Supreme Court Rules Capital Gains Tax Owed in Chapter 12

The Supreme Court just issued a ruling that any capital gains tax owed as a result of selling farmland in a Chapter 12 bankruptcy filing is not dischargeable in bankruptcy and will remain a debt of the farmer.

Chapter 12 is a special type of bankruptcy for farmers.  It allows them to reorganize their assets and liabilities and in most cases allows the farmer to continue farming.  Sometimes, however, the farmer will need to sell part of the farmland to payoff the debt.  If the farmer had incurred income taxes before the bankruptcy, in many cases, this debt for taxes is forgiven as part of the bankruptcy process.

In the current case, the farmer argued that the capital gains tax arising from the sale of farmland should also be forgiven.  The IRS disagreed and the case went all the way to the Supreme Court.  The 5-4 decision was very close, but the final ruling is that this debt is owed by the farmer since the bankrupt estate cannot owe tax.

If you are in a situation like this, it is wise to discuss it with your attorney and tax advisor since it may make more sense to trigger the capital gains tax before you file Chapter 12.

Paul Neiffer, CPA