In a 2/1 decision, the Fourth Circuit employed a “functional analysis” to side with the Third Circuit in holding that the shared-responsibility payment, although called a “penalty” under the Affordable Care Act, was a tax on income afforded priority under the Bankruptcy Code.

The dissenter believes that the court instead was obliged to employ a traditional statutory analysis requiring the court to adopt the ACA’s characterization of the mandate as a penalty, which would not be a priority claim.

The Third Circuit opinion is In re Szczyporski, 34 F.4th 179 (3d Cir. May 11, 2022). To read ABI’s report, click here. The Fourth Circuit’s majority also aligns with an opinion from the Sixth Circuit Bankruptcy Appellate Panel in In re Juntoff, 636 B.R. 868 (B.A.P. 6th Cir. Mar. 21, 2022). Click here to read ABI’s report on Juntoff.

The opinions no longer have practical significance, because Congress lowered the “penalty” to zero in 2017. However, the decisions will provide guidance should a future administration resurrect some form of universal health care with penalties for those who do not buy insurance.

Typical Facts

The debtors filed a chapter 13 petition in 2019. The Internal Revenue Service filed a $30,000 priority claim that included $2,400 for failure to comply with the individual mandate and to make the shared-responsibility payment in the debtors’ 2018 federal tax return.

The debtors objected to the portion of the claim based on the individual mandate, contending that it did not give rise to a tax on income or an excise tax on a “transaction” under Section 507(a)(8)(A) or (a)(8)(E). Rather, the debtors said it was a “penalty” not entitled to priority.

The bankruptcy court agreed with the debtors, calling the exaction a penalty not entitled to priority. The district court affirmed, only to be reversed by the Fourth Circuit panel’s majority on January 19.

The Majority Opinion

Every opinion about the priority of the individual mandate tussles with National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), where the Supreme Court held that the shared-responsibility payment was a tax for constitutional purposes but was not a tax for the Anti-Injunction Act.

For the majority, Circuit Judge William B. Traxler, Jr. said that Supreme Court authority required the court of appeals to employ a “functional analysis” in deciding whether the mandate gave rise to a tax, even though the ACA called it a “penalty.”

Given that the Supreme Court used a functional analysis in deciding that the exaction was a tax, Judge Traxler said “it would seem difficult for an intermediate court to reach a different conclusion.” Bound by the Supreme Court’s functional analysis, he held that the exaction was a tax, not a penalty.

Next, Judge Traxler analyzed whether the tax was “measured by income” and was thus entitled to priority under Section 507(a)(8)(A). Because “household income provides the starting point” for calculating the exaction, he had “no difficulty concluding” that it was a tax “measured by income.”

The majority reversed, holding that the exaction was a tax entitled to priority.

The Dissent

Circuit Judge Paul V. Neimeyer “respectfully” dissented. He believes “that [Sebelius] requires that the payment be treated as a penalty in the context of the Bankruptcy Code.”

Judge Neimeyer had a different interpretation of the Supreme Court’s analysis in Sebelius. Unlike the majority, he saw the high court as having used “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.”

He saw the Supreme Court as having used a functional analysis on the constitutional question while employing “rules of statutory construction” in deciding how the ACA interacted “with another statute.”

Judge Neimeyer saw the case on appeal as “one of statutory interpretation — whether the shared responsibility payment is a penalty as so labeled by Congress in the ACA.” [Emphasis in original.]

“Given the plain meaning of the text,” Judge Neimeyer concluded “that Congress’s labeling it a penalty is controlling for purposes of other congressional enactments, and therefore it should be treated as a penalty in the Bankruptcy Code, which distinguishes penalties from taxes.” He said that congressional labels must “be honored,” even when the labels were inaccurate, citing Sebelius.

Saying that he would have affirmed, Judge Neimeyer felt obliged to “honor the congressional texts as written.” [Emphasis in original.]