The recent bankruptcy case of In re Creative
Hairdressers, Inc. et al, Case Nos. 20-14583 and
20-14584 (jointly administered) (Bankr. D. Md., March 3, 2022)
involved the intersection of IRC section 4980H’s employer shared responsibility
payment and bankruptcy law.
Bankruptcy and Section 4980H’s Employer Shared
Responsibility Payment
This case addresses an interesting intersection of tax and bankruptcy law. Specifically, it
looks at the bankruptcy court’s treatment of claims made by the
Internal Revenue Service (IRS) under §4980H of the Internal
Revenue Code. The specific issue addressed is whether or not
such claim is entitled to priority status as an excise tax under
§507(a)(8)(E) of the Bankruptcy Code. Ultimately, the
Court concluded that it is entitled to such priority status to the
extent that such claim related to any payments required under the
statute arising within three years from the petition date.
Section 4980H was added to the Internal Revenue Code by
the Affordable Care
Act (“ACA“), enacted on March
30, 2010. Section 4980H applies to applicable “large
employers” (generally, employers who employ at least 50
full-time employees, including full-time equivalent employees, on
business days during the preceding calendar year). Section
4980H generally provides that an applicable large employer is
subject to an assessable payment if either (1) §4980H(a)
applies because the employer fails to offer its full-time employees
(and their dependents) the opportunity to enroll in minimum essential coverage under an
eligible employer-sponsored plan and any full-time employee is
certified to receive a premium tax credit or cost-sharing
reduction; or (2) § 4980H(b) applies because the employer
offers its full-time employees (and their dependents) the
opportunity to enroll in minimum essential coverage and one or more
full-time employees is certified to receive a premium tax credit or
cost-sharing reduction.
In this case, the IRS asserted a priority claim against the
Debtors for the employer shared responsibility
payment (“ESRP“) under
§4980H. Specifically, the IRS sought priority status as
an excise tax under 11 U.S.C. §507(a)(8)(E). The Debtors
objected, contending the ESRP is not an excise tax entitled to
priority treatment, but is a nonpriority penalty. The parties also
disputed when the “transaction occur(red)” that gave rise
to the ESRP, as that phrase is used in 11 U.S.C.
§507(a)(8)(E)(ii).
The Debtor was partially self-insured as defined by the ACA.
The Debtors qualified as an Applicable Large Employer under the ACA.
The Debtors offered minimum essential health insurance
coverage to at least 95% of their employees, but some employees
were allowed a tax credit or cost-sharing reduction for any of the
following reasons: (a) the coverage did not provide minimum value;
(b) the coverage was not affordable; or (c) the employee was not
offered coverage. Under the ACA, if an employee receives a tax
credit or cost-sharing reduction, then the IRS may charge the
employer a shared responsibility payment under §4980H.
For the tax period ending December 31, 2016, the IRS charged the
Debtors an ESRP for the employees that were allowed a tax credit or
cost-sharing reduction under the ACA. For each month from January
2016 through November 2016, over 450 of the Debtors’ full-time
employees were enrolled in a qualified health plan for which they
were allowed a tax credit or cost-sharing reduction. On December
19, 2018, the IRS sent the Debtors a Letter 226-J with a proposed
ESRP of $818,640.00 for tax year 2016, noting liability was
applicable under 26 U.S.C. § 4980H(b). Ultimately, the amount
was reduced to $778,050.00.
Beginning in 2017, the Debtors did not offer a health plan
offering minimum essential coverage to salon
employees. As a result, CHI accrued ESRP charges for 2017 and 2018.
For each month of tax year 2017, over 350 of CHI’s full-time
employees were allowed a tax credit or cost-sharing reduction by
the IRS. On October 3, 2019, the IRS sent the Debtors a
Letter 226-J certifying that one or more employees were allowed a
tax credit and proposing an ESRP of approximately $13,901,259.96,
but later reduced to $1,311,930.00 upon a showing that the Debtors
had offered minimum essential coverage to at least 95% of their
full-time employees and their dependents.
Bankruptcy and the IRS’s Proof of Claim
The Debtors filed for bankruptcy in 2020. The IRS filed a
Proof of Claim against the Debtors asserting a liability of
$2,094,029.28 and asserting priority status under
§507(a)(8)(E). In the Form 410 Summary, the IRS
identified the tax as an “Excise” tax for the relevant
periods.
The Court looked at two issues in relation to the IRS claims, as
follows:
- Whether the ESRP was an excise tax entitled to priority
under §507(a)(8)(E) of the Bankruptcy Code; and - if the ESRP was an excise tax, whether the amounts claimed by
the IRS for 2016 and 2017 taxes were “on a transaction
occurring within three years of the petition” as required by
§507(a)(8)(E).
The Bankruptcy Code grants priority status to certain allowed
claims. Section 507(a)(8) grants priority to “excise”
taxes:
((8)) Eighth, allowed unsecured claims of governmental
units, only to the extent that such claims are for—
****
((E)) an excise tax on—
((i)) a transaction occurring before the date of the
filing of the petition for which a return, if required, is last
due, under applicable law or under any extension, after three years
before the date of the filing of the petition; or
((ii)) if a return is not required, a transaction
occurring during the three years immediately preceding the date of
the filing of the petition.
Section 507(a)(8)(E).
Is the ESRP an Excise Tax?
The Bankruptcy Code does not define the term “excise
tax.” In United States v. Reorganized CF & I
Fabricators of Utah,
Inc.(“CF&I“), 518 U.S. 213, 224
(1996), the U.S. Supreme Court addressed whether an exaction was an
excise tax entitled to priority under the statutory predecessor to
§507(a)(8)(E) or a nonpriority penalty. The IRS asserted a
claim against the debtor CF&I Steel Corporation for fees
assessed for failing to make annual minimum funding contributions
to a pension plan, as provided in 26 U.S.C. §§4971(a).
Under §4971(a), an employer that failed to make its required
contribution was assessed a tax of 10% on the accumulated funding
deficiency. The debtor failed to pay $12.4 million of the required
contribution into its pension plans for the tax year prior to
filing bankruptcy. The amount due under 26 U.S.C.
§§4971(a) was approximately $1.24 million. The IRS
similarly sought priority status for the exaction as an excise
tax. The bankruptcy court allowed the claim, but determined
it was a noncompensatory penalty, not an excise tax, and denied
priority. The district court and the Court of Appeals for the 10th
Circuit affirmed.
In affirming, the Supreme Court focused on the
operation—not the label—of the provision establishing
the liability. CF&I, 518 U.S. at 224. It
concluded that the Bankruptcy Act of 1978, which codified priority
to several types of taxes, “reveals no congressional intent to
reject generally the interpretive principle that characterizations
in the Internal Revenue Code are not dispositive in the bankruptcy
context, and no specific provision that would relieve us from
making a functional examination of §
4971(a).” Id. The Court noted that a
functional examination is supported by a long history of precedent
in determining whether a tax is an “excise tax” for
bankruptcy priority purposes. Id. ; see
United States v. La Franca, 282 U.S. 568, 571-72 (1931)
(a “tax” and a “penalty” “are not
interchangeable one for the other. No mere exercise of the art of
lexicography can alter the essential nature of an act or a thing;
and if an exaction be clearly a penalty it cannot be converted into
a tax by the simple expedient of calling it
such.”); City of New York v. Feiring, 313 U.S.
283, 285 (1941) (determining whether a “tax” was entitled
to priority treatment under §64 of the Bankruptcy Act of
1938); United States v. New York, 315 U.S. 510,
514-17 (1942) (relying on its decision
in Feiring which examined the effect of the
exaction).
The Court stated that “a tax is an enforced contribution to
provide for the support of government; a penalty, as the word is
here used, is an exaction imposed by statute as punishment for an
unlawful act.” CF&I, 518 U.S. at 224 (citing
to La Franca, 282 U.S. at 571-72). The Court
concluded that the pension provision at issue was obviously penal
in nature. The 10% exaction was not created to support the
government. The legislative committee reports stated that the
previous statutory penalties did not incentivize employers to fully
fund their plans. Id. at 226. Instead, the new
provision would penalize employers directly by requiring them not
only to fund the deficiency but also pay the 10%
exaction. Id. The Court highlighted that the 10%
excise was in addition to the Pension Benefit Guaranty
Corporation’s independent claim to the total amount of the
pension contribution deficiency. Thus, the pension provision had a
primarily punitive aim versus a goal to support the government.
The Supreme Court affirmed the use of this “functional
approach” analysis of an exaction in Nat’l
Fed’n of Independ. Bus. v. Sebelius
(“NFIB”), 567 U.S. 519 (2012), which addressed
whether the individual shared responsibility payment of the ACA
passed Constitutional muster under the Taxing Clause. At the
time of the decision, the individual mandate required most
Americans to maintain minimum essential health insurance coverage.
Under the ACA, if an individual did not maintain minimum essential
health insurance coverage, then the individual was required to make
a shared responsibility payment to the IRS with their taxes and it
was collected like a tax penalty.
After NFIB, many courts grappled with the question
of whether the individual mandate was an excise tax under
§507(a)(8)(E), with differing results. The Court here
focused on the Fourth Circuit’s opinion in Liberty
Univ., Inc. v. Lew (“Liberty”), 733 F.3d 72
(4th Cir. 2013). The Court
in Liberty relied on the Supreme Court’s
analysis in NFIB to determine that ESRP is a tax
under the “Taxing and Spending or General Welfare
Clause.” Liberty , 733 F.3d at 95-96. The
Fourth Circuit applied the “functional approach” and
concluded that the ESRP functioned as a tax and not a
penalty. Turning to the case at bar, the Maryland Bankruptcy
Court ultimately concluded that the employer shared responsibility
payment is an excise tax entitled to priority.
Does the IRS have Priority?
Turning to the second issue, the Court noted that finding that
the ESRP was an excise tax did not end the inquiry. Section
507(a)(8)(E) provides that allowed unsecured government claims are
entitled to priority only to the extent such claims are for an
excise tax on “a transaction occurring during the three years
immediately preceding the petition date.” §507(a)(8)(E).
The parties disputed whether there was a “transaction”
that imposed the ESRP and, if so, when the transaction
“occur(ed)” under the ACA. The Court determined
that it is the underinsured or uninsured employee’s act of
enrolling in a qualified health plan that triggers the ESRP, and
therefore concluded that the “transaction occur(s)” under
§507(a)(8)(E) when an employee who is not offered the minimum
level of insurance coverage and who meets certain financial
standards enrolls in a qualified health plan.
Ultimately, the Court determined that, based on the petition
date of April 23, 2020, the three-year period of §507(a)(8)(E)
began on April 23, 2017. Any ESRP amounts arising from
employee enrollments in a qualified plan prior to that date were
excluded from priority, and would be deemed general unsecured
claims. Therefore, the court granted in part and denied in
part the Debtors’ objection to the IRS claim.
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