim filed under paragraph (1) or (2) shall be allowed or disallowed under section 502, but shall be determined as of the date such claim arises, and shall be allowed under section 502 (a), (b), or (c) of this title, or disallowed under section 502(d) or 502(e) of this title the same as if such claim had arisen before the date of the filing of the petition.'. (2) MODIFICATION OF PLAN AFTER CONFIRMATION- Section 1229(a) of title 11, United States Code, is amended-- (A) in paragraph (2), by striking `or' at the end; (B) in paragraph (3), by striking the period at the end and inserting `; or'; and (C) by adding at the end the following: `(4) provide for the payment of a claim described in section 1222(a)(5) that arose after the date on which the petition is filed.'. (c) Technical Correction- Section 1228(a) of title 11, United States Code, is amended in the matter preceding paragraph (1)-- (1) by inserting a comma after `all debts provided for by the plan'; and (2) by inserting a comma after `allowed under section 503 of this title'. (d) Effective Date- The amendments made by this section shall apply to any bankruptcy case that-- 23 Exhibit "1" Page 2 of 3

28 (1) is pending on the date of enactment of this Act and relating to which an order of discharge under section 1228 of title 11, United States Code, has not been entered; or (2) commences on or after the date of enactment of this Act. 24 Exhibit "1" Page 3 of 3

29 25 Exhibit "2" Page 1 of 8

30 26 Exhibit "2" Page 2 of 8

31 27 Exhibit "2" Page 3 of 8

32 28 Exhibit "2" Page 4 of 8

33 29 Exhibit "2" Page 5 of 8

34 30 Exhibit "2" Page 6 of 8