Eighth Circuit’s In re Knudsen Opinion is Still Good Law on Chapter 12 Taxes — Despite the U.S. Supreme Court

By: Donald L. Swanson

In 1986, Congress enacted Chapter 12 of the Bankruptcy Code to help farmers.

Throughout the 1980s, many farmers liquidated their farm assets, either voluntarily or involuntarily, and moved on to other careers.

Unfortunately, the liquidation left many of them with nondischargeable tax liabilities beyond anything they could ever repay.

Congressional Action on Chapter 12 Taxes

So, Congress stepped in again.  In 2005, Congress amended Chapter 12.  This amendment allowed farmers to discharge tax liabilities arising from sales of farm assets as general unsecured claims.

The IRS took a dim view of this amendment and began contesting it immediately. That contest reached the Eighth Circuit Court of Appeals in Knudsen v. IRS (In re Knudsen), 581 F3d 696 (8th Cir. 2009). The In re Knudsen opinion addressed these three issues raised by the IRS:

Issue # 1: IRS said tax benefits could arise only from pre-petition sales of farm assets and not from post-petition sales;

Issue # 2: IRS said tax benefits could apply only to sales of capital assets (like land, equipment and breeding stock) and could not apply to farm products raised for sale (like market hogs and corn); and

Issue # 3: IRS said taxes should be allocated between income from sales of farm assets and income from other sources in a manner most-favorable to the IRS.

The Eighth Circuit ruled against the IRS on all three issues.  Here is part of its rationale:

“Congress has chosen to recognize the uncollectibility” of income taxes “occasioned by the sale of the farm debtor’s assets”;

The 2005 tax amendment provides “financially strapped family farmers the opportunity to downsize and restructure their farming operations without the necessity of paying the taxes in full as required under old Chapter 12”; and

“The statute . . . cannot be read to apply only to pre-petition claims.”

The In re Knudsen opinion became final.

Reversal by U.S. Supreme Court

Nevertheless, the U.S. Supreme Court addressed one of the In re Knudsen issues in Hall v. United States, 566 U.S. 506 (2012).  It addressed Issue # 1:

–whether favorable tax treatment under Chapter 12 could arise from post-petition sales of farm assets.

The Supreme Court, in Hall’s 5 to 4 majority decision, ruled in favor of the IRS, declaring that favorable tax treatment under Chapter 12 could apply only to pre-petition sales—not to post-petition sales.

Hall’s five-Justices majority consists of Sotomayor as author, joined by Scalia (no longer on the Court), Roberts, Thomas and Alito. This majority cited a number of technical norms for its decision. Here are portions of its rationale:

“If Congress wished to alter these background norms,” it needed to do so clearly;

“the dissent begins with the single Senator’s stated purpose,” then “reasons backwards from there,” and “upsets background norms in both Chapters 12 and 13”;

“there may be compelling policy reasons for treating postpetition income tax liabilities as dischargeable,“ but Congress “did not so provide in the statute”;

“Given the statute’s plain language, context, and structure, it is not for us to rewrite the statute”; and

“Congress is entirely free to change the law by amending the text.”

The four-Justices dissenting in Hall are Breyer as author, joined by Kennedy (no longer on the Court), Ginsburg and Kagan. Here are portions of the dissenting rationale:

“Congress did not intend this result”;

“a Chapter 12 farmer . . . might have to sell farmland or other farm assets at a price that would give rise to considerable capital gains taxes”;

“If the resulting tax debt” were treated as a priority claim, “it might well absorb much of the money raised to the point where . . . the farmer might be unable to proceed under Chapter 12”;

The statute “seeks to place the tax authorities farther back in the creditor queue”; and

“The Amendment’s chief legislative sponsor, Senator Charles Grassley, explained this well when he told the Senate”:

“Under current law, farmers often face a crushing tax liability if they need to sell livestock or land in order to reorganize their business affairs”;

“If the farmer can’t pay the I. R. S. in full, then he can’t keep his farm”;

“This isn’t sound policy”;

“Why should the I. R. S. be allowed to veto a farmer’s reorganization plan?”; and

“The Amendment takes this power away from the I. R. S. by reducing the priority of taxes during proceedings,” which will “free up capital for investment in the farm, and help farmers stay in the business of farming.”

Reversal By Congress

In 2017, Congress accepted the Hall majority’s invitation to “change the law,” by enacting the Family Farmer Bankruptcy Clarification Act of 2017 [see 11 U.S.C. § 1232, formerly § 1222(a)(2)(A)]. The explicit intent and purpose of this new Act was to overrule the Supreme Court’s Hall majority opinion.

Congress not only enacted the 2017 law, it did so on a bipartisan and super-majority basis: the legislation was introduced in the U.S. Senate by Senators Charles Grassley (R) and Al Franken (D) and passed the Senate on an 82 to 17 vote.

In re Knudsen Revisited

So . . . back to In re Knudsen. That Eighth Circuit case is still good law on the pre-petition v. post-petition sales issue, despite being overturned in Hall. That’s thanks to Congress’s 2017 reversal of Hall.

But what about the other two issues decided against the IRS in In re Knudsen?

Here’s suggesting that Congress has made its intent abundantly and emphatically clear, in its 2017 enactment:

that it meant, back in 2005, to provide tax relief to financially-stressed farmers on all sales of farm assets; and

that it will enforce such relief against challenges by the IRS and the courts, whenever needed!

Do the IRS and/or the Federal Courts have the temerity to challenge Congress again on this?

Only they know.

But it seems foolhardy to continue arm wrestling Congress on a policy matter like this, over which Congress holds constitutional power and has expressed its intent.

Conclusion

The Eighth Circuit’s In re Knudsen decision is still good law on all issues, despite being overruled by the U.S. Supreme Court on one issue.

Moreover, Congress’s remedial action against the Supreme Court’s Hall opinion should insulate the other In re Knudsen rulings from further negative action in the courts.

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