U.S. Senate Bill Cultivates Tax Relief for Bankrupt Farmers

Bloomberg Law’s® Bankruptcy Law News publishes case summaries of the most recent important bankruptcy law decisions, tracks major commercial bankruptcies, and reports on developments in bankruptcy...

By Daniel Gill

Bipartisan legislation introduced in the U.S. Senate would provide tax relief for family farmers in bankruptcy, a proposal described as a “game changer” for those kinds of cases.

The Family Farmer Bankruptcy Clarification Act of 2017 ( S. 1237) aims to “correct” a 2012 Supreme Court ruling on Chapter 12, said Charles Grassley, an Iowa Republican who introduced the measure in the Senate May 25 with Al Franken, a Minnesota Democrat.

Specifically, the proposal would help farmers sell a portion of their land to help fund their reorganization and stay in business despite getting hit with a big capital gains bill. The act would change how those capital gains taxes are treated. Instead of being a priority claim that would have to be satisfied in full before unsecured creditors receive payments, the capital gains would be treated as another general unsecured claim.

Lawyers in the field said the measure, if it becomes law, would vastly alter the landscape of small farm bankruptcy cases.

“In many cases, those capital gains taxes would force the debtors to quit farming altogether,” Carol F. Dunbar told Bloomberg BNA in a June 5 email about the law in its current state. Dunbar has been a Chapter 12 trustee in Iowa since the chapter’s inception in 1986.

While heartening to farmers, the bill’s prospects are unclear as standalone legislation. Similar bills over the past few years, also proposed in the Senate, have died in committee. The Judiciary Committee plans hearings.

Farming Crisis

Chapter 12 of the Bankruptcy Code is designed to protect family farmers and family fishermen with a regular income. The debtors are afforded protection from creditors while they make payments under a plan to repay all or a portion of their debts over a three- to five-year period.

It was enacted in 1986 at a time when the nation was facing a “devastating farm crisis,” Dunbar said.

Originally a temporary measure, it became permanent in 2005. At that time, a provision was approved to change how capital gains taxes would be treated after a sale of land in a Chapter 12 farm bankruptcy.

Where certain taxes are treated as priority claims throughout most of the Bankruptcy Code (including in Chapters 7, 11 and 13), capital gains would be treated as general unsecured claims in Chapter 12.

The Problem with Capital Gains

Grassley said in a statement that “family farmers faced serious problems” when they had to sell land to fund their reorganization. For example, he said a family farmer might sell portions of the farm in order to generate cash and pay creditors.

“Unfortunately, in most of these cases, the family farmer is selling land with a low cost basis, because it has likely been held in the family for a very long time. As a result, the family farmer gets hit with a substantial capital gains tax, which is owed to the Internal Revenue Service,” Grassley said.

To be approved, the plan would have to pay the tax claim in full, unless the IRS agreed to accept less. Often the size of the capital gains would be too great to leave anything for other trade creditors.

The legislation passed in 2005 was supposed to change that tax treatment to allow the family farmer to sell some land during Chapter 12 as a source of reorganization plan funding. Capital gains from the sale would be paid like other general unsecured claims and could be discharged at the end of the plan.

Undone by the Supreme Court

But that’s not how the U.S. Supreme court read the language. Instead, in Hall v. United States, the Court, in a 5-4 2012 decision, said that capital gains taxes would be treated as general unsecured claims only if the sale was in the tax year prior to the filing of the bankruptcy case, not if the sale was conducted during the bankruptcy.

The day after the Hall decision there was already legislation being discussed to correct the ruling, Joe Peiffer told Bloomberg BNA June 5.

Peiffer has more than 30 years experience as a bankruptcy and insolvency attorney in agriculture and farming and has testified before Congress about Chapter 12 and related tax reform. Peiffer has been asked to testify regarding the Family Farmer Clarification Act, he said.

Bills have been introduced to the Senate three times prior to the current act—in 2012, 2013 and 2015, Peiffer said. None reached the floor. The current bill is essentially identical to the previous two iterations.

Nevertheless, there is still hope Congress will act.

“It is a game changer for small farmers to discharge capital gains from the sale of farm related assets before and during Chapter 12, which was the goal of the original legislation,” attorney Walter Kelley told Bloomberg BNA in a June 2 email.

Kelley has been a standing Chapter 12 trustee in Georgia and Florida since 1986 and 1990, respectively.

“There is no way to determine how many farmers could have remained in business, but for the tax consequences arising from the sale of farm assets needed to downsize,” Kelley said.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bna.com

To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com

Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.

Request Bankruptcy Law News on Bloomberg Law