New Tax Law May Help Distressed Farmers [A State Bar of Wisconsin Re-post]

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Feb 22

A recent change in tax law may help more farmers survive tough financial times, although issues still remain. David Krekeler discusses the Additional Supplemental Appropriations for Disaster Relief Requirements Act 2017, and what it means for farmers facing bankruptcy.

Jan. 17, 2018 — Contracting the size of the operation, or downsizing, is often a valuable tactic for businesses in financial trouble.

Farms are no different from other businesses in this respect. Selling nonproductive or low productive assets to reduce debt can be the difference between success and failure going forward.

Sometimes advance planning can permit a farmer to dispose of such assets before filing a bankruptcy, but much more often, these asset dispositions take place later. The farmer, and even his or her attorney, may have waited until absolutely necessary to consult with reorganization counsel. The farmer may be extremely reluctant to part with any of these assets and only does so as a last resort. The need to contract the operation may not even have been obvious, or it may come about as part of the negotiations that are integral to the reorganization process. Whatever the reason, the post-petition disposition of assets is common and often results in non-dischargeable tax debt.

The Additional Supplemental Appropriations for Disaster Relief Requirements Act 2017

Congress passed and the president signed the Additional Supplemental Appropriations for Disaster Relief Requirements Act 2017.

Effective October 26, 2017, the capital gain taxes resulting from the post-petition disposition of capital assets may be de-prioritized and treated as general unsecured claims.  The effect is that these tax debts will share in any distribution to unsecured creditors and will be discharged upon the completion of the Chapter 12 plan.

This change in tax law may help more farmers survive tough financial times.  2017 is proving to be a tough year for many farmers.  While bankruptcy numbers are down from 2016 in Chapters 7, 11 and 13, Chapter 12 filings increased more than 10 percent, and there are double the Chapter 12 filings in 2017 compared with 2015.

Effective Oct. 26, 2017, the capital gain taxes resulting from the post-petition disposition of capital assets may be de-prioritized and treated as general unsecured claims. The effect is that these tax debts will share in any distribution to unsecured creditors and will be discharged upon the completion of the Chapter 12 plan.

This change in tax law may help more farmers survive tough financial times. 2017 is proving to be a tough year for many farmers. While bankruptcy numbers are down from 2016 in Chapters 7, 11, and 13, Chapter 12 filings increased more than 10 percent, and there are double the Chapter 12 filings in 2017 compared with 2015.

Chapter 12

Chapter 12 was enacted in 1986, during another, and more severe, time of financial stress for farmers.

The other forms of reorganization available at the time under the Bankruptcy Code were not effective for many farmers, due to the debt limits and time constraints of Chapter 13 and the voting process and absolute priority rule under Chapter 11.

Among the benefits of Chapter 12 is the ability to de-prioritize the claims. Most taxes are not dischargeable in bankruptcy. They generally are priority claims and must be paid in full during the term of the reorganization plan and always within five years.

Income taxes can be discharged, but only if certain requirements are met. Those requirements are as follows:

  • The return’s due date was at least three years prior to the bankruptcy filing
  • The return was filed at least two years prior to the bankruptcy filing
  • The tax claim was assessed at least 240 days prior to the bankruptcy filing

Downsizing and Tax Liabilities for Farmers

These limitations, particularly the three-year waiting period, results in few farmers being able to downsize without facing potential tax liabilities.

Farm businesses generally require capital assets. Land, equipment, and livestock are significant assets necessary to a farm operation. Such assets are often held for a long time. The adjusted basis of these assets is often very low or zero by the time the asset is sold. Land may have been acquired long ago and have a low basis in comparison to current market prices.

In what was then the leading case on this issue, the Eighth Circuit held that taxes on post-petition sales qualified for de-prioritization in Knudsen v. Internal Revenue Serv.1

A split in the circuits arose a few years later when the Ninth Circuit held that the taxes from post-petition sales of a farm did not so qualify. United States v. Hall2 went to the U.S. Supreme Court and was affirmed in a 5-4 decision.3

The effect of the Hall decision was that farmers could not utilize downsizing in their reorganization efforts, at least not without facing potentially damaging tax consequences. We have seen cases which failed because of this problem. We have had to dismiss cases in which farmers downsized and then filed new cases to be able to include the tax debt as a pre-petition claim.

Chapter 12 permitted farmers to de-prioritize the taxes owing on the disposition of capital assets and treat those tax liabilities as general unsecured debts. This meant that the tax claims would be discharged upon completion of the plan, even if the taxes would otherwise not be dischargeable.

The statutes, however, left numerous issues, and the courts began wrestling with these. Among these issues was whether the favorable de-prioritization treatment applied to assets disposed of prior to filing, post-filing, or both.

The Ninth Circuit had invited Congress to rectify this – and now Congress has at least in part. The new statute will help some Wisconsin farms stay farming.

Issues Still Remain

A number of issues still remain when it comes to the treatment of taxes in Chapter 12.

For example:

  • What farm assets will qualify for this special tax treatment?
  • How will the tax be calculated?

Follow this blog for future development – and please let me know what you think about this change in the law, or if you have questions. I can be reached at (608) 258-8555 or via email at jdkrek@ks-lawfirm.com.