Chapter 12: In re Knudsen Revisited, After a U.S. Supreme Court Ruling

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A livestock farm (photo by Marilyn Swanson)

By: Donald L. Swanson

Congress adopted Chapter 12 in 1986.

Then, in 2005, Congress added special tax provisions to Chapter 12 at § 1222(a)(2)(A). Those provisions made taxes arising from sales of farm assets dischargeable as general unsecured claims.

In re Knudsen

The IRS didn’t like this new law and worked to limit its effect. That effort resulted in the In re Knudsen, 581 F.3d 696 (8th Cir. 2009), ruling. In Knudsen, the IRS raised three arguments:

  1. That § 1222(a)(2)(A) does NOT apply to post-petition sales of farm assets;
  2. That § 1222(a)(2)(A) does NOT apply to a farm’s end-products like slaughter hogs and grain; and
  3. That allocations of tax liability between income from farm assets and other income should favor the IRS, NOT the farmer.

The Eighth Circuit Court of Appeals, in In re Knudsen, ruled in favor of farmers and against the IRS on all three issues. The IRS did not appeal.

In re Hall

Meanwhile, a similar case (In re Hall) began working its way to the Ninth Circuit Court of Appeals. That case had a single issue: Whether § 1222(a)(2)(A) applies to post-petition sales of farm assets. Ultimately, the Ninth Circuit agreed with the IRS and rejected In re Knudsen, declaring that §1222(a)(2)(A) does NOT apply to post-petition sales of farm assets.

Hall appealed, and the U.S. Supreme Court affirmed on May 14, 2012 (Case No. 10-875).

–Congress Acts

Then, Congress steps back in to overrule the Supreme Court.  It passed an amended statute (now codified at § 1232(a)), declaring that Chapter 12’s tax benefits DO apply to a sale that “arises after the filing of the petition.”

Revisiting

Accordingly, let’s now revisit the Eighth Circuit’s In re Knudsen ruling in light of the subsequent actions by U.S. Supreme Court and Congress.

The Eight Circuit ruled on three issues. The Supreme Court and Congress subsequently addressed only one of those issues: the post-petition sale issue. The Supreme Court reversed the Eight Circuit’s position, and Congress reinstated it.

So, what’s the status of the Eighth Circuit’s ruling on the other two In re Knudsen issues?

–Farm End-Products Issue

Two bankruptcy courts and one BAP have addressed one of those two issues—with opposite results.

In re Pedersen (Case No. 17-00771 in the Northern Iowa Bankruptcy Court) is a Chapter 12 case with a confirmed plan. The Iowa Department of Revenue had objected to confirmation on grounds that the sale of crops, an end-product of debtor’s farming operation, does not qualify for Chapter 12’s tax benefits. The Northern Iowa Bankruptcy Court follows In re Knudsen, overrules the Department of Revenue’s objection, and confirms the plan (see opinion at Doc. 70, dated December 12, 2018). Notably, the Northern Iowa Bankruptcy Court is in the Eighth Circuit and, presumably, the Bankruptcy Judge views In re Knudsen as both persuasive and controlling on this issue.

In re Keith (Case No. 10-12997 in the Kansas Bankruptcy Court) is a Chapter 12 case with a confirmed plan. The IRS had objected to confirmation, arguing that sale of crops and livestock, end-products of Debtor’s farming operation, do not qualify for Chapter 12’s tax benefits. The Kansas Bankruptcy Court rejects In re Knudsen, and it requires that Debtor’s plan treat taxes arising from sales of corn and livestock “as a priority claim, not an unsecured claim under § 1222(a)(2)(A).” See opinion dated July 8, 2013 (Doc. 95).

In re Ficken, 430 B.R. 663 (10th Cir. BAP 2010), predates the Supreme Court’s In re Hall opinion. It follows In re Knudsen’s lead on all three issues. Specifically on the “calf inventory” issue, the 10th Circuit BAP declares: “We are persuaded by the rationales articulated” by the Eighth Circuit’s Knudsen opinion and by what “Common sense tells us.”

–Tax Allocation Issue

Both the Kansas Bankruptcy Court opinion and the Tenth Circuit BAP opinion cited above follow In re Knudsen on the tax allocation issue. The Northern Iowa Bankruptcy opinion does not deal with this issue—but here’s guessing it would have followed Knudsen, had the opportunity arisen.

Conclusion

Based on rulings by bankruptcy courts in Iowa and Kansas and by the Tenth Circuit BAP, it looks like In re Knudsen:

  • Is still good law on the tax allocation issue; but
  • Is still subject to dispute on the farm end-products issue.

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