Reorganization of the Family Farm: Recent Tax and Debt Limit Updates to Chapter 12

August 08, 2019

By: Trav Baxter

Category: Agriculture , Tax

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The past few years haven’t been so kind to farmers. It appears that this year will continue the recent trend of subpar net farm income and increasing debt levels due to several years of various detrimental factors, including low commodity prices, poor weather conditions and the ongoing trade war. Studies show that levels of delinquent agricultural loans are the highest they have been in more than six years.[1]

Accompanying such times is the increase in the number of farmers filing for reorganization under Chapter 12 of the Bankruptcy Code. Arkansas is no exception, with bankruptcy filings having increased for the fiscal year ending July 2019 as compared with the previous fiscal year ending July 2018.[2]

While farmers are generally able to file for bankruptcy under various chapters of the Bankruptcy Code, Chapter 12 is specifically designed to assist qualifying “family farmers” by allowing them to propose and carry out a plan to repay all or part of their debts.[3] Senator Chuck Grassley previously stated that “[b]ecause much of farm assets are tied up in farmland, family farmers face unique challenges when reorganizing debt.[4] Chapter 12 eliminates many obstacles that family farmers when looking 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 corporate reorganizations. In addition, few family farmers or fishermen find chapter 13 to be advantageous because it is designed for wage earners who have smaller debts than those facing family farmers. In Chapter 12, Congress sought to combine the features of the Bankruptcy Code which can provide a framework for successful family farmer and fisherman reorganizations.”[5]

Chapter 12 provides certain extraordinary tax benefits to farmers that qualify for such filing. Generally, if a debtor in a bankruptcy proceeding is required to sell assets the debtor will remain responsible for capital gain recognized by the sale. Furthermore, the capital gain liability will be treated as a claim taking priority over general unsecured claims. Such is not the case in a Chapter 12 bankruptcy. At the end of 2017, the Family Farmer Bankruptcy Clarification Act was enacted, adding a new Section 1232 of the Bankruptcy Code stating that in a Chapter 12 bankruptcy an IRS tax claim arising from “the sale, transfer, exchange, or other disposition of any property used in the debtor’s farming operation” shall be treated as “(1) an unsecured claim arising before the date on which the petition is filed; (2) shall not be entitled to priority . . .; (3) shall be provided for under a plan; and (4) shall be [dischargeable].” This is significant because Chapter 12, unlike other chapters of the Bankruptcy Code, “allows family farmers to sell portions of their farms to reorganize without capital gains taxes jeopardizing the reorganization. Before the [enactment of Section 1232], the IRS was able to collect any tax liabilities generated during a family farmer bankruptcy reorganization. Too often, when the IRS took its cut through the capital gains taxes, there was no money to pay the other creditors, like the local feed store or the 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 looking to reorganize under Chapter 12.

There are certain requirements 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 debts less than existing debt limit set forth in Chapter 12, which is approximately $4.4 million (the “Debt Limit”). If the farmer’s debts exceed the Debt Limit, then they can file for relief under Chapter 11 or possibly Chapter 7, the provisions of which are not nearly as kind to the debtor. However, at the end of July 2019, Congress passed the Family Farmer Relief Act of 2019, amending Section 101(18) of the United States Code, to increase the Debt Limit to $10 million.

Passage of the Family Farmer Relief Act of 2019 is significant in that more farmers will now be able to qualify for the preferential tax treatment afforded by Chapter 12.

[1] Farm Loan Delinquencies and Bankruptcies are Rising, Market Intel (July 31, 2019), available at https://www.fb.org/market-intel/farm-loan-delinquencies-and-bankruptcies-are-rising/?utm_source=Social&utm_medium=Facebook&utm_campaign=AFBF&fbclid=IwAR2VqfRNEmnPJJKIPGOtXHAk9E8T68NDPRf-NL8Ra3P2WIqv16xgHRHiYDQ

[2] Id.

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

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

[5] Chapter 12 - Bankruptcy Basics – United States Courts, supra note 3.

[6] Grassley, supra note 4.

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