Fifth Circuit: ACA shared responsibility payment is dischargeable in bankruptcy

The Fifth Circuit held that the ACA shared responsibility payment (SRP) is not entitled to IRS priority status and thus dischargeable in bankruptcy.

March 12, 2020

In yet another turn of events, the U.S. Court of Appeals for the Fifth Circuit held that the ACA shared responsibility payment (SRP) is not entitled to IRS priority status and thus dischargeable in bankruptcy.

Court case: U.S. v. Chesteen, No. 19-30195 (5th Cir. Feb. 20, 2020)

Background on the Chesteen case

John Chesteen filed for bankruptcy relief under of the Bankruptcy Code. The issue before the bankruptcy court was whether his unpaid $695 SRP should be treated as a tax or a penalty. Certain tax debts are entitled to IRS “priority status” meaning that they are not dischargeable in bankruptcy. If the SRP is a penalty rather than a tax debt it is not entitled to priority status and Mr. Chesteen could be relieved of the debt.

The bankruptcy court, noting that the ACA refers to the SRP as a “penalty” 18 times, concluded that Congress’ primary purpose in imposing the mandate was to discourage Americans from living without health insurance. The court held that the $695 SRP was not a “tax” within the meaning of §507(a)(8) of the Bankruptcy Code and thus dischargeable in bankruptcy. The IRS appealed.

A Louisiana district court disagreed, maintaining that it is the purpose of the SRP and not its label that controls for bankruptcy purposes. In contrast to the bankruptcy court’s findings, the district court found that the SRP is not a punishment for unlawful activity, but an excise tax that is a “pecuniary burden laid upon individuals or property for purposes of supporting the government.” The district court ordered the lower court to reverse its decision. Mr. Chesteen appealed.

See the February 28, 2018 and March 20, 2019 editions of TAX in the News for more background on Chesteen.

The Fifth Circuit’s ruling

Both the bankruptcy court and district court had analyzed different legal precedents’ definitions of “tax” and “penalty” in view of the SRP and came to different conclusions. The Fifth Circuit stated that it did not need to determine if the SRP should be defined as a tax or penalty for bankruptcy proceeding purposes. Instead the Fifth Circuit agreed with Mr. Chesteen that the SRP is not an “excise tax on transaction” because it does not tax an activity. Rather, it “taxes inactivity.”

Consequently, the Fifth Circuit ruled that the SRP is not an excise tax that is entitled to priority status within the meaning of the Bankruptcy Code. The case was remanded to the district court with instructions to remand to bankruptcy court for the revised judgment or other proceedings as needed.

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