January 23, 2023
By: William L. Hallam
As originally enacted, the Affordable Care Act (“ACA”) required most people to maintain health insurance. Those who did not maintain the required insurance were obligated to pay a “shared responsibility payment” (“SRP”), often referred to as the ACA “individual mandate,” through their annual federal income tax returns. Although the SRP was repealed as of 2019, the repeal did not excuse taxpayers from paying the SRP for tax years 2018 and earlier. Consequently, in the words of the concurring opinion in the January 19, 2023 opinion of the U.S. Court of Appeals for the Fourth Circuit in United States v. Alicea, et al., “The smoke of battle lingers still, however, in our fine bankruptcy courts of all places.”
The debtors in the case, Fabio Alicea and Sarah Zabek, did not maintain the health insurance required by the ACA. They did not include the SRP when they filed their 2018 income tax return. Then, they filed a Chapter 13 bankruptcy case. The IRS filed a proof of claim for the unpaid SRP and asserted that the claim was entitled to priority under Bankruptcy Code § 507(a)(8). That section affords priority to a claim for a “tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition.”
The Debtors objected to the claim, asserting that the SRP was not a “tax,” but a “penalty” assessed against them for failing to maintain health insurance. They relied on the Supreme Court’s decision in National Federation of Independent Business v. Sebelius in which the Court held that the SRP was not a tax for purposes of the Anti-Injunction Act. That Act prohibits lawsuits to “restrain the assessment or collection of any tax.”
The IRS also relied on Sebelius. It noted that, although the Supreme Court held that the SRP was not a tax for purposes of the Anti-Injunction Act, it also said that whether the SRP was a tax for purposes of that Act “does not determine whether the payment may be viewed as an exercise of Congress’s taxing power” and that the SRP was constitutional because it fell within the taxing power.
The Bankruptcy Court agreed with the Debtors. So did the United States District Court on appeal. The IRS appealed the lower court decisions in favor of the Debtors to the Fourth Circuit. The Fourth Circuit sided with the IRS and reversed the decisions of the lower courts.
The Fourth Circuit began its analysis by noting that there is a long line of cases, including a Supreme Court decision, holding that whether an obligation is a tax for bankruptcy purposes does not depend on the label given to the obligation by the applicable statute. Rather, whether an obligation is a tax for bankruptcy purposes requires “a functional analysis” looking to “the operation of the provision using the term in question.” Under a functional analysis, an obligation is a tax if it is “an enforced contribution to provide support of the government.” It is a penalty if it is “an exaction imposed by statute as punishment for an unlawful act.”
Because of the history of ignoring labels and using a functional analysis when determining whether an obligation is a tax for bankruptcy purposes, the Fourth Circuit said that the Supreme Court’s holding that the SRP was not a tax for purposes of the Anti-Injunction Act was not dispositive. The Court declined to accept the argument that when the Supreme Court held in Sebelius that the SRP was not a tax for Anti-Injunction Act purposes, it “silently upended bankruptcy practice and overruled a long line of cases.”
Applying a functional analysis, the Fourth Circuit concluded that the SRP is a tax. The Court said:
The SRP is imposed by the government under its taxing power on a large identifiable class of people (uninsured, non-exempt taxpayers), and the SRP is collected by the IRS as part of the regular income tax filing process. The SRP serves public purposes, as it raises some amount of revenue for the government and encourages individuals to maintain health insurance, which reduces the expenses of providing medical care to the uninsured borne by governments and medical providers.
Furthermore, the Fourth Circuit rejected the Debtors’ argument that the SRP was not a tax because its primary purpose “was to encourage the purchase of health insurance, not to raise revenue.” The Fourth Circuit cited Sebelius for the proposition that the “essential feature of any tax” is that it “produces at least some revenue for the Government” and that “taxes that seek to influence conduct are nothing new.” The fact that the SRP was intended to encourage the purchase of health insurance did not prevent it from being a tax.
Because Bankruptcy Code § 507(a)(8) does not afford priority to all claims for taxes, but only for a “tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition,” determining that the SRP was a tax for bankruptcy purposes did not end the inquiry. “The Debtors argued that even if the SRP was a tax, it was not entitled to priority because ‘[t]he threshold question of whether the [SRP] is triggered is not answered by reference to how much income an individual earned, but by reference to whether an individual had health insurance.’” The Fourth Circuit rejected this argument, saying:
[T]he bankruptcy statute gives priority to claims for taxes measured by income, not claims triggered by a particular income level. Even if income has nothing to do with triggering liability for the SRP, the amount owed for the SRP is measured by income. (Emphasis in original)
Although the Fourth Circuit only addressed the issue of priority of a claim for the SRP, its decision that the SRP is a tax entitled to priority under Bankruptcy Code § 507(a)(8) has implications for the ability of a debtor to discharge SRP obligations. Bankruptcy Code § 523(a)(1)(A) provides that a discharge entered in a Chapter 7 bankruptcy case does not discharge liability for “a tax…of the kind and for the periods specified in section…507(a)(8) of this title.” Thus, in a Chapter 7 case, not only would SRP obligations have to be paid before garden variety unsecured claims if there were assets in the debtor’s estate to pay claims, but the debtor would remain obligated to the IRS for whatever was not paid from the debtor’s estate. Although the concurring judge said, “This fight [over the SRP] is over. R.I.P.” for debtors who owe SRP obligations to the IRS, the fight may not be so over after all.