Is the Liability a Taxpayer Incurs under the Affordable Care Act for Failing to Obtain Health Insurance a Tax or a Penalty for Bankruptcy Purposes

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Today we welcome back guest blogger Professor Bryan Camp of Texas Tech. Professor Camp writes today on the issue of the proper classification of the liability imposed for failure to obtain health insurance. The issue can apply to many excise taxes and has importance in the bankruptcy context.    

Before getting to Bryan’s post, I want to comment a misleading statement I made in the post last week entitled Bankruptcy Court Jurisdiction Over a Tax Claim. In that post I questioned the timing of the filing of their bankruptcy petition because I said they should have waited until three years had passed from the due date of the returns for all years. The issue has applicability to Bryan’s post and he gets it right. Thanks to Ken Weil for pointing out to me that if they filed a Chapter 13 plan and if they completed their plan there is no need to wait three years from the due date of the return to file bankruptcy if you seek to discharge a penalty. For debtors who complete a Chapter 13 plan, the discharge is covered by B.C. 1328(a). Prior to 2005, this provision gave what was called a superdischarge to debtors completing their Chapter 13 plans and made that chapter especially attractive to debtors with late filed returns, fraudulent returns and lots of other penalties. The changes in 2005 watered down the broad scope of the B.C. 1328(a) discharge but did not change the superdischarge of penalties. So, the timing of the bankruptcy vis a vis penalty discharge very much depends on the chapter of bankruptcy debtors choose and their ability to complete their Chapter 13 plan. Keith

Whether a debt is a tax or a penalty is not always easy to determine. The Supreme Court has weighed in on this topic twice, first in Sotelo v. United States, 436 U.S. 268 (1978)(in a case involving the trust fund recovery penalty) and then in United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996)(in a case involving the excise tax for failure to properly fund a pension plan). In each case the Court determined that the label in the statute did not match the true nature of the statute.

Whether a liability in the Internal Revenue Code is a tax or a penalty has importance in the treatment of the liability in bankruptcy cases. Taxes can rise above other unsecured claims and have priority status in the payout process. Penalties cannot have priority status as unsecured claims. The latest liability to raise issues concerning its status as a tax or a penalty is the liability for failing to obtain health insurance. The liability arises because the Affordable Care Act (ACA) seeks to have as many individuals enroll as possible to make the pool of insured individuals better. Internal IRS guidance directs its employees to categorized the ACA penalty as an “excise tax” for bankruptcy purposes. See IRM 5.9.4.18.1 (“The individual SRP liability will be treated as an excise tax under USC § 507 (a)(8)(E).”)

For the reasons discussed below the fold, I do not think the courts are likely to consider the ACA penalty an excise tax which can achieve priority status. They are more likely to classify it as a penalty which will become a general unsecured claim.

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First, the ACA calls it a penalty and not a “tax.”  IRC 5000A(g) provides that “the penalty provided by this section shall be…assessed and collected in the same manner as an assessable penalty under subchapter B or chapter 68.”  The Congressional decision to label this exaction a “penalty” and not a “tax” was a critical reason why the Supreme Court held that challenges to the penalty were not barred by the Anti-Injunction Act.  National Federation of Independent Business v. Sebelius, 132 S.Ct. 2566, 2582-3.  The Court found that, although the label did not matter for constitutional purposes, it did matter for purposes of figuring out the relationship of the ACA penalty with other statutes because statutes “are creatures of Congress’s own creation. How they relate to each other is up to Congress, and the best evidence of Congress’s intent is the statutory text.”  As in the NFIB case, here we have to figure out the relationship between the use of the work “tax” in the bankruptcy code and in the tax code.  Accordingly, the Congressional decision to label the payment as a penalty, and to direct that it be collected in the same manner as other assessable penalties, establishes a strong presumption that it is not a tax for purposes of other statutes, including the Bankruptcy Code.

Therefore, I don’t see a bankruptcy court treating the ACA as an excise tax or any other kind of tax.  I’m betting the IRS guidance is calling it an excise tax because section 5000A is in the excise tax chapter.  Theoretically, one might defend the penalty as an excise tax because it is imposed on taxpayers for engaging in certain transactions—or failing to engage in specified transactions, which is economically the same thing.  But I don’t see either of these two rationales for treating the ACA penalty as an excise tax as being very strong.

 

A good case to consider is In re Marcucci, 256 B.R. 685 (D. N.J. 2000), where the district court agreed with four bankruptcy courts that certain payments mandated by the State of New Jersey—payments quite similar in structure and purpose to the ACA penalty—were not excise taxes but were penalties.  In Marcucci, the court considered the character of a “motor vehicle surcharge” that New Jersey imposed on drivers who were considered high risk or convicted of certain traffic offenses.  These mandated payments to the state were to help the state fund a pool of money intended to even out the risk among all drivers.  The surcharges had been imposed by private insurers but the New Jersey legislature decided that the market was unfair and inefficient and so rather than indirectly regulating surcharges, decided to have the surcharge program administered by the DMV.   The state argued that these were excise taxes but the court disagreed.

The court first noted that “in cases where the Supreme Court has considered whether a particular exaction was a tax for bankruptcy purposes, the Court looked beyond the titular label given to the exaction and examined its actual operation” and “[t]he proper analysis therefore is to assess whether the attributes of the state’s claim, as provided by state law, fit the definition of a tax within the meaning of the Bankruptcy Code.”

The court then decided that the surcharge’s function was more like a penalty than a tax.  “In contrast to a neutral tax, the surcharge system is designed to deter poor driving habits. As discussed above, the legislative history of the Insurance Reform Act implies that the surcharges are intended to penalize “bad drivers”. That the surcharge system requires payment of outstanding surcharges before allowing a driver to return to the roadways should not be confused with a general tax imposed upon all drivers for the privilege of driving. A motor vehicle surcharge is not a generic exaction imposed to raise revenue for the government, but a penalty imposed as a result of specific motor vehicle violations. The State merely appropriates the monies obtained from specifically established assessments to fund the Merit Rating Plan.”  (internal quotes and citations omitted)

The NJ surcharge at issue in Marcucci is quite similar to the ACA shared responsibility payment.  The ACA penalty is imposed more as a consequence for violating the Individual Mandate (and, consequently, to encourage compliance) than to raise revenue.  See Jordan Barry and Bryan Camp, “Is the Individual Mandate Really Mandatory,” Tax Notes, June 25, 2012, p. 1633.

Second, however, just because the ACA penalty is not a tax does not automatically disqualify it from priority status.  Some penalties get priority status in bankruptcy and some do not.  Section 507(a)(8)(G) describes the kind of penalties that get priority status as “[a] penalty related to a claim of a kind specified in this paragraph and in compensation for actual pecuniary loss.” The legislative history provides that such claims cannot be punitive in nature and that in regard to taxes such claims represent collection of the principal tax liability under the misnomer of a “penalty” See 124 Cong. Rec. H. at 11,096 and 11,113 (Sept. 28, 1978).  For this reason, these types of penalties are called “pecuniary loss penalties.”  All other penalties are nonpecuniary loss penalties and they are treated as general unsecured claims.

I think it likely that a bankruptcy court would consider the ACA penalty to be a nonpecuniary loss penalty.  First, note that the penalties described in 507(a)(8)(G) must be BOTH “related to” a tax described in paragraph (8), AND have the purpose of compensating the government for actual pecuniary loss.  The ACA penalty is sui generis.  It is simply not connected to any of the taxes described in paragraph 8.  Therefore, it cannot be a pecuniary loss penalty, even if it was, in some sense, designed to compensate the government for some pecuniary loss.  Further, I really do not see a court finding that the purpose of the penalty is to compensate for pecuniary loss.  The NJ state government made a bold attempt to convince the court in Marcucci that the surcharge imposed on bad drivers was

In addition to the priority issue I would be remiss to omit a word about dischargeability.  The starting point for discharge of non-priority tax penalties is governed by §523(a)(7).  Non-pecuniary loss penalties may not get priority status, but they also may not be discharged in bankruptcy if they arose within three years prior to the petition date.  The one exception to the 523(a)(7) rules are for debtors who successfully complete their Chapter 13 plans. They get a “super discharge” which, per §1328(a) includes an unqualified discharge of all non-pecuniary loss penalties. Chapter 13 debtors who fail to complete their plans, however, get the usual rules. §1328(b).

Here’s what the relevant part of §523(a)(7) provides:

A discharge…does not discharge an individual debtor from any debt-

 

***

 

(7) to the extent such a debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty-

 

(A) relating to a tax of a kind not specified in paragraph (1) of this subsection; or

 

(B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition;

***

.

11 U.S.C. § 523(a)(7).

The Ninth Circuit did a nice job in parsing this forest of double negatives in McKay v. U.S., 957 F.2d 689 (9th Cir. 1992). Here’s that Court’s explanation,

Carefully parsed, the section initially makes nondischargeable a “debt that is for a fine, penalty or forfeiture payable to and for the benefit of a governmental unit.” Withdrawn from this class, however, are any such fines, penalties, or forfeitures that are “compensation for actual pecuniary loss.” These are dischargeable. The double negative, “does not discharge” and “not compensation for actual pecuniary loss,” accomplishes this end.

Another group of penalties are withdrawn from the nondischargeable group. These appear in parts (A) and (B) of § 523(a)(7). Part (A) withdraws tax penalties attributable to taxes which are not nondischargeable. That is, part (A) makes dischargeable tax penalties attributable to dischargeable taxes. This follows because part (A) relates “to a tax of a kind not specified in paragraph (1) of this subsection.” 11 U.S.C. § 523(a)(7)(A) (emphasis added). Those types specified in paragraph (1) are not dischargeable taxes. In relevant part “paragraph (1) of this subsection” makes not dischargeable “any debt” that is “for a tax … with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” 11 U.S.C. § 523(a)(1)(C).

The other group of penalties withdrawn from the nondischargeable group is described in part (B). It is quite straightforward. It makes dischargeable any tax penalty “imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition.” A penalty imposed on unpaid taxes accruing more than three years before the filing of the bankruptcy petition is dischargeable.

Conclusion:

The bottom line for me is that bankruptcy courts will likely treat the ACA penalty as a general unsecured claim, which means it stands way back in the payout line. The trick is to be sure that the due date of any return that omits paying the ACA penalty is older than three years before the bankruptcy petition date unless your client is one of those rare debtors who successfully completes their Chapter 13 plan, and then they do not need to worry about that.

 

Comments

  1. Bob Kamman says:

    I would not call completion of a Chapter 13 plan “rare,” especially for debtors who have a lawyer. The most recent statistic I can find is from 2012, when a third of Chapter 13 plans were successful. According to a blog post updated in May 2015:

    It is possible to get through a Chapter 7 case without an attorney — possible but not advisable. On the other hand, I have never heard of a successful pro se Chapter 13 case.. . .This is borne out in a recent study conducted by the Bankruptcy Court for the Central District of California. The Central District has a particular interest in this issue because it has more pro se filers than any other district in the country. The 2011 study found that approximately 60.9% of pro se Chapter 7 filers obtained a discharge (compared with 94.5% of those represented by an attorney), but less than one-half of one percent (compared with 55% of those represented by an attorney) of pro se Chapter 13 plans were actually confirmed.

    https://www.thebalance.com/why-do-so-many-chapter-13-cases-fail-316195

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