Family Farm Reorganization: Recent Updates to Chapter 12 Tax and Debt Limits | Mitchell, Williams, Selig, Gates & Woodyard, LLC

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Recent years have not been so good for farmers. It looks like this year will continue the recent trend of below-average net farm income and rising debt levels due to several years of a variety of damaging factors, including low commodity prices, bad weather and the ongoing trade war. Studies show that levels of delinquent agricultural loans are the highest in more than six years.[1]

Along with this period, the number of farmers seeking reorganization under Chapter 12 of the Bankruptcy Code is increasing. Arkansas is no exception, with bankruptcy filings increasing for the fiscal year ending July 2019 compared to the prior fiscal year ending July 2018.[2]

While farmers can generally file for bankruptcy under various chapters of the Bankruptcy Code, Chapter 12 is specifically designed to assist eligible “family farmers” by allowing them to propose and implement a plan to pay back all or part of their debts.[3] Senator Chuck Grassley has previously said that “[b]Because a large portion of farm assets are tied to farmland, family farmers face unique challenges when reorganizing their debt.[4] Chapter 12 removes many obstacles that family farmers face when seeking to reorganize under other chapters of the Bankruptcy Code. Chapter 12 “is more streamlined, less complicated and less expensive than Chapter 11, which is better suited to large business reorganizations. Moreover, few family farmers or fishers find Chapter 13 advantageous because it caters to wage earners with less debt than those faced by family farmers. In Chapter 12, Congress sought to combine features of the Bankruptcy Code that can provide a framework for successful reorganizations of family farmers and fishers.[5]

Chapter 12 provides some extraordinary tax benefits to farmers who qualify for such reporting. As a general rule, if a debtor in bankruptcy proceedings is required to sell assets, the debtor will remain liable for the gain realized by the sale. In addition, capital gain liabilities will be treated as a claim having priority over general unsecured claims. Such is not the case in a Chapter 12 bankruptcy. In late 2017, the Family Farmer Bankruptcy Clarification Act was signed into law, adding a new section 1232 to the Bankruptcy Code stating that in a Chapter 12 bankruptcy, a debt tax from the IRS arising from “the sale, transfer, exchange or any other disposition of any property used in the agricultural operation of the debtor” are assimilated to “1° an unsecured debt arising before the date of filing of the request ; (2) is not entitled to priority. . .; (3) must be provided for under a plan; and (4) must be [dischargeable].” This is important because Chapter 12, unlike other chapters of the Bankruptcy Code, “allows family farmers to sell portions of their holdings to reorganize without capital gains taxes impairing the reorganization. Before [enactment of Section 1232], the IRS was able to recover all of the tax debts generated in a bankruptcy reorganization of a family farmer. Too often, when the IRS collected its share of capital gains taxes, there was no money to pay other creditors, like the local grocery store or local bank. So the farmer had to sell the rest of his land and still lost the family farm.[6] Section 1232 solidified a key tax benefit for family farmers seeking to reorganize under Chapter 12.

There are certain conditions for a farmer to qualify for Chapter 12 protection (i.e. to be considered a “family farmer”), one of which is that the farmer must have less than to the existing indebtedness limit set forth in Chapter 12, which is approximately $4.4. million (the “debt limit”). If the farmer’s debts exceed the debt limit, he can seek relief under Chapter 11 or possibly Chapter 7, the provisions of which are not as favorable to the debtor. However, in late July 2019, Congress passed the Family Farmer Relief Act of 2019, amending United States Code Section 101(18), to increase the debt limit to $10 million.

The passage of the Family Farmer Relief Act of 2019 is significant in that more farmers will now be able to benefit from the preferential tax treatment afforded by Chapter 12.

[1] Agricultural Loan Defaults and Bankruptcies Are on the Rise, Market Intel (July 31, 2019), available at https://www.fb.org/market-intel/farm-loan-delinquencies-and-bankruptcies-are-rising/

[3] Chapter 12 – Basics of Bankruptcy – United States Courts, available athttps://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-12-bankruptcy-basics.

[4] Grassley-Franken Farm Bankruptcy Relief Bill Passes Senate (September 8, 2017) available athttps://www.grassley.senate.gov/news/news-releases/grassley-franken-farm-bankruptcy-relief-bill-clears-senate

[5] Chapter 12 – Basics of Bankruptcy – United States Courts, above footnote 3.

[6] Grassley, above note 4.

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