Financially strapped farmers and their lenders finally get some much-needed bankruptcy tax relief.
Normally, pre-bankruptcy income and capital gains tax claims have a priority and non-dischargeable status in bankruptcy. And the same taxes, when arising during bankruptcy, add an administrative claim status.
Some Farm History
Such normal rules had a devastating impact on farmers and their lenders back in the 1980s Farm Crisis. Here is some farm history that might help explain why.
–The number of U.S. farms reached a peak of 6.8 million in 1935 (according to U.S.D.A. statistics). That was, of course, in the midst of the Great Depression. Farmers were among the many who suffered in those days, with added disadvantages of drought, grasshopper plagues and dust storms that destroyed crops and crippled farming in the Midwest.
–Then, the number of farms began a four-decades-long decline to around 2.5 million in the mid-70s. I remember as a youngster (back in the 60s and early 70s) riding with my Grandpa on Sunday afternoon drives around our rural Nebraska countryside, as he pointed to abandoned homesteads dotting the land and told stories of families who lived and farmed at each place: people who made their living from the land—few had other sources of income.
–Then, the 1980s become a reenactment of the 1930s debacle for farmers. Only this time the culprits driving farmers off the land are high interest rates (i.e., 18% per annum) and plummeting prices for farm products and land. Today, I could do with my grandchildren the same Sunday afternoon drives that I had with my Grandpa and point to abandoned farmsteads that were occupied and active in the days of my youth.
–What’s happened since the 1980s is this: career farmers are tilling many, many more acres than before; lots of people farm as a hobby or avocation; and the number of people making their living on a farm continues to shrink. To illustrate, look at what’s happened to high schools in farming communities: class sizes of 40 students in the 70s, for example, might now be in the teens-or-less and consolidated with another school.
–Farming in the 1900s focused heavily on labor, with machinery playing a limited but increasingly important role over time: imagine, for example, plowing an entire quarter section of ground with a Farmall M tractor and a three-bottom plow and then planting the same area with a two-row or four-row lister. Today’s farming is the opposite, preferring large equipment and technology over labor: e.g., envision a huge tractor pulling a planter making swaths 25 yards wide with gps precision.
–Today’s large farming operations are often referred to as “corporate farming,” when a common reality is that these are the same family farms of decades past—they’re just farming more land.
During the 1980s Farm Crisis, many farm families were ready and willing to leave the farm and pursue a different occupation. But they couldn’t. Here’s why: if they sold out (either voluntarily or by foreclosure), the income and capital gains tax bill would be huge—something they could never hope to repay. So, many tried to hold on by bankruptcy filings and other means: but often to no avail—they ended up incurring the tax anyway. This created huge problems for farmers and their lenders!!
Congress Addressing the Problem
In a better-late-than-never mode, Congress finally addressed the problem—in 2005. An amendment that year to Chapter 12 of the Bankruptcy Code added the following tax benefit for farmers (§ 1222(a)(2)(A)):
A tax “claim” arising from “the sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation” will be treated as a general unsecured claim and can be discharged under a Chapter 12 plan.
This amendment, at the very least, allowed a farmer (who’s eligible for Chapter 12) to sell out and move on to another occupation without being saddled with unaffordable amounts of tax liability.
And it provided an opportunity for farmers and their lenders to work cooperatively toward common goals. Such an opportunity would have solved many problems, had it existed back in the 1980s farm crisis.
Battling the IRS
In subsequent years, the IRS sought help from federal courts to limit the impact and effect of this farmer-friendly provision—with varying levels of success. For example:
—A win for Farmers: In Kudsen v. IRS, 581 F.3d 696 (8th Cir. 2009), the Eighth Circuit Court of Appeals ruled in favor of farmers and against the IRS on two issues: (i) the § 1222(a)(2)(A) phrase “any farm asset” includes both breeding and slaughter stock, and (ii) the correct method for allocating taxes between income from sales of farm assets and income from other sources is the method that’s best for farmers—not the one best for the IRS.
—A win for the IRS: In Hall v. U.S., 566 U.S. 506 (2012), the U.S. Supreme Court ruled in favor of the IRS by narrowly construing the § 1222(a)(2)(A) tax benefit and limiting it’s effect to sales made prior to bankruptcy filing: so, taxes arising from sales made during the Chapter 12 case would hold the same administrative and non-dischargeable status as before.
The IRS’s Supreme Court victory in Hall v. U.S. became a big loss for farmers. Here are a couple reasons why:
–A financially stressed debtor is often unable to sell real estate or other assets outside of bankruptcy because junior lienholders, who are out of the money, won’t release their liens without a premium payment the debtor cannot afford.
–One of the things bankruptcy is good at doing (there aren’t many of such things) is this: selling assets at top dollar. So, it would make sense for a farmer, wanting to liquidate in part or in full, to sell assets within a Chapter 12 case. But the technical ruling in Hall v. U.S. eliminates the Chapter 12 tax benefit, if the debtor attempts to do so.
The New Law
U.S. Senators and Representatives from farm states have been working for years to legislatively overturn the Hall v. U.S. ruling that limit’s the Chapter 12 tax benefit. And they finally achieved success, on October 26, 2017, when President Trump signed the Family Farmer Bankruptcy Clarification Act of 2017 (H.R. 2266) into law. This Act, sponsored by Senate Judiciary Committee Chairman Charles E. Grassley (R-Iowa) and Sen. Al Franken (D. Minn.), passed the Senate on October 24, 2017, by a vote of 82 to 17—all of which proves, once again, that bankruptcy issues tend to be apolitical and nonpartisan.
This new Act eliminates the old § 1222(a)(2)(A) referenced above that the U.S. Supreme Court construed narrowly, replacing it with a new section at the end of Chapter 12, titled:
“§ 1232. Claim by a governmental unit based on the disposition of property used in a farming operation.”
Here are the essential terms of this new section (statutory language is in italics, and bold face is added for emphasis):
“Any unsecured claim of a governmental unit . . . that arises before the filing of the petition, or that arises after the filing of the petition and before the debtor’s discharge . . . , as a result of the sale, transfer, exchange, or other disposition of any property used in the debtor’s farming operation—“
–“shall be treated as an unsecured claim arising before the date on which the petition is filed”;
–“shall not be entitled to priority under section 507”;
–“shall be provided for under a plan”; and
–“shall be discharged in accordance with section 1228.”
When a Chapter 12 debtor wants to take advantage of this tax benefit, “the debtor shall serve notice of the claim on the governmental unit,” after which “the governmental unit may file a proof of claim not later than 180 days after the date on which such notice was served.”
This new law will benefit farmers who want to partially or fully liquidate. It will also benefit their lenders, who always prefer voluntary liquidation over foreclosure. And it will allow farmers and their lenders to work cooperatively toward a common goal, rather than allowing tax problems to force them into an adversarial posture.
In today’s environment of financial stress for farming communities, this new bankruptcy law is a welcome addition to the options available for financially strapped farmers and their lenders.
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