Bankruptcy and Farm Debt

The provision for farmers in the bankruptcy code is unusual, in part, because Congress placed it in an even numbered chapter while leaving the rest of the bankruptcy in odd numbered chapters and, in part, because of the amazingly different way Congress treats debts owed by farmers.  The case of In re Richards provides a glimpse of some of the unusual provisions in chapter 12 of the bankruptcy code.  At issue is whether the IRS can offset a tax refund against debts owed by the farming couple.

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When chapter 12 came into the bankruptcy code in the early 1980s, the nation was in the midst of a farm crisis.  Interest rates had reached stratospheric highs, and many farmers were going bankrupt as a result.  Movie makers even took notice of the crisis.

In creating chapter 12 Congress created a remedy that kept most farmers from filing bankruptcy.  The basic remedy allowed farmers to rewrite their debt through chapter 12 to reduce the debt to the current value of the land and to reduce the interest rate to the current interest rate.  Knowing what would happen in a bankruptcy case, most banks worked with their debt-laden farm clients to restructure debt and avoid the cost of bankruptcy to all parties.

Even the generous provisions allowing farms to rewrite their debt did not work for all farmers and some still needed to file bankruptcy.  Congress decided that it needed to create additional relief in the last major bankruptcy reform package in 2005.  In that legislation it recognized that sometimes farmers sold part of the farm in order to generate cash and that such sales often involved low basis property, which created large capital gains and the resulting tax debt.  To address this problem, Congress passed BC 1222(a)(2)(A) which transforms priority tax claims into general unsecured claims.  This is a huge deal in allowing farmers to confirm plans and to discharge the taxes that do not get paid.  I will not go into a long explanation of why but trust me that this is important for both reasons.

Because even BC 1222(a)(2)(A) did not provide enough protection for farmers who sold property while the bankruptcy case was pending, Congress subsequently pass BC 1232 to allow farmers to strip priority status off of sales occurring after the filing of a bankruptcy petition.  A good deal for farmers.

The Richards confirmed their chapter 12 plan and in the plan was the following language that “no creditor shall take action to collect on any claim, whether by offset or otherwise, unless specifically authorized by this Plan”. That same paragraph later recites that “[t]his paragraph does not curtail the exercise of a valid right of setoff permitted under §553”.

Section 553 preserves a creditor’s right to offset if it exists outside of bankruptcy law.  Generally speaking, debts need to be mutual and pre-petition in order to allow offset in bankruptcy.  The court noted the current split of authority concerning whether the IRS can offset a liability of a debtor once a plan is confirmed.  The court provided:

Courts are divided as to whether a confirmed plan under §1141, §1227 or §1327 bars the IRS from exercising its §553 setoff rights. Courts within the Seventh Circuit have held that, absent an express plan provision extinguishing such rights, a creditor’s §553 rights survive confirmation. Section 553 provides that “this title does not affect any right of a creditor to offset a mutual debt” and courts have reasoned that the “effect of confirmation” provisions are contained in “this title” (Title 11) and thus, do not affect the creditor’s §553 rights. U.S. v. Munson, 248 B.R. 343, 346 (C.D. Ill. 2000 (§553 trumps §1327); In re Bare, 284 B.R. 870, 874-75 (Bankr. N. D. Ill. 2002) (“confirmation of a debtor’s plan . . . does not extinguish prepetition setoff rights, especially . . . where the plan does not specifically treat those setoff rights”). However, a creditor’s §553 setoff rights may be extinguished by express provision under a confirmed plan. Daewoo Int’l (America) Corp. Creditor Trust v. SSTS Am. Corp., No. 02 Civ. 9629 (NRB), 2003 WL 21355214 at *4 (S.D.N.Y. 2003) (“[i]ndeed, where there is a specific provision in the confirmation order prohibiting setoff claims, courts have indicated that the right to setoff may not survive the confirmation plan”); IRS v. Driggs, 185 B.R. 214, 215 (D Md. 1995); In re Lykes Bros. Steamship Co., 217 B.R. 304, 310 (Bankr. M.D. Fla. 1997) (holding that §1141 takes precedence over §553 where plan of reorganization specifically prohibited setoff).

We have been writing about offset quite a lot lately because of the role it plays in the EIP payments and in other matters here, here and here. We are also adding a new section on offset into Chapter 14A of the Saltzman and Book treatise “IRS Practice and Procedure.”  Bankruptcy adds another level of issues involving offset.

Here, the bankruptcy court decides that it does not need to get into the debate over the effect of confirmation, because the offset performed by the IRS in this instance did not satisfy the requirements of §553.  The refund was post-petition while the debt to which the IRS made the offset was prepetition, meaning that the debts lacked the necessary mutuality.  As such it violated the language of the plan in this case.

While the bankruptcy court decides that the IRS should not have offset the debt owed by the debtor against the post-petition refund, it also determines that it does not have the power to order the IRS to turn over the refund in the current proceeding.  It suggests that the debtor initiate a BC 505 proceeding to determine the correct amount of the refund and through that process obtain the refund it seeks.  The case provides a useful reminder of the impact of bankruptcy on the ability of the IRS to offset and also the special provisions of chapter 12.

Given the pressure that the pandemic places on farmers, not to mention the pressure that U.S. trade policy has placed on them, chapter 12 may become more prominent in the near future.  Be aware that it has provisions for farmers quite different that those applying to debtors in other chapters.  Approach any chapter 12 case with caution to get to know the lay of the land.

Summary Opinions for 6/7/14

Interesting posts on PT last week. We had two posts each by Keith and Les; in a two-part series Keith wrote about the consequences of IRS failing to issue a notice and demand, and Les wrote about penalties and reasonable cause and whether the IRS can collect penalties after a taxpayer dies. On to other procedure items that caught our attention:

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  • Most folks don’t like paying much in taxes and often complain, but I think Louis Balestra has a substantially stronger case for b!*#ing than most. The first paragraph of the Court of Federal Claims opinion summarizes the issue well, “[t]his is a suit for a refund of…FICA taxes…At bottom, this case concerns a simple issue: whether the Balestras should have to pay FICA taxes on deferred compensation to which Mr. Balestra had a vested right but, due to the bankruptcy of his employer, he will never receive. So, does Mr. Balestra owe tax on the compensation he did not and will not receive? Yep. Under the Code, nonqualified deferred comp plans must be taken into account as wages for FICA the later of when the services are performed or when there is no substantial risk of forfeiture. See Section 3121(v)(2). “Substantial risk of forfeiture” is based on the taxpayer’s requirements, not the potential for his company to go belly up. I have not researched this issue, but the result does not surprise me based on what I know of this area.
  • Whistleblower 11332-13W is on a roll, which I guess is cool considering the death threats he/she received. The Tax Court has held it has jurisdiction to review the award determination the Whistleblower received, which the Government had contested arguing that the information provided by the Whistleblower was provided prior to the enactment of Section 7623(b). Section 7623(b)(4) states the Tax Court has jurisdiction to review determinations. The Court’s official holding was that it had jurisdiction to review the award determination where whistleblower alleged that he/she provided information to the Government before and after the effective date of the statute.
  • From Jack Townsend’s Federal Tax Procedure Blog, Jack discusses the 2013 Lockheed case and the government’s “second defense” arguing for a theoretical setoff. The lack of actual items for the setoff is troublesome, as Jack highlights, because it could result in a fishing expedition to find setoffs. The post goes on to discuss the needs for factual assertions in this type of matter and the split in circuits, and provides the revised version of Jack’s text on this matter.
  • On May 23, 2014, TIGTA issued a report that should be of great concern to corporate officers or employees responsible for paying over withheld employment taxes, especially if those companies are behind. TIGTA reported that it found trust fund recovery penalties were not always timely or adequate, and the investigations were incomplete. In well more than a third of cases, the actions were untimely or inadequate, and most took over 500 days to review and process. TIGTA and the Service have agreed that this needs to be rectified, TFRP cases need to be processed better and more efficiently. The Service plans to make additional changes to the program shortly.
  • CPA Amit Chandel posted a link to Parkertaxpublishing.com, which discussed the case Bruce v. Comm’r. In Bruce, married taxpayers were in the process of getting divorced. H filed a tax return as married filing jointly for 2010 in January of 2011, and informed his ex-to-be that they were getting a refund. She provided bank information for her share of the refund. Unbeknownst to H, W filed a 2010 tax return in March of 2011 filing as head of household, and taking the children as dependents. The Service then modified H’s return to married filing separately, and assessed additional tax. The Tax Court upheld the adjustment because W filed her return prior to April 15th, which she was allowed to do under Section 6702(a) and Treas. Reg. 1.6013-1(a)(1). I’ll be discussing this with our family law folks later today – what a great way to piss off your ex.
  • Jack Townsend has a post on his Federal Tax Crimes Blog on the potential changes to OVDP for non-willful violators, including substantial quotes from Comm’r Koskinen’s speech about the topic.
  • From Bloomberg BNA, for this filing season, virtual currencies do not have to be reported on FBARs, but that could change in the future.
  • Mary McNulty and Emily Parker of Thompson & Knight recently presented for the Tax Executives Institute on preparing clients for the new IDR process. The slides from the presentation are available here.