United States v. Brown, CV-21-02092-PHX-DWL

CourtUnited States District Courts. 9th Circuit. United States District Courts. 9th Circuit. District of Arizona
Writing for the CourtDominic W. Lanza, United States District Judge
PartiesUnited States of America, Appellant, v. Russell Brown, Appellee.
Docket NumberCV-21-02092-PHX-DWL
Decision Date27 February 2023


United States of America, Appellant,

Russell Brown, Appellee.

No. CV-21-02092-PHX-DWL

United States District Court, D. Arizona

February 27, 2023


Dominic W. Lanza, United States District Judge

This is an appeal by the Internal Revenue Service (“IRS”) arising from the Chapter 13 bankruptcy proceeding of David and Deborah Vallejo (“Debtors”). During that proceeding, the IRS asserted that it was entitled to priority on its claim for just under $1,500 in Shared Responsibility Payments (“SRPs”) that Debtors incurred due to their failure to maintain essential health insurance in 2016 and 2017. The basis for the SRPs was a controversial provision of the Patient Protection and Affordable Care Act (“ACA”), sometimes known as the individual mandate penalty, that has since been rescinded.

The trustee of the bankruptcy estate, Russell Brown (“Brown”), objected to the IRS's priority claim and the bankruptcy court eventually ruled in Brown's favor, concluding in a carefully reasoned order that SRPs are not entitled to priority treatment. Along the way, the bankruptcy court noted some of the unusual features of the parties' dispute. (Doc. 11-1 at 1 [“The [dispute] brings to this Court a trio of this Court's favorite topics: (1) the [ACA], (2) a tax issue which is now just an historical footnote, and (3) an amount in controversy under $1,500. The background leading to this bankruptcy issues


jackpot can be summarized as follows . . . .”].)

Whether SRPs are entitled to priority treatment is a difficult question that has generated an array of conflicting decisions by bankruptcy, district, and circuit courts across the country. Acknowledging the closeness of the question, the Court respectfully disagrees with one portion of the bankruptcy court's analysis and thus reverses.


Under the Bankruptcy Code, certain categories of “expenses and claims have priority.” 11 U.S.C. § 507(a). Two such recognized categories of priority claims are, in shorthand, (1) excise taxes on transactions, as set forth in § 507(a)(8)(E), and (2) taxes on or measured by income, as set forth in § 507(a)(8)(A).

As the Supreme Court has recognized, because priorities deviate from the “equal distribution objective underlying the Bankruptcy Code,” they “must be tightly construed.” Howard Delivery Serv., Inc. v. Zurich Am. Ins. Co., 547 U.S. 651, 667 (2006). Additionally, “the trend of amendments . . . has been to erode the preferred status of taxes.” In re Lorber Indus. of Cal., Inc. (“ Lorber I '), 675 F.2d 1062, 1068 (9th Cir. 1982).


I. Factual Background And Bankruptcy Proceedings

The facts here are simple, straightforward, and uncontroverted.

During the 2016 and 2017 tax years, Debtors did not maintain the minimum essential health insurance required under the ACA and were therefore required to make an SRP pursuant to 26 U.S.C. § 5000A(b) (2017). (Doc. 11-1 at 119-20.)[1]

On February 11, 2020, Debtors filed a Chapter 13 voluntary petition for bankruptcy without having made their SRP payments. (Id. at 23-106.)

On February 24, 2020, the IRS timely filed a proof of claim for unsecured excise and income taxes totaling $5,071.79. (Id. at 107-10 [“Claim 4-1”].)


On January 8, 2021, the IRS filed an amended proof of claim reducing the income tax to $0 and the unsecured excise tax to $1,540.59. (Id. at 111-14 [“Claim 4-2”].)

On February 4, 2021, the IRS filed another amended proof of claim, this time asserting unsecured priority claims totaling $1,451.59. (Id. at 115-18 [“Claim 4-3”].) The income tax remained at $0. (Id. at 118.) However, the IRS altered the kind of tax for which it asserted claims, from claims for an excise tax to “EXCISE-INC” claims. (Compare Id. at 114 with id. at 118.) The operative proof of claim lists two separate “EXCISE-INC” claims, one assessed in 2017 and another in 2018.2 (Id. at 118.)

On May 17, 2021, Brown, as trustee, objected to the claim under 11 U.S.C. §§ 502(a) and 1302(b) and Federal Rule of Bankruptcy Procedure 3007. (Id. at 119-20.) Brown argued that the SRP “is not a tax” or, even if it were, “the SRP is not an excise tax under 11 U.S.C. § 507(a)(8)(E) and does not fit any other category under § 507(a)(8)” that would result in priority status. (Id.)

On August 20, 2021, the IRS filed its opposition to the objection. (Id. at 122.) The IRS argued that the Supreme Court had already determined that the SRP is a tax (not a penalty) in National Federation of Independent Business v. Sebelius (“ NFIB ”), 567 U.S. 519 (2012). (Id. at 122-23.) Accordingly, the IRS argued that the SRP “must necessarily fall within one of the enumerated types of tax entitled to priority set forth in 11 U.S.C. § 507(a)(8).” (Id. at 123.) The IRS concluded that the SRP is either an excise tax or a tax on or measured by income, both of which would be entitled to priority status. (Id. at 123, 127-33.)

II. The Bankruptcy Court's Decision

In November 2021, in a written order issued following oral argument, the bankruptcy court sustained Brown's objection. (Id. at 10-21.) The court addressed the following issues: (1) whether SRPs qualify as penalties or taxes; (2) even if taxes, whether[2] During the underlying proceedings, the IRS asserted that “EXCISE-INC” is a notation by the IRS intended to communicate that the line item may qualify either as an excise tax or as a tax on or measured by income. (Doc. 11-1 at 262-63 [“[T]he way that tax is now coded is as EXCISE-INC which is excise-income because it could be qualified as either one of those taxes.”].)


SRPs further qualify as excise taxes on “transactions” such that they trigger priority status under § 507(a)(8)(E); and (3) alternatively, whether SRPs qualify as taxes on or measured by income such that they trigger priority status under § 507(a)(8)(A). (Id. at 13.)

A. Penalty Or Tax

The bankruptcy court acknowledged that although the ACA purports to characterize the SRP as a penalty, the Supreme Court in NFIB “determined the SRP was a tax.” (Id. at 14.) The bankruptcy court further noted that, under tests set out in In re Lorber Industries of California (“Lorber II'), 564 F.3d 1098 (9th Cir. 2009), and In re George, 361 F.3d 1157 (9th Cir. 2004), courts in the Ninth Circuit consider certain factors when deciding whether an exaction is a penalty or tax. (Id.) Applying those factors, the bankruptcy court concluded that the SRP is an excise tax because the SRP is a “pecuniary burden,” “Congress authorized the SRP,” “the purpose of the SRP is to provide revenue” in addition to offsetting medical expenses of uninsured individuals, the SRP was constitutionally enacted under Congress's taxing power, and “no other hypothesized private creditor could make a claim for the SRP, as the SRP is purely a function of federal statute.” (Id. at 1415.)

B. Excise Tax Under § 507(a)(8)(E)

The bankruptcy court next observed that “[w]hile the SRP is properly classified as an excise tax under the Lorber II and George tests, it does not necessarily mean the SRP is an excise tax within the meaning of § 507(a)(8) of the Bankruptcy Code.” (Id. at 15.) Accordingly, the court focused on the language of § 507(a)(8)(E)(i)-(ii), which affords priority status only to an excise tax on a “transaction.” (Id. at 15-19.) The bankruptcy court concluded that the failure to obtain health insurance as required by the ACA is not a “transaction” for purposes of § 507(a)(8)(E), reasoning that the Ninth Circuit's holding in George-that “the failure to make the transaction of purchasing workers' compensation insurance is the absence of a transaction and, therefore, not an excise tax for purposes of federal bankruptcy law”-similarly applied to Debtors' failure to obtain required health insurance. (Id., internal quotation marks omitted.)


In the course of this analysis, the bankruptcy court distinguished the three cases on which the IRS primarily sought to rely: Matter of Cousins, 601 B.R. 609 (Bankr. E.D. La. 2019), In re Nat'l Steel Corp., 321 B.R. 901 (Bankr. N.D.Ill. 2005), and In re DeRoche, 287 F.3d 751 (9th Cir. 2002). (Id. at 16-19.) For example, Cousins held that a taxpayer exercises his or her right to remain uninsured, thus making the SRP “a tax imposed, ‘upon the exercise of a right or privilege,' making it an excise tax.'” (Id. at 16 [quoting Cousins, 601 B.R. at 620].) The bankruptcy court found this rationale unpersuasive because Cousins “was reluctant to even name the SRP an excise tax” and did not identify how the exercise of a right fits within the “‘transactional' requirement of § 507(a)(8)(E).” (Id. at 16-17.) Next, the bankruptcy court distinguished National Steel Corp., which focused on a franchise tax required by Texas for the ‘privilege to transact business in the state,' from the facts here, reasoning that the “failure to obtain health insurance” is the “absence of a transaction.” (Id. at 17, citation omitted.) The bankruptcy court added: “This Court views a ‘transaction' as requiring an active excise, i.e. the purchase of insurance, not a decision to not buy insurance. Here, the Debtors' decision to not purchase health insurance was a passive choice, a ‘nonexcise' if you will.” (Id.) Finally, the bankruptcy court noted that DeRoche “considered whether an employer's obligation to reimburse the Arizona Workers' Compensation ‘Special Fund' constituted an excise tax under § 507(a)(8)(E).” (Id.) Because “the 9th Circuit identified six events that led to characterizing the tax as an excise tax on a ‘transaction,” and thus the transaction was “not simply the employer's failure to obtain workers' compensation insurance but events subsequent to that passive choice,” the bankruptcy court held that Debtors' conduct was distinguishable and was instead more like the conduct at issue in George. (Id. at 17-18.) Finally, the bankruptcy court identified In re Jones, 610 B.R. 663 (B...

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