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Liability for ACA Shared Responsibility Payment Isn't a Priority Claim in Bankruptcy

(Parker Tax Publishing March 2018)

A bankruptcy court held that the IRS's claim against a debtor for failure to purchase health insurance was not entitled to priority status under the Bankruptcy Code because it was a penalty and not a tax. The court found the primary purpose of the individual mandate under the Affordable Care Act is to discourage Americans from going without health insurance, not to fiscally support or fund the government. In re John Chesteen, 2018 PTC 31 (Bankr. E.D. La. 2018).

John Chesteen filed for Chapter 13 bankruptcy relief in June 2017. In his petition, Chesteen estimated that he owed the IRS $5,100 in taxes and his petition reflected a priority claim in that amount. The IRS filed a proof of claim seeking $5,795 in priority debt, which included $695 as Chesteen's shared responsibility payment (SRP) liability under Code Sec. 5000A for failing to maintain health insurance in 2016. Chesteen objected to the IRS's proof of claim with respect to the $695.

An IRS claim is entitled to priority status in bankruptcy only if it is for a tax and not a penalty. The issue before the bankruptcy court was whether an IRS exaction for failure to purchase health insurance in accordance with the Affordable Care Act (ACA) individual mandate is a tax entitled to priority status under Bankruptcy Code Section 507(a)(8) or a penalty not entitled to priority status under the Bankruptcy Code. For bankruptcy purposes, a tax is defined as a pecuniary burden applied for the purpose of supporting the government, while a penalty is punishment that is intended to discourage certain conduct. Thus, for the bankruptcy court to determine whether the SRP is a tax, it had to decide whether the primary, dominant purpose of the individual mandate is to support the government or to punish or discourage certain conduct.

The IRS argued that the SRP should be treated as a tax for bankruptcy purposes because it is similar to the nondischargeable Code Sec. 6672 trust fund recovery penalty. The IRS cited United States v. Sotelo, 436 U.S. 268 (1978), which held that the employment tax liability, although labeled a penalty in the Code, was a tax liability that could not be discharged in bankruptcy.

The bankruptcy court held that the IRS's claim represented a penalty, not a tax, and was therefore not entitled to priority status. The court rejected the IRS's analogy to the trust fund recovery penalty. It reasoned that the Code Sec. 6672 penalty applies where an employer has collected employment taxes but failed to pay them over to the government. In that case, the liability represents a pecuniary loss to the government and the penalty is a tax, notwithstanding the penalty moniker. By contrast, the consequence for failing to maintain health insurance is an additional payment to the IRS. It does not result in any of the typical consequences resulting from nonpayment of taxes like wage garnishments or tax liens.

The bankruptcy court also acknowledged the Supreme Court's holding in National Federation of Independent Business (NFIB) v. Sebelius, 2012 PTC 167 (2012), in which the Court found that the ACA individual mandate is a tax for constitutional purposes. However, the court determined that it had to look beyond that ruling. The court reasoned that Congress did not make failing to purchase health insurance an unlawful act so, in order to justify the constitutionality of the individual mandate, the Supreme Court ruled it was a tax. The bankruptcy court was unconvinced that the narrow constitutional ruling in NFIB extended to the bankruptcy priority scheme.

Finally, the court noted that the SRP is labeled a penalty and that the Code refers to it as such 18 times, but does not refer to it once as a tax. This further suggested to the court that Congress's primary purpose in imposing the SRP was not to fund the government but to discourage Americans from living without health insurance coverage.

For a discussion of Chapter 13 bankruptcy, see Parker Tax ¶16,120. For a discussion of the ACA individual mandate, see Parker Tax ¶190,100.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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