In In re Chesteen, No. 17-11472 (Bankr. E.D. La. 2-9-2017), the bankruptcy court determined that the liability imposed by the individual mandate is not a tax but a penalty. The consequence of that determination is that the IRS has a general unsecured claim in the debtor’s bankruptcy case and not a priority claim. With the elimination of the individual mandate last year, this decision may not have a significant impact; however, it is another in a series of cases pairing back items in the IRC that are classified as tax for purposes of the bankruptcy code. Guest blogger Bryan Camp teed up this issue and correctly predicted the outcome in a post in 2016.
read more...The debtor failed to sign up for health insurance. That failure resulted in a liability to the IRS. He filed for chapter 13 bankruptcy on June 8, 2017. Both the debtor and the IRS filed multiple schedules or claims listing varying amounts of priority tax liability; however, in the final claim filed by the IRS it listed, inter alia, the amount of $695.00 due for 2016 as an excise tax entitled to priority status. The debtor objected to the claim, arguing that it was not a tax but a penalty.
Excise taxes that arise within three years of the filing of a bankruptcy petition receive priority status pursuant to BC 507(a)(8)(E)(i). The individual mandate liability is imposed under IRC 5000A and is labeled as an excise tax. The label placed on a liability by the Internal Revenue Code does not control the character of a debt for bankruptcy purposes. As we have discussed previously here, and here, the Supreme Court has determined that a liability labeled as a penalty under IRC 6672 is, for bankruptcy purposes, a tax in Sotelo v. United States, 436 U.S. 268, 275 (1978) and that an excise tax under IRC 4971(b) is, for bankruptcy purposes, a penalty in CF&I Fabricators, 518 U.S. 213, 224 (1996).
The court in Chesteen cites to Sotelo and CF&I Fabricators and numerous other cases that have decided this issue. To decide whether the individual mandate is a tax or a penalty, the court must determine whether the primary purpose of the individual mandate serves to support the government or punish and discourage certain conduct. The court cited CF&I Fabricators for the proposition that the proper analysis turns on whether the liability acts more like a penalty or more like a tax. The IRS argued that the individual mandate excise tax had many characteristics similar to the trust fund recovery penalty imposed by IRC 6672. The court rightly rejected that argument. The individual mandate bears little resemblance to the TFRP in form or substance; however, that does not necessarily mean that it is a penalty.
The court found that it is “designed to deter citizens from living without health insurance.” While true, that also does not necessarily control the determination. Many taxes seek to encourage or deter certain behaviors. If ever tax that influenced behavior or, sticking to the negative side, tried to keep people from doing certain things the number of liabilities imposed in the IRC which achieved the label of tax for bankruptcy purposes could be quite small. Here, the court looked also at the limitation imposed on the collection of the individual mandate. The severe limitation on the IRS collection function with respect to this tax influenced the court in its thinking of the special nature of this liability.
The court also looked at the label Congress placed on the individual mandate. In the statute imposing this liability, Congress referred to the liability 18 times as a penalty and none as a tax. While not controlling, this labeling certainly played an influential role in the thinking of the court.
Conclusion
To my knowledge, this decision represents the first bankruptcy court to render an opinion on the character of the individual mandate. The court follows traditional analysis in reaching the conclusion that the liability falls more on the penalty side of the equation than the tax side. Much about provisions placed into the Internal Revenue Code such as the Affordable Care Act will fail traditional tests of tax. As Congress loads more and more non-traditional liabilities into the IRC, practitioners should push back hard on the label of tax which results in priority status, which results in non-dischargeability. These types of issues will continue to provide a battleground for the IRS.
“The label placed on a liability by the Internal Revenue Code does not control the character of a debt for bankruptcy purposes.”
It doesn’t control the character for other purposes either, as the Supreme Court explained in order to accept jurisdiction in a famous case.
“To decide whether the individual mandate is a tax or a penalty, the court must determine whether the primary purpose of the individual mandate serves to support the government or punish and discourage certain conduct.”
This would suggest that if a frivolous tax return is filed with the intention of avoiding payment of tax then the penalty should be considered tax and maybe subject to the Flora rule; but if a frivolous tax return violates IRB 2005-14 with the misguided intention to be honest, when the filer doesn’t know about IRB 2005-14 and doesn’t hold any other frivolous position and doesn’t owe any tax, then the penalty should be considered penalty and not subject to the Flora rule.
(I still wonder why the IRS didn’t penalize Donald Rumsfeld. Even though he knew to sign the preprinted jurat, his letters to the IRS showed that he did not believe what he signed and his letters violated IRM 4.10.12.1.3 every bit as much as honest declarations on the returns themselves would have done.)