Priority Stripping of Capital Gains Taxes Under § 1232(a) Does Not Allow a Chapter 12 Plan to Compel a Taxing Authority to Disgorge Pre-Petition Tax Withholdings

By Alexander Beeby posted 07-30-2021 15:10

Contributing Editor: Karl J. Johnson, Taft

In Iowa Department of Revenue v DeVries (In re DeVries), 621 B.R. 445 (B.A.P. 8th Cir. Nov. 25, 2020), the Bankruptcy Appellate Panel held that the bankruptcy court misapplied 11 U.S.C. § 1232 when it confirmed a chapter 12 plan that included a provision stating that the taxing authorities should “refund the overpayment of 2017 income taxes” attributable to capital gains taxes. In 2017, the debtors sold farmland and machinery, incurring substantial capital gains taxes. The tax liability was reduced by the joint debtor’s payroll tax withholding. In 2019, the debtors filed a petition under chapter 12 along with a pro forma 2017 tax return showing that no income tax would have been owed that year without the sales. The Iowa Department of Revenue (the “IDR”) and the IRS objected to confirmation of the plan based on the disgorgement provision. The debtors argued that the prepetition withholding should be disgorged because of § 1232, which provides that pre- and post-petition capital gains taxes are to be treated as general unsecured claims without priority and subject to the discharge of § 1228. The bankruptcy court looked beyond the plain language of § 1232 to overrule the objections based on § 1232’s legislative history. The IDR appealed.

The BAP held that § 1232 is unambiguous, that it should be enforced solely on its terms, and that its plain language does not provide for disgorgement of prepetition tax payments. The BAP noted that § 1232 is solely a priority-stripping provision that does not change the way the claim is calculated and does not “establish the right to or amount of a refund.” The BAP held that the prepetition withholdings simply are not part of the IDR’s claim as defined by 101(5)(A) because the IDR did not have a “right to payment” of such amounts on the petition date. Because the prepetition payments simply are not part of the IDR’s claim, there is no refund to be disgorged regardless of whether the taxes would have had priority if unpaid. The debtors cited Knudsen v I.R.S., 581 F.3d 696, 718 (8th Cir. 2009), which the BAP distinguished because Knudsen was about an ambiguity in § 1232’s predecessor statute regarding how to allocate a debtor’s tax liability between priority and non-priority amounts, not whether a plan could compel disgorgement of prepetition payments. The BAP distinguished other cases cited by the debtors because they involved post-petition sales of farmland and equipment, and not prepetition payments. Finding that the plain language of § 1232 does not allow a chapter 12 plan to compel a taxing authority to disgorge prepetition tax withholdings, the BAP reversed the bankruptcy court’s decision to confirm the debtors’ chapter 12 plan.

Co-Editors in Chief
Alexander J. Beeby, Larkin Hoffman Daly & Lindgren Ltd.
Kesha Tanabe, Tanabe Law