Health Reform WK-EDGE SRP mandated by Affordable Care Act is an income tax entitled to IRS priority claim in bankruptcy
Friday, April 9, 2021

SRP mandated by Affordable Care Act is an income tax entitled to IRS priority claim in bankruptcy

By Jeffrey H. Brochin, J.D.

The Shared Responsibility Payment (SRP) that is required to be paid by taxpayers who are without health insurance coverage is not a penalty but rather an income tax.

A federal district court in Pennsylvania has affirmed the ruling of a federal bankruptcy court that the Internal Revenue Service (IRS) is entitled to a priority claim in bankruptcy case for a Debtor’s unpaid SRP because the SRP is an income tax and not a penalty. Although the term "tax" is not defined in the Bankruptcy Code, federal case law has provided various criteria, including functional analysis, in determining that the SRP is a tax (In Re: Robert Szczyporski, Debtor, March 31, 2021, Leeson, J.).

Bankruptcy filing. In 2018, the debtor earned enough income to require him to file an income tax return, but had not obtained health insurance for that year. Consequently, the IRS assessed an SRP against him in the amount of $927. On July 19, 2019, the debtors jointly filed a Chapter 13 bankruptcy case in the United States Bankruptcy Court for the Eastern District of Pennsylvania. The following month, the IRS filed a proof of claim under 11 U.S.C. §507(a)(8) for taxes in the total amount of $18,027.08, which included the SRP of $927 for the 2018 tax year. The IRS listed the SRP as an excise tax and the remaining amounts as income taxes.

The debtors filed an objection to the claim, asserting that the SRP claim is in fact a "penalty" and therefore does not qualify for priority treatment under bankruptcy law. A hearing on the claim was not held until after the Chapter 13 plan was confirmed on February 12, 2020. When the IRS filed a brief in response to Debtors’ objection to the claim, it alleged that the SRP was either an excise or an income tax. The bankruptcy court issued an Opinion and Order overruling Debtors’ objection and holding that the IRS’s claim was entitled to priority under 11 U.S.C. § 507(a)(8). The instant appeal ensued.

Basis for the SRP. The Patient Protection and Affordable Care Act (ACA) (P.L. 111–148) provides that the SRP be assessed on behalf of taxpayers who do not maintain health insurance for at least a month in any given tax year. However, the ACA does not specify whether the SRP is a tax or a penalty. Furthermore, because the Bankruptcy Code itself surprisingly does not define the term "tax," the court looked to federal case law to determine the nature of the assessment (also referred to as an "exactment").

The Supreme Court has held that generally speaking, a tax is a pecuniary burden laid upon individuals or property to support the government, and various Supreme Court as well as lower court opinions have predominantly focused on two aspects of the definition of a tax: (1) involuntariness, i.e., that the charge is imposed regardless of the consent of the individual, and (2) the public purpose. However, beyond those rather simple factors, the courts have added specific factors in what is referred to as the Lorber-Suburban analysis: (1) whether the obligation is an involuntary pecuniary burden, regardless of name, laid upon individuals or property; (2) whether the obligation is imposed by, or under authority of, the legislature; (3) whether the obligation is for public purposes, including the purposes of defraying expenses of government or undertakings authorized by it; (4) whether the obligation is imposed under the police or taxing power of the state; (5) whether the obligation is universally applicable to similarly situated entities; and (6) whether granting priority status to the government will disadvantage private creditors with like claims.

Functional analysis. But the Supreme Court has also held that courts must look beyond labels and conduct a functional analysis to determine if an exaction is a tax or a penalty for bankruptcy purposes, and in conducting such examination, the court should consider whether the exaction looks and works like a tax or a penalty by looking at, inter alia, how it is calculated and enforced.

Using the functional approach of the SRP, the Supreme Court has previously concluded that it is a "tax" for constitutional purposes because it is paid into the Treasury by taxpayers when they file their returns, and for taxpayers who do owe the payment, its amount is determined by such familiar factors as taxable income, number of dependents, and joint filing status. The Supreme Court has further reasoned that the SRP does not have the defining characteristics of a penalty: the payment raises considerable revenue, and it is plainly designed to expand health insurance coverage, therefore, the underlying motive of the SRP does not show that it is a penalty.

Applying the Supreme Court’s prior functional analyses to the question of whether the SRP is a tax for bankruptcy priority claim purposes, the court concluded that under any of the tests outlined by the Supreme Court and in the Third Circuit, the SRP is a tax, not a penalty, in the bankruptcy context. The court’s additional analyses determined that the nature of the SRP is that of an income tax, and they therefore affirmed the ruling of the bankruptcy court giving the IRS priority claim entitlement as to the Debtors’ unpaid SRP.

The case is No. 2:20-cv-03133-JFL.

Attorneys: Kyle Lamar Bishop, U.S. Department of Justice, for Internal Revenue Service. Sergey Joseph Litvak (Sergey Joseph Litvak, Attorney at Law) for Robert Szczyporski and Bonnie Szczyporski.

Companies: Internal Revenue Service

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