EIGHTH CIRCUIT BANKRUPTCY MONITOR
Judge Thad Collins of Bankr. N.D. Iowa held, as a matter of first impression, that “§ 1232(a) allows family farmers who have capital gains tax debt under Chapter 12 process to require taxing entities to issue a refund of withheld income taxes to the bankruptcy estate.”
A husband and wife filed a joint petition under chapter 12. The husband was a farmer; the wife had other employment. Pre-petition, the husband sold farmland and farming machinery, thereby incurring significant capital gains. The primary purpose for filing the case was to address the resulting tax debt. The debtors’ plan called for de-prioritizing the tax debt under section 1232(a) and for relevant taxing authorities to return withheld taxes from the wife’s non-farm income.
The taxing authorities objected, arguing that the de-prioritization permitted under section 1232(a) did not and could not require turnover of pre-petition withholdings that could be setoff against the de-prioritized tax debt. More particularly, they argued that section 1232(a) did not alter the preservation of setoff rights in section 553(a). The debtors, on the other hand, argued that sections 1232(a) and 553(a) conflicted with one another and that section 1232(a), as the more specific statute, should prevail over section 553(a).
After considering various canons of statutory interpretation, the Court looked to the legislative history. The Court found “Congress intended the priority-stripping provision [of section 1232(a)] to be interpreted to promote successful reorganization of family farming operations—by limiting the impact of substantial capital gains taxes that tend to follow the sale of farm land or equipment—and to put that capital in farmers’ hands—not the taxing authorities.” The Court concluded that allowing “taxing entities to setoff withheld taxes against these capital gains taxes runs directly counter to these objections.” From this, the Court found that sections 1232(a) and 553(a) conflicted with one another (in intent, if not on their face) and held that a chapter 12 plan that de-prioritizes tax debt could also compel taxing authorities to turn over withheld taxes notwithstanding section 553(a) and any setoff rights the taxing authorities may otherwise hold.
Although in the case before the Court, the amount to be refunded only came to a couple of thousand dollars, the outcome could afford important liquidity to reorganizing debtors with more substantial tax withholdings or other potential setoffs. Chapter 12 practitioners should monitor whether the holding is adopted in other jurisdictions.
The opinion can be viewed here.