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Fourth Circuit Reverses Lower Courts; ACA Penalty Is Entitled to Priority Status in Bankruptcy

(Parker Tax Publishing March 2023)

The Fourth Circuit, in a 2-1 decision, reversed a district court and bankruptcy court and held that the shared responsibility payment (SRP) enacted as part of the Affordable Care Act qualifies as a tax measured by income and is thus entitled to priority status in bankruptcy. As a result, a married couple who failed to pay their SRP before that provision was repealed could not exempt it from their bankruptcy estate. U.S. v. Alicea, 2023 PTC 20 (4th Cir. 2023).


When first enacted, the Affordable Care Act (ACA) included a mandate requiring most individuals to maintain health insurance meeting certain minimum requirements (i.e., the individual mandate). Individuals covered by the ACA who failed to maintain the minimum level of insurance were required to pay a shared responsibility payment (SRP) to the IRS through their annual income tax returns. In Code Sec. 5000A(b)(1), the SRP is identified as a penalty rather than a tax. In National Federation of Independent Business v. Sebelius (NFIB), 567 U.S. 519 (2012), the Supreme Court upheld the constitutionality of the individual mandate. Although the Court determined that the SRP was a penalty, not a tax, for purposes of the Anti-Injunction Act, it concluded that, as a constitutional matter, the SRP could fairly be read as a tax on the uninsured, which the Court found was within Congress's power to impose. A question which continues to arise in bankruptcy cases is whether the SRP qualifies as a tax measured by income or as an excise tax.

Chapter 11 of the Bankruptcy Code gives priority to certain classes of unsecured claims, which must be paid in full before other unsecured claims may be paid. Section 507(a)(8)(A) gives priority to unsecured claims for a tax on or measured by income or gross receipts for a tax year ending on or before the date of the filing of the petition. Section 507(a)(8)(E) gives priority status to "an excise tax on . . . a transaction" occurring within a designated time period. The Bankruptcy Code does not define "tax" or "excise tax." When applying Section 507(a), courts distinguish between taxes and penalties. Taxes are entitled to priority if they qualify as taxes measured by income or as excise taxes, but penalties are not entitled to priority and must be dealt with as an ordinary, unsecured claim. At issue in a number of bankruptcy cases is whether, for purposes of priority treatment in bankruptcy proceedings, the SRP qualifies as a tax or a penalty. If the SRP is determined to be a tax rather than a penalty, then the next step is to determine whether it qualifies as a tax measured by income or as an excise tax.

In 2018, when the ACA's mandate and SRP were still in effect, taxpayers Fabio Alicea and his wife Sarah Zabek, did not maintain the minimum insurance coverage required by the ACA. The taxpayers did not include their $2,409 SRP when they filed their 2018 federal tax return. In December 2019, the taxpayers filed for Chapter 13 bankruptcy protection. The IRS filed a proof of claim for the unpaid SRP and asserted that its claim was entitled to priority as an income or excise tax under 11 U.S.C. Section 507. The taxpayers objected to the government's claim of priority. The bankruptcy court granted the objection, concluding that, for purposes of the Bankruptcy Code, the SRP is a penalty, not a tax, and therefore is not entitled to priority under Section 507(a)(8). The government appealed to the district court, which affirmed the bankruptcy court's decision. The district court held that even if the SRP was generally a tax, it did not qualify as a tax measured by income or an excise tax and thus was not entitled to priority. The government appealed to the Fourth Circuit.

Taxpayer and Government Arguments

Before the Fourth Circuit, the government argued that the Supreme Court's decision in NFIB upholding the individual mandate largely resolved the questions at issue because the Court found the SRP to be a tax by engaging in the same functional analysis required in the bankruptcy context.

The taxpayers, however, argued that the NFIB Court's analysis of the tax question was not binding on the Fourth Circuit because the constitutional question of whether the SRP was within Congress's taxing power is governed by different principles than the statutory question of whether the SRP constitutes a tax within the meaning of the Bankruptcy Code. Relying instead on the NFIB Court's analysis of the SRP under the Anti-Injunction Act, the taxpayers contended that because Congress deliberately labeled the SRP as a penalty, Congress did not intend to treat the SRP as a tax. The taxpayers also argued that the SRP cannot be viewed as a tax because the primary purpose of the individual mandate and the SRP was to encourage the purchase of health insurance, not to raise revenue.

The taxpayers also suggested that the SRP is not measured by income because some groups - like members of Indian tribes and those who cannot afford the SRP - are not required to pay it at all, and others pay only a flat rate.


The Fourth Circuit reversed the judgment of the district court and held that the SRP is properly viewed as a tax. The court found that when determining whether a governmental exaction is a tax or penalty for bankruptcy purposes, Supreme Court precedent requires applying a functional analysis that ignores the label given to the exaction and instead considers whether the exaction operates as a tax or a penalty. Accepting the taxpayers' argument, the court said, would mean that the NFIB Court silently upended bankruptcy practice and overruled a long line of cases.

The statute setting out the method for calculating the SRP, the court observed, is Code Sec. 5000A(c), which contains formulas keyed to individual and household income. The amount of the SRP is 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 the individual would have to pay for qualifying private health insurance. Because household income provides the starting point for all SRP calculations, the court had no difficulty in concluding that the SRP is measured by income. Thus, it concluded that the SRP qualifies as a tax measured by income and found it unnecessary to consider whether the SRP also amounted to an excise tax.

The court found that the SRP qualifies as a tax under the functional approach that has consistently been applied in bankruptcy cases and that nothing in the Supreme Court's decision in NFIB required it to abandon that functional approach. Thus, because the SRP is a tax that is measured by income, the Fourth Circuit concluded that the government's claim was entitled to priority under 11 U.S.C. Section 507(a)(8)(A).

Concurring and Dissenting Opinions

In a concurring opinion, Judge Wilkinson said that the taxpayers' case struck him as a not-too-subtle rearguard action against the ACA and the decision to uphold it (i.e., NFIB). He pointed out that the SRP was effectively slain by the Tax Cuts and Jobs Act of 2017 when the SRP payments were reduced to zero. But, he said, the "smoke of battle lingers still, however, in our fine bankruptcy courts of all places." According to the judge, "It is time now to give the SRP a decent burial, with all the accoutrements of priority the Bankruptcy Code affords it. This fight is over. R.I.P."

In a dissenting opinion, Judge Niemeyer said that like the majority, he also concluded that the answer to the question in this case is provided by the NFIB decision. But he differed with the majority in that he concluded that NFIB requires that the payment be treated as a penalty in the context of the Bankruptcy Code. By concluding instead that the payment is a tax in that context, he said, the majority failed to recognize that NFIB applied two distinct analyses, one when construing the ACA's statutory text and another when determining the scope of Congress's constitutional authority for enacting the ACA. While Congress described numerous exactions in the Act as "taxes," Judge Niemeyer noted that it described the shared responsibility payment as a "penalty." Thus, when determining how the SRP must be treated under the Bankruptcy Code, Judge Niemeyer concluded that courts must yield to Congress's determination that it is a penalty.

For a discussion of how SLR penalties are treated in bankruptcy, see ¶16,160.

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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