Siding with the Fifth Circuit, a majority on a Sixth Circuit Bankruptcy Appellate Panel reversed the bankruptcy court by holding that the “penalty” imposed on a taxpayer for failure to purchase health insurance under the Affordable Care Act (a/k/a ACA or Obamacare) is a “tax” afforded priority under Section 507(a)(8).
Responding to public criticism, Congress lowered the “penalty” to zero. Although the issue no longer has had financial consequence since the repeal, the courts’ analyses should provide guidance for legislators if they adopt a new form of universal health care built on the ACA.
The Fifth Circuit opinion was U.S. v. Chesteen (In re Chesteen), 799 F. App’x 236, 241 (5th Cir. Feb. 20, 2020). To read ABI’s report, click here.
To be brief, the debtors before the BAP argued that the exaction was a penalty because the ACA repeatedly referred to it as a “penalty.” If it was a penalty, it would not be accorded priority under Section 507(a)(8)(G) because it was not compensation for “actual pecuniary loss.”
On the other hand, the statute was part of the Internal Revenue Code, suggesting that the exaction was one of many federal taxes.
Debtors had another argument based on Section 507(a)(8)(A), which affords priority to “a tax on or measured by income.” Debtors contended that income was only one factor in measuring the exaction under the ACA.
Like other courts, the BAP decided that the outcome was not controlled by National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), where the Supreme Court upheld the constitutionality of the ACA. As Bankruptcy Judge Alan C. Stout said for the BAP majority in his March 21 opinion,
[T]he question presented on constitutionality was not whether the [exaction] was better construed as a tax or a penalty, but rather whether the [exaction] could possibly be construed as a tax to permit a finding that Congress had the authority to enact the ACA.
Employing the “functional analysis” required by the Sixth Circuit, the BAP majority concluded that the exaction indeed was a tax, because it was “universally applicable to all persons who are in a position to be subject to the exaction.” The majority also concluded that the exaction was not a “penalty” under Supreme Court precedent.
Finally, the BAP majority decided that the exaction was “measured” by income. The majority said that “Section 507(a)(8)(A) does not require that the tax be calculated solely or primarily by measuring income.” [Emphasis in original.]
Bankruptcy Judge Scott W. Dales “respectfully” dissented. He based his opinion in part on fundamental bankruptcy principles, an approach not often seen these days.
To accord equality of distribution among creditors, Judge Dales said that “courts must be sparing in permitting priority treatment.” He continued, “Sixth Circuit case law and fundamental bankruptcy policy [regarding the fresh start] tip the scales against affording the IRS priority.”
Were the exaction not located in the IRS Code, Judges Dales said that it “would appear to be a regulatory penalty for an individual’s failure to comply with a statutory requirement.”
Because the exaction functions as a penalty and because the ACA calls it a penalty numerous times, Judge Dales said, “the Panel should treat it as a penalty for purposes of the Bankruptcy Code, just as the Supreme Court did for purposes of the Anti-Injunction Act.” He would have affirmed the bankruptcy court’s decision that the exaction was not entitled to priority.
Siding with the Fifth Circuit, a majority on a Sixth Circuit Bankruptcy Appellate Panel reversed the bankruptcy court by holding that the “penalty” imposed on a taxpayer for failure to purchase health insurance under the Affordable Care Act (a/k/a ACA or Obamacare) is a “tax” afforded priority under Section 507(a)(8).
Responding to public criticism, Congress lowered the “penalty” to zero. Although the issue no longer has had financial consequence since the repeal, the courts’ analyses should provide guidance for legislators if they adopt a new form of universal health care built on the ACA.