Third Circuit: ACA Shared Responsibility Payment Is a Priority Claim in Bankruptcy

(Parker Tax Publishing June 2022)

The Third Circuit affirmed a district court and held that an IRS claim against debtors for failing to purchase health insurance was entitled to priority status under the Bankruptcy Code because the amount assessed (i.e., the shared responsibility payment) for the debtors' failure was a tax rather than a penalty. The court found that the shared responsibility payment functioned like a tax and lacked the typical characteristics of a penalty and was entitled to priority status because it was a tax that was "measured by income" under 11 U.S.C. Section 507(a)(8)(A). In re Szczyporski, 2022 PTC 129 (3d Cir. 2022).

Background

In July 2019, Robert and Bonnie Szczyporski filed a Chapter 13 bankruptcy petition. The IRS filed a proof of claim against their estate for various unpaid taxes and interest, including a $927 shared responsibility payment the Szczyporskis owed under Code Sec. 5000A for failing to maintain health insurance in 2018. Code Sec. 5000A was enacted in 2010 as part of the Patient Protection and Affordable Health Care Act and the shared responsibility payment for failing to maintain health insurance is also referred to as the individual mandate. The IRS's proof of claim characterized the payment as an excise tax entitled to priority. The Szczyporskis objected to the IRS's claim, arguing that the shared responsibility payment was not a tax. They claimed it was a penalty not entitled to priority.

The bankruptcy court confirmed the Szczyporskis' repayment plan but reserved decision on their objection to the IRS's proof of claim. After briefing from the parties and a hearing, the bankruptcy court held that (1) the shared responsibility payment is a tax, not a penalty, for bankruptcy purposes; and (2) the payment is entitled to priority under 11 U.S.C. Section 507(a)(8) as either an income tax or an excise tax. In In re Szczyporski v. U.S., 2021 PTC 95 (E.D. Pa. 2021), a district court affirmed the bankruptcy court's decision. The Szczyporskis appealed to the Third Circuit.

In a bankruptcy, only claims for certain taxes enumerated in 11 U.S.C. Section 507(a)(8) are entitled to priority status. Section 507(a)(8) gives priority to "a tax on or measured by income" and to "an excise tax...on a transaction." However, the Bankruptcy Code does not define what it considers a "tax." The shared responsibility payment under Code Sec. 5000A applies to certain individuals who do not maintain minimum essential health coverage throughout the year. Though described by the statute as a penalty, the payment is collected by the IRS along with the taxpayer's federal income tax as shown on the taxpayer's tax return. In NFIB v. Sebelius, 2012 PTC 167 (S. Ct. 2012), the Supreme Court held that the shared responsibility payment was a tax for constitutional purposes, but not a tax for purposes of the Anti-Injunction Act.

Observation: The issue of whether the shared responsibility payment is a penalty or a tax for bankruptcy purposes remains contested among the circuit courts. In In re Juntoff, 2022 PTC 80 (B.A.P. 6th Cir. 2022), the Sixth Circuit Bankruptcy Appellate Panel held that the payment is a tax measured by income that is entitled to priority. However, in In re Chesteen, 2020 PTC 69 (5th Cir. 2020), the Fifth Circuit held that the payment was a nonpriority penalty.

The Supreme Court held in U.S. v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213 (S. Ct. 1996), that when determining whether an exaction is a tax for bankruptcy purposes, courts should look beyond the label placed on the exaction and consider its "actual effects." The Third Circuit applies a functional examination that balances the characteristics of the exaction to determine if it is tax for bankruptcy purposes. The Third Circuit noted that it may consider six factors (i.e., the Lorber-Suburban factors), which ask whether the exaction is: (1) an involuntary pecuniary burden, regardless of name, laid upon individuals or property; (2) imposed by or under authority of the legislature; (3) for public purposes, including the purposes of defraying expenses of government or undertakings authorized by it; (4) under the government's police or taxing power; (5) universally applicable to similarly situated entities; and (6) whether granting priority status to the government will disadvantage private creditors with like claims.

The Szczyporskis argued that the shared responsibility payment is not a tax because the fifth and sixth Lorber-Suburban factors were not satisfied. They also argued that the shared responsibility payment is not an "income tax" entitled to priority under Section 507(a)(8)(A) and that the payment is not "measured by" income because income is only indirectly considered in determining the payment amount.

Analysis

The Third Circuit held that the shared responsibility payment is a tax for bankruptcy purposes and is entitled to priority in bankruptcy as a tax that is "measured by income."

First, the Third Circuit noted that it disagreed with the bankruptcy court's and district court's conclusion that the Supreme Court's determination in Sebelius, i.e., that the payment was a tax for constitutional purposes, was dispositive in the bankruptcy context. The court found that the Sebelius opinion did not address the Lorber-Suburban factors or other factors that are relevant in the bankruptcy context. Further, the court reasoned that an exaction could function as a tax for the broader purpose of constitutional validity but not within the narrower confines of bankruptcy priority. Accordingly, the Third Circuit said that there was no reason to conclude that Sebelius was controlling in the context of the Bankruptcy Code.

The Third Circuit determined that the shared responsibility payment was a tax based on a functional examination of the payment's actual effects and operation. In the court's view, all six of the Lorber-Suburban factors indicated that the payment was a tax. Moreover, the court found that, as the Supreme Court observed in Sebelius, the shared responsibility payment was calculated and administered like a tax. In addition, despite its statutory "penalty" label, the court said that the payment lacked typical penal characteristics since it did not impose a heavy financial burden, had no wrongful intent requirement, could not be enforced through punitive means like criminal prosecution, and was not imposed for an unlawful act.

Next, the Third Circuit determined that the shared responsibility payment was a tax that was "measured by income" because the amount of the payment was calculated as a percentage of household income, subject to a floor based on a specified dollar amount and a ceiling based on the average annual premium. Thus, the court rejected the Szczyporskis' argument that the payer's income played only a minor role in determining the amount of the shared responsibility payment owed. The court noted that the location of the shared responsibility payment provision in Subtitle D of the Internal Revenue Code, titled "Miscellaneous Excise Taxes," did not alter its conclusion that the payment is measured by income, since titles within the Code have no legal effect. Further, the court concluded that the IRS's initial characterization of the payment as an excise tax in its proof of claim was not determinative given that payment obligations may fall under more than one bankruptcy priority category.

For a discussion of Chapter 13 bankruptcy, see Parker Tax ¶16,120. For a discussion of the shared responsibility payment, 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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