Health Reform WK-EDGE It’s a penalty! No tax, no priority status for IRS
Monday, February 26, 2018

It’s a penalty! No tax, no priority status for IRS

By Anthony H. Nguyen, J.D.

An exaction not enacted for the primary purpose of fiscally supporting the government is a penalty that should not be entitled to priority as a tax claim. An Internal Revenue Service (IRS) exaction for failure to purchase health insurance in accordance with the Patient Protection and Affordable Care Act (ACA) (P.L. 111-148) individual mandate is considered a penalty, not a tax. The exaction is not entitled to priority status under the Bankruptcy Code (In re Chesteen, February 9, 2018, Brown, J.).

Background. The individual debtor filed for relief under Chapter 13 of the Bankruptcy Code and schedule a priority claim in his bankruptcy petition to the IRS based on estimated amounts owed to the IRS for 2015 and 2016 taxes. Subsequently, the IRS filed multiple amended proof of claims with different priority debts. The fourth amended proof of claim included listed an additional $695.00 as an "excise tax." In its response to the debtor’s objection to its proof of claim, the IRS described this "excise tax" as the debtor’s shared responsibility payment liability under Internal Revenue Code § 5000A for failure to maintain health insurance in 2016.

Penalty, not tax. In order to determine whether the individual mandate of the ACA is a "tax" granted priority under IRS code or a "penalty," the court needed to determine whether the primary, or dominant, purpose of the individual mandate or the "shared responsibility payment" was to support the government or to punish or discourage certain conduct. The court stated that Supreme Court had emphasized the distinction between a penalty and a neutral exaction—a penalty as an exaction imposed by a statute as punishment for an unlawful act.

If an exaction is labeled a sanction, a fine, or a forfeiture, it can more readily be classified as a penalty and thus not a tax motivated primarily by revenue raising concerns. However, the court added even if a tax is imposed upon a subclass of taxpayers rather than the public in general, this does not necessarily mean that the exaction is a penalty.

The court found that the ACA individual mandate is a penalty designed to deter citizens from living without health insurance. Under the ACA if an individual does not maintain health insurance, the consequence is an additional payment to the IRS when taxes are paid. Failure to make the individual mandate payment does not result in typical consequences associated from non-payment of taxes, such as wage garnishments or tax liens. Instead, the court noted that the penalty is having an exaction deducted out of future tax returns.

Congress itself labeled the ACA individual mandate a "penalty" and not a tax. Under 26 U.S.C. §5000A, the ACA’s individual mandate is referred to as a "penalty" eighteen times; not once does it refer to the exaction as a "tax." Thus, it could not be said that the ACA individual mandate was an exaction imposed for the purpose of supporting the government. Congress’s primary, or dominant, purpose of imposing the individual mandate of the ACA was not to support or fund the government fiscally, but to discourage Americans from living without health insurance coverage. As such, the court held that the individual mandate exaction was not a tax and the individual’s objection to the IRS’ proof of claim was sustained.

The case is No. 17-11472.

Attorneys: Rachel Thyre Anderson (Law Office of Rachel Thyre Anderson) for John D. Chesteen, Jr. John M. Bilheimer, U.S. Department of Justice, for U.S. Internal Revenue Service.

Companies: U.S. Internal Revenue Service

Cases: CaseDecisions GeneralNews IndividualMandateNews TaxExemptionNews LouisianaNews NewsFeed

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