Opinion ID: 1266472
Heading Depth: 2
Heading Rank: 2

Heading: Allocation of Tax Claims Entitled to Beneficial Treatment

Text: The government's final argument is that the proration methodas opposed to the Knudsens' preferred marginal methodis the appropriate method for allocating the Knudsens' 2004 tax liability. Some method must be used for allocating the Knudsens' 2004 tax liability between the tax arising out of the transactions within the scope of § 1222(a)(2)(A) and the tax arising from those transactions outside of its scope. The § 1222(a)(2)(A) portion would be an unsecured claim but the remainder would retain its priority status. The government points out that § 1222(a)(2)(A) is silent as to the proper allocation of tax liability, thereby requiring us to consult legislative history and the statutory purposes of Chapter 12 to determine the proper allocation method. According to the government, its allocation method, which divides the taxes proportionately between the two types of claims, gives effect to Congress's intent to balance the interests of debtors and creditors in Chapter 12. The bankruptcy court adequately summarized the parties' competing positions as follows: IRS argues that the appropriate way to allocate the taxes is to prepare a tax return which recognizes total income and all deductions and exemptions and calculates the income tax based on all taxable income. IRS would then calculate the percentage of total income attributable to sales of qualifying capital assets and the percentage of total income attributable to non-qualifying sources. The income tax would be divided according to these percentages. See IRS exhibit A (applying this method to Knudsens' 1040X amended return for 2004). IRS would add the total self-employment tax to the tax for non-qualifying income because it says the self-employment tax is not based on income from the sale of capital assets. Knudsens' 2004 tax returns show this to be so (exhibits 1 and 64). IRS would next subtract any credits according to their relation to the sources of income. In the case of its example for 2004, it applied two credits to the non-qualifying tax calculation (tax withheld and fuels credit). IRS arrives at a net tax due for each treatment and then calculates the percentage of the tax attributable to qualifying and non-qualifying sources of income. In exhibit A, the priority claim is 82 per cent of the total tax, and the unsecured general claim is 18 per cent. IRS would then apply any payments on taxes for 2004 in accordance with the percentage relationship of net tax due for qualifying and non-qualifying income, yielding a tax balance for each. IRS calls this method a proration or proportional method. Knudsens argue for a marginal rate method. They would calculate a tax return for all income, and then a second, pro forma tax return removing all qualifying sales income. The Knudsens contend that this is a better method because it taxes the non-qualifying income at lower marginal tax rates. This results in a lower tax for income not entitled to beneficial treatment and likely makes reorganization more feasible, furthering the intent of the amendment. Knudsens would also apply any and all payments on taxes to the non-qualifying tax, the tax which would not be discharged unless paid. No tax payments for 2004 would be applied to the portion of the tax that would receive beneficial treatment as unsecured debt under § 1222(a)(2)(A).    IRS otherwise objects to the marginal rate method for the very reason Knudsens support itit calculates the remaining priority taxes at lower marginal rates. IRS argues for a method that taxes all taxable income at the marginal rates that would be applicable outside of bankruptcy and then prorates the result. Neither party provides any other argument for the proposal. Knudsen, 356 B.R. at 486-87 (finding that the proration method is the better method for determining what amount of tax qualifies for beneficial treatment under § 1222(a)(2)(A) and what does not because [i]t recognizes all income, deductions, exemptions, and credits in arriving at a tax and allocates according to the percentage of each type of income and divides the actual tax without regard to which sales produced the last dollar of income). Section 1222(a)(2)(A) is silent as to how a debtor's tax liability should be allocated between non-priority and priority claims. This silence is somewhat explainable by § 1222(a)(2)(A)'s priority-stripping nature. The provision does not relate solely to taxes but also to a claim owed to a governmental unit. If a statute is silent, then such statute is deemed ambiguous. See Clark v. U.S. Dep't of Agriculture, 537 F.3d 934, 942 (8th Cir.2008). [A]mbiguities in the Code are generally resolved in favor of the debtor. New Neighborhoods, Inc. v. W. Va. Workers' Comp. Fund, 886 F.2d 714, 719 (4th Cir. 1989); cf. Matter of Nickerson & Nickerson, Inc., 530 F.2d 811, 814 (8th Cir.1976) (The referee reasoned that this ambiguity should be resolved in favor of the debtor, since excluding priority claims from the fee base would result in reducing the expenses incurred by the debtor and thus would foster the rehabilitative purposes of the Act.). [S]o long as [the creditor's right] is protected[,] the creditor certainly is in no position to insist that doubts or ambiguities in [an] Act be resolved in its favor and against the debtor. Rather the Act must be liberally construed to give the debtor the full measure of the relief afforded by Congress . . . lest its benefits be frittered away by narrow formalistic interpretations which disregard the spirit and the letter of the Act. Wright v. Union Cent. Life Ins. Co., 311 U.S. 273, 278-79, 61 S.Ct. 196, 85 L.Ed. 184 (1940) (internal citations omitted). Additionally, once this court concludes that a particular statute is ambiguous, we may `seek guidance in the statutory structure, relevant legislative history, [and] congressional purposes expressed in the statute.' United States v. Villanueva-Sotelo, 515 F.3d 1234, 1243 (8th Cir.2008) (quoting Fla. Power & Light Co. v. Lorion, 470 U.S. 729, 737, 105 S.Ct. 1598, 84 L.Ed.2d 643 (1985)) (alteration in Villanueva-Sotelo ). The purpose of Chapter 12 is to provide family farmers with a faster, simpler, and cheaper alternative to Chapter 11 and Chapter 13 procedures, while preserving the fair treatment of creditors under those chapters. Rowley v. Yarnall, 22 F.3d 190, 193 (8th Cir. 1994). It was designed to `give family farmers facing bankruptcy a fighting chance to reorganize their debts and keep their land . . . while, at the same time, preventing abuse of the system and ensuring that farm lenders receive a fair repayment.' Id. (quoting H.R. Conf. Rep. No. 958, 99th Cong., 2d Sess. 48 (1986), reprinted in 1986 U.S.C.C.A.N. 5227, 5249) (alteration in Rowley ). Courts have recognized that Chapter 12 was enacted as an emergency response to a then-existing farm debt crisis. Travelers Ins. Co. v. Bullington, 878 F.2d 354, 360 (11th Cir. 1989). Congress intended the family farmer provisions to be novel, but short-lived. The statute by its terms expires after only seven years. 28 U.S.C. § 581 note. The short lifetime of Chapter 12 suited Congress' desire to `evaluate both whether the chapter is serving its purpose and whether there is a continuing need for a special chapter for the family farmer.' H.R. Conf. R. at 48, USCCAN at 5249. Common sense suggests Congress was mindful of the farmer' existing loans when it set the seven year limitation. Id. (quoting Dahlke v. Doering, 94 B.R. 569 (D.Minn.1989)); see also In re Sohrakoff, 85 B.R. 848, 849 (Bankr.E.D.Cal.1988) ([C]hapter 12 was enacted for those farmers who want to keep their land and continue to farm.); In re McCann, 202 B.R. 824, 826 (Bankr.N.D.N.Y.1996) (Chapter 12 was enacted in 1986 and was modeled after the existing chapter 13. Congress recognized the financial problems farmers were encountering in the 1980s as well as their difficulties in complying with the requirements of Chapters 11 and 13 and crossbred them resulting in the birth of Chapter 12.). [4] Moreover, the the IRS does not always apply the proportional method. Ficken v. Internal Revenue Serv. (In re Ficken), Case No. 05-52940-HRT, Adversary No. 08-01687-HRT, slip opn. at 14 (Bankr. D.Colo. July 30, 2009) (unpublished). Although the observation that [the] IRS does not always use the proportional method when allocating the tax is not determinative, it does illustrate some exceptions where the IRS does not apply what would be the proportional method to treat each dollar of income as the same. Id. For example, [t]he IRS utilizes the marginal method to determine estate taxes for special use valuation under 26 U.S.C. § 2032A. Id. [T]he estate tax, like the income tax, is a graduated tax. Id. Pursuant to § 2032A, farmland may be passed from one generation to the next by a `qualified heir.' [The] IRS requires the estate to report only the Special Use Value, and not the Fair Market Value, on Form 706 to determine the estate tax due. Id. And, the IRS requires computation of [tax on prior transfers (TPT)] using the marginal method under I.R.C. § 2013. Id. (citing Robert J. Stommel & Lester B. Law, Planning to Maximize the § 2013 Credit, 72 Fla. Bar J. 66 (1998)). [T]he TPT credit is a credit applied to the federal (and not state) estate tax liability of the decedent's estate equal to the amount of the federal estate tax deemed paid on property transferred to the decedent from the transferor. [Stommel & Lester] at 66. The tax is the amount of federal estate tax attributable to the transferred property in the decedent's estate. The tax is computed as the lesser of the average or pro rata method of tax allocation and the with and without or marginal method of tax allocation. Id. at 69. With respect to TPT, [the] IRS contemplates that the taxpayer compute the tax under the marginal method, and if the marginal method results in a lower tax than the pro rata or proportional method, that is the tax to be paid. Id. We hold that the proper allocation method under § 1222(a)(2)(A)a priority-stripping provision as opposed to a tax provisionis the marginal method. As the district court observed: By treating the proceeds of transactions that qualify for beneficial treatment under § 1222(a)(2)(A), in effect, as the last dollars in, and, therefore, subject to the highest marginal tax rate, the marginal method maximizes the percentage of the taxes to which beneficial (unsecured) treatment will apply, reducing the IRS's veto power, and making the debtors' reorganization plan more feasible and, hence, more confirmable. The IRS's method, in contrast, would minimize the taxes entitled to beneficial treatment and reinstate much of the IRS's veto power, thereby fritter[ing] away the benefits of § 1222(a)(2)(A) in stripping priority from claims of governmental units, at least to the extent that such claims are tax claims. See Wright, 311 U.S. at 279, 61 S.Ct. 196, 85 L.Ed. 184 (J. Douglas) (observing that the [Bankruptcy] Act must be liberally construed to give the debtor the full measure of the relief afforded by Congress, lest its benefits be frittered away by narrow formalistic interpretations which disregard the spirit and letter of the Act). The Knudsens' approach does not, however, entirely eliminate the IRS's veto power, which, consistent with the plain language of § 1222(a)(2)(A), see B & D Land & Livestock Co., 332 F.Supp.2d at 1210 (the first approach to statutory interpretation is the plain language of the statute in question); accord In re Hen House Interstate, Inc., 177 F.3d at 722 (interpretation of provisions of the Bankruptcy Code begins with the plain meaning of the statute); In re Martin, 140 F.3d at 807-08 (same), remains in place to the extent that the family farmer's reorganization plan does not provide for the payment of the priority portion of the claim or the family farmer still fails to obtain a discharge under the reorganization plan. See 11 U.S.C. § 1222(a)(2) (subject to the exception § 1222(a)(2)(A), the plan must provide for payment of priority claims, and the claims subject to the exception are only treated as unsecured if the debtor receives a discharge). Therefore, the marginal method is the correct method to determine the allocation of taxes between priority and non-priority claims. To apply that method, the Knudsens should calculate a return for all income, then a second pro forma tax return removing all qualifying sales income, so that non-qualifying income would be taxed at lower marginal tax rates, and the taxes shown on the pro forma return would represent the portion of the tax claim entitled to priority status, while the difference between the taxes shown on the return for all income and the taxes shown on the pro forma return would represent the unsecured portion of the tax claim. Knudsen, 389 B.R. at 668-69. Therefore, we reverse and remand the portion of the bankruptcy court's judgment choosing the proration method instead of the marginal method.