Creative Hairdressers, Inc.

Signed: March 3rd, 2022 Ago □□□

SO ORDERED @,

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Ps _ □□

LOF MAS

THOMAS J. CATLIOTA

U.S. BANKRUPTCY JUDGE

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF MARYLAND

at Greenbelt

In re: * Case No. 20-14583-TJC

Creative Hairdressers, Inc., et al. * Chapter 11

Debtors x Jointly Administered with

Case No. 20-14584-TJC

MEMORANDUM OF DECISION

The Internal Revenue Service (“IRS”) asserts a priority claim against debtors Creative

Hairdressers, Inc. and Ratner Companies, L.C. (the “Debtors”) for the employer shared

responsibility payment under §4980H of the Internal Revenue Code, part of the Patient

Protection and Affordable Care Act. The IRS seeks priority status as an excise tax under 11

U.S.C. §507(a)(8)(E). The Debtors object, contending the employer shared responsibility

payment is not an excise tax entitled to priority treatment, but is a nonpriority penalty. The

parties also dispute when the “transaction occur[red]” that gave rise to the employer shared

responsibility payment, as that phrase is used in 11 U.S.C. §507(a)(8)(E) Gi).

For the reasons that follow, the Court concludes the employer shared responsibility

payment is an excise tax entitled to priority and the “transaction occur[red]” at the time an

employee enrolls in a qualified health insurance plan under the Patient Protection and Affordable

Care Act. The Court also concludes that the claim against debtor Ratner Companies, L.C. should

be disallowed

Jurisdiction

The Court has jurisdiction over this matter pursuant to 28 U.S.C. §1334, 28 U.S.C.

§157(a), and Local Rule 402 of the United States District Court for the District of Maryland.

This matter is a “core proceeding” under 28 U.S.C. §157(b)(2)(K) and the Court has statutory

and Constitutional authority to enter a final order.

Background

On April 23, 2020, Creative Hairdressers, Inc. (“CHI”) and Ratner Companies, L.C.

(“RC”) filed for Chapter 11 relief and have proceeded as debtors in possession pursuant to 11

U.S.C. §§1107(a) and 1108.1 The Court entered an order jointly administering these related

cases under the CHI case, No. 20-14583-TJC. ECF 86.

Prior to filing bankruptcy, CHI was one of the nation’s largest independent family-owned

chain of hair salons, operating approximately 800 hair salons under the Hair Cuttery, Bubbles

and Cielo brands. CHI employed over 10,000 full- and part-time employees. RC provided

management services to CHI and certain other affiliated entities.

As is well publicized, at the onset of the COVID-19 pandemic in March 2020, state and

local governments ordered non-essential businesses like the Debtors’ hair salons to close. As a

result of the sudden closure of CHI’s stores, the Debtors were almost immediately depleted of

liquidity, and filed bankruptcy soon thereafter.

1 Unless otherwise noted, all statutory references herein are to the Bankruptcy Code, 11 U.S.C. §§101 et seq., as

currently in effect.

On June 2, 2020, the Court approved the sale of substantially all the Debtors’ business to

HC Salon Holdings, Inc. pursuant to the Order (A) Approving and Authorizing the Sale of

Substantially All of Debtors’ Assets Pursuant to the Amended and Restated Asset Purchase

Agreement, Free and Clear of All Liens, Claims, Encumbrances and Other Interests, (B)

Approving the Assumption and Assignment of Certain Executory Contracts and Unexpired

Leases Related Thereto, and (C) Granting Related Relief. ECF 465. The sale closed effective as

of June 4, 2020. ECF 478.

Pertinent Facts Not in Dispute

CHI was partially self-insured as defined by the Patient Protection and Affordable Care

Act (the “ACA”). The Debtors qualified as an Applicable Large Employer under the ACA.2

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 (“ESRP”).

For the tax period ending December 31, 2016, the IRS charged CHI 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

2 An Applicable Large Employer is described as “an employer that is an applicable large employer (ALE). In

general, an employer is an ALE for a year if it had an average of 50 or more full-time employees (including full-

time equivalent employees) during the preceding calendar year.” IRS’s Ex. A; ECF 881-1 at p. 4 of 7.

proposed ESRP of $818,640.00 for tax year 2016, noting liability was applicable under 26

U.S.C. §4980H(b). IRS’s Ex. A; ECF 881-1. The letter stated:

This letter certifies, under section 1411 of the Affordable Care Act, that for at least

one month in the year, one or more of your fulltime employees was enrolled in a

qualified health plan for which a PTC was allowed. Based on this certification and

information contained in our records, we are proposing that you owe an ESRP of

$818,640.00.

ECF 881-1 at p. 2 of 7.

CHI responded on February 14, 2019, identifying errors, which included the mistaken

identification of some employees as full-time and eligible under the ACA for tax credits or cost-

sharing reductions. IRS’s Ex. B; ECF 881-2. The IRS responded by Letter 227-L dated April

29, 2019, reducing the proposed ESRP to $778,050.00 again noting liability was applicable

under 26 U.S.C. §4980H(b). IRS’s Ex. C; ECF 881-3.

Beginning in 2017, CHI 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

under 26 U.S.C. §4980H(a). IRS’s Ex. D; ECF 881-4. The letter stated:

This letter certifies, under Section 1411 of the Affordable Care Act, that for at least

one month in the year, one or more of your fulltime employees was enrolled in a

qualified health plan for which a PTC was allowed. Based on this certification and

information contained in our records, we are proposing that you owe an ESRP of

$13,901,259.96.

ECF 881-4 at p. 2 of 7.

CHI responded on December 4, 2019, and provided support that CHI had offered

minimum essential coverage to at least 95% of their full-time employees and their dependents.

IRS’s Ex. E; ECF 881-5. The IRS responded by Letter 227-L dated August 31, 2020, reducing

the proposed ESRP for tax year 2017 to $1,311,930.00 and noting liability was applicable under

26 U.S.C. §4980H(b). IRS’s Ex. F; ECF 881-6. The ESRP for 2017 is an estimate and has not

been assessed.

In CHI’s Schedules of Assets and Liabilities, ECF 281, it listed the IRS on Schedule E/F

with a contingent, unliquidated, disputed claim of $778,050.00 for “ACA – ESRP PAYMENT –

2016” and a contingent, unliquidated, disputed claim in the amount of $1.00 for “ACA – ESRP

PAYMENT – 2017-2019.”

The IRS filed Proof of Claim No. 175-1 (“Claim No. 175-1”) against only CHI for

$2,094,029.28, asserting priority status under §507(a)(8). In the Form 410 summary, the IRS

listed an “Excise” for tax period ending December 31, 2016, assessed March 16, 2020, for

$778,050.00, plus $4,049.28 in matured interest and an “Excise” tax for the period ending

December 31, 2017, assessed October 8, 2019, for $1,311,930.00.

The IRS later filed an amended Proof of Claim No. 175-2 (“Claim No. 175-2”). It asserts

the same amounts due, but as to both the Debtors, CHI and RC.

The IRS filed Proof of Claim No. 424-1 (“Claim No. 424-1”). In its papers, the IRS

concedes that Claim No. 424-1 is a duplicate of Claim No. 175-2.

Conclusions of Law

The dispute before the Court raises two questions: (1) whether the ESRP is an excise tax

entitled to priority under §507(a)(8)(E) of the Bankruptcy Code and (2) if the ESRP is an excise

tax, are the amounts claimed by the IRS for 2016 and 2017 taxes “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.

§507(a)(8)(E).3 “Statutory priorities . . . are intended ‘to assure payment, if possible, to certain

classes of claims by requiring that they be paid before others are satisfied.’” New

Neighborhoods, Inc. v. W. Virginia Workers' Comp. Fund, 886 F.2d 714, 718 (4th Cir. 1989)

(quoting L. King, Collier Bankruptcy Manual §507.01 (1988)). Claims entitled to priority are

paid before other unsecured claims. After the payment of priority claims, there is a presumption

that the bankruptcy estate’s remaining assets will be distributed equally among unsecured

creditors. Ford Motor Credit Co. v. Dobbins, 35 F.3d 860, 865 (4th Cir. 1994). “Thus, statutory

priorities must be narrowly construed.” Id. “[I]f one claimant is to be preferred over others, the

purpose should be clear from the statute.” Howard Delivery Serv., Inc. v. Zurich Am. Ins. Co.,

547 U.S. 651, 667 (2006) (citation omitted).

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

3 Both the IRS and the Debtors agree a return is not required to impose ESRP liability on the taxpayer, and therefore

§507(a)(8)(E)(ii) applies.

Supreme Court addressed whether an exaction was an excise tax entitled to priority under

§507(a)(7)(E) (1988)4 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 exaction due

under 26 U.S.C. §4971(a) was approximately $1.24 million.

The IRS 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

4 Section 507(a)(8) is the current version of the same statute.

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.5 At the time of the decision, the individual mandate required most

5 As a threshold matter, the Court had to determine whether it had authority to enjoin the assessment or collection of

the individual shared mandate under the Anti-Injunction Act (“AIA”), which barred suits going forward that sought

to restrain the assessment or collection of any tax. The AIA “provides that no suit for the purpose of restraining the

assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the

person against whom such tax was assessed.” NFIB, 567 U.S. at 543 (quoting 26 U.S.C. §7421(a)). The Court held

that the AIA does not apply to every exaction and it only applies if Congress intended for the AIA to bar the court

from restraining the assessment or collection at issue. Whether the exaction functioned as a tax was not

determinative. Congress’s intent was the sole inquiry. The Court looked to the statute to determine whether

Congress intended for the AIA to apply to the individual shared responsibility payment. The Court found that the

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.6

Under the mandate, if an individual does not maintain health insurance, the only

consequence is that he must make an additional payment to the IRS when he pays

his taxes. That, according to the Government, means the mandate can be regarded

as establishing a condition—not owning health insurance—that triggers a tax—the

required payment to the IRS. Under that theory, the mandate is not a legal

command to buy insurance. Rather, it makes going without insurance just another

thing the Government taxes, like buying gasoline or earning income. And if the

mandate is in effect just a tax hike on certain taxpayers who do not have health

insurance, it may be within Congress's constitutional power to tax.

NFIB, 567 U.S. at 562-563 (citations omitted).

The Court applied a broad standard to determine whether the individual mandate was

considered a tax authorized under Congress’s taxing power: “When the validity of an act of the

Congress is drawn in question, and even if a serious doubt of constitutionality is raised, it is a

cardinal principle that this Court will first ascertain whether a construction of the statute is fairly

possible by which the question may be avoided.” See Id. at 563 (citing Crowell v. Benson, 285

U.S. 22, 62 (1932)).

The Court pointed out that the ACA’s label of the exaction was not controlling. See id. at

564-565. It determined that the individual mandate had attributes of a tax—it is paid to the

Treasury; set in proportion to taxable income, dependents, and the like; and governed by

regulations provided in the tax code. See id. at 563-564.

statute described the exaction as a “penalty”, and that Congress would have named the individual shared payment a

“tax” if it wanted the AIA to apply. Thus, the Court concluded that the AIA did not bar the suit.

6 The law has since changed so that the individual shared responsibility payment is now zero dollars. See Tax Cuts

and Jobs Act of 2017, Pub. L. 115–97, § 11081, 131 Stat. 2092 (codified in 26 U.S.C. § 5000A(c)).

The Court next discussed the “functional approach” standard and the cases that applied

the standard as confirmation that statutory labels cannot be relied upon to establish whether an

exaction is a tax for constitutional purposes. The Court distinguished its reliance on labels when

applying the AIA to statutorily described “taxes”. See, supra n. 5. The fact that the individual

mandate would influence conduct was not determinative because Congress had authorized taxes,

such as the cigarette tax, to deter the purchase of tobacco and nicotine products. The mandate

also raised revenue for the government, and the only negative consequence to the individual was

to pay the exaction or pay for healthcare insurance.

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. See e.g., In re Parrish, 583 B.R.

873, 875 (Bankr. E.D.N.C. 2018), vacated sub nom. United States v. Parrish, No. 5:18-CV-173-

FL, 2018 WL 6273577 (E.D.N.C. Nov. 30, 2018) (the individual mandate is a penalty); In re

Bradford, 534 B.R. 839, 866 (Bankr. M.D. Ga. 2015) (“Exaction is not a penalty in

compensation for actual pecuniary loss under §507(a)(8)(G)”); United States - Internal Revenue

Serv. v. Alicea, 634 B.R. 54, 63 (E.D.N.C. 2021) (individual shared responsibility payment is not

a tax entitled to priority).

The Fourth Circuit addressed whether the ESRP was a constitutional tax in Liberty Univ.,

Inc. v. Lew (“Liberty”), 733 F.3d 72 (4th Cir. 2013). It 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 now to the employer mandate, it is clear from the provision’s face that it

possesses the essential feature of any tax: it produces at least some revenue for the

Government. Indeed, the Congressional Budget Office estimated that the employer

mandate exaction will generate $11 billion annually by 2019.

Looking beyond the essential feature to other functional characteristics, the

exaction the ACA imposes on large employers looks like a tax in many respects.

The exaction is paid into the Treasury, found in the Internal Revenue Code, and

enforced by the IRS, which must assess and collect it in the same manner as a tax.

Further, the employer mandate lacks a scienter requirement, does not punish

unlawful conduct, and leaves large employers with a choice for complying with the

law—provide adequate, affordable health coverage to employees or pay a tax.

Id. at 97–98 (cleaned up). The Fourth Circuit further rejected Liberty University’s argument that

the ESRP had penal characteristics:

The employer mandate exaction is devoid of any scienter requirement and does not

punish unlawful behavior. Further, the exaction is collected by the Secretary of the

Treasury in the same manner as a tax.

Moreover, the amount of the employer mandate exaction is proportionate rather

than punitive. If Liberty offers adequate health coverage, but that coverage fails to

satisfy the employer mandate's affordability and minimum value requirements,

Liberty will be taxed $3000 times the number of employees who receive

government assistance, prorated on a monthly basis and subject to a cap. And if

Liberty fails to offer adequate health coverage to its full-time employees, it will be

taxed $2000 times thirty less than its number of full-time employees—presumably

all of whom are being deprived of coverage—prorated over the number of months

for which Liberty is liable.

Id. at 98 (cleaned up). Thus, the Circuit rejected the argument that the ESRP is a penalty rather

than a tax, and concluded that the ESRP “need not be read to do more than impose a tax.” Id.

Strictly speaking, the holding of Liberty is not determinative here. The Fourth Circuit

was required to determine whether the ESRP should be invalidated as an unconstitutional

exercise of Congressional authority. The Court applied the broad standard stated in NFIB—

“whether a construction of the statute is fairly possible by which the question may be avoided”

and that “every reasonable construction must be resorted to, in order to save a statute from

unconstitutionality.” NFIB, 567 U.S. at 563. In addition, as Liberty recognized, an exaction may

be a tax for one purpose but not another, holding that the employer mandate exaction, like the

individual mandate, was a tax under the Constitution but not for purpose of the AIA. Liberty,

733 F.3d at 88-89. Thus, an exaction may be a tax for constitutional purposes but a penalty

under §507(a)(8)(E). Accordingly, the specific holding of the case—that the ESRP is a tax for

constitutional purposes—does not itself foreclose a court from reaching a different conclusion on

the question whether the exaction is an excise tax under §507(a)(8)(E).

Nevertheless, while the specific holding of Liberty may not be determinative, the

conclusions made by the Fourth Circuit in reaching that determination control. In CF&I, the

Supreme Court determined that “a tax is an enforced contribution to provide for the support of

government; a penalty, as the word is used in the discussion under §507(a)(8)(E), is an exaction

imposed by statute as punishment for an unlawful act.” CF&I, 518 U.S. at 224. The Court also

highlighted that the 10% excise was in addition to the independent claim for pension contribution

deficiency and was primarily punitive.

In Liberty, the Fourth Circuit expressly concluded that the ESRP “does not punish

unlawful behavior.” Liberty, 733 F.3d at 98. It further concluded that “the amount of the

employer mandate exaction is proportionate rather than punitive.” Id. It stated the ESRP

possesses the essential feature of any tax and produces at least some revenue for the government.

In light of these express conclusions, this Court could not conclude that the ESRP is a penalty,

and not an excise tax, under the standards of CF&I. Accordingly, the Court concludes the ESRP

is an excise tax under §507(a)(8)(E).

The Court finds additional support for this conclusion in Fourth Circuit case law

predating CF&I. The Fourth Circuit previously held that an “excise tax is an indirect tax, one

not directly imposed upon persons or property . . . and is one that is imposed on the performance

of an act, the engaging in any occupation, or the enjoyment or [sic] a privilege.” New

Neighborhoods, 886 F.2d at 719 (holding that an assessment made to satisfy workers’

compensation claims where the employer failed to maintain workers’ compensation insurance

was entitled to priority as an excise tax). The Fourth Circuit further announced that an

assessment is an excise tax if it is (i) an involuntary pecuniary burden, regardless of name, laid

upon individuals or property; (ii) imposed by, or under authority of the legislature; (iii) for public

purposes, including the purposes of defraying expenses of government or undertaking authorized

by it; (iv) under the police or taxing power of the state. Williams v. Motley, 925 F.2d 741, 743

(4th Cir. 1991) (granting excise tax priority to a $300 uninsured motorist assessment imposed for

failing to carry liability insurance as a motorist). The ESRP is an involuntary burden imposed by

Congress and, as held in Liberty, was enacted for public purposes, including to raise funds for

the Treasury, and is a valid exercise of Congress’s taxing power. It therefore meets the standard

set forth in Williams. While it is not apparent whether the Fourth Circuit test and its progeny

survives CF&I7, to the extent it does, it only serves to support this Court’s conclusion that the

ESRP is an “excise tax” under §507(a)(8)(E).

Finding that the ESRP is an excise tax does not resolve the dispute. As pertinent here,

§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 dispute whether there is a

“transaction” that imposes the ESRP and, if so, when the transaction “occur[s]” under the ACA.

Congress enacted the ACA “to increase the number of Americans covered by health

insurance and decrease the cost of health care.” NFIB, 567 U.S. at 538-539.

7 See In re C-T of Va., Inc. for a discussion of the expansive nature of the Fourth Circuit definition of “excise tax” in

the context of an assessment like that in CF&I. United States v. Unsecured Creditors’ Comm. of C-T of Va. (In re

C-T of Va., Inc.), 977 F.2d 137, 140 (4th Cir. 1992). This Court is not aware of any case law that specifically alters

the Fourth Circuit’s definition of “excise tax,” even if the holding of C-T might have been the opposite after CF&I.

The ACA “pursues these goals through a complex network of interconnected policies focused

primarily on helping individuals who do not receive coverage through an employer or

government program to purchase affordable insurance directly.” Halbig v. Burwell, 758 F.3d

390, 394 (D.C. Cir. 2014).

The ACA is designed to facilitate the enrollment in qualified plans by employees who are

not offered adequate insurance by the employer. Such employers are charged the ESRP as an

exaction—determined to be an excise tax above—for their failure to provide coverage. The

ACA imposes the ESRP on large employers that either do not offer health coverage or do not

offer a certain level of coverage where the employee “enroll[s] . . . in a qualified health plan with

respect to which an applicable premium tax credit or cost-sharing reduction is allowed or paid

with respect to the employee.” 26 U.S.C. §4980H(a); (b).8 In essence, “§4980H(a) imposes an

8 Sections 4980H (a) and (b) provide:

(a) Large employers not offering health coverage. If –

(1) any applicable large employer fails to offer to its full-time employees (and their dependents) the

opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan (as

defined in section 5000A(f)(2)) for any month, and

(2) at least one full-time employee of the applicable large employer has been certified to the

employer under section 1411 of the [ACA] as having enrolled for such month in a qualified health

plan with respect to which an applicable premium tax credit or cost-sharing reduction is allowed or

paid with respect to the employee,

then there is hereby imposed on the employer an assessable payment equal to the product of the

applicable payment amount and the number of individuals employed by the employer as full-time

employees during such month.

(b) Large employers offering coverage with employees who qualify for premium tax credits or cost-

sharing reductions.—

(1) In general. —If—

(A) an applicable large employer offers to its full-time employees (and their dependents) the

opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan (as

defined in section 5000A(f)(2)) for any month, and

(B) 1 or more full-time employees of the applicable large employer has been certified to the

employer under section 1411 of the [ACA] as having enrolled for such month in a qualified health

assessable payment on an applicable employer who fails to offer coverage to its full-time

employees and their dependents, while §4980H(b) imposes an assessable payment on an

applicable employer who provides coverage that does not satisfy the mandate's affordability

criteria.” Liberty, 733 F.3d at 85.

It is the underinsured or uninsured employee’s act of enrolling in a qualified health plan

that triggers the ESRP. While it is true that the amount of the ESRP is not finally determined or

imposed until a later date, 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. Enrolling underinsured or uninsured employees in

qualified health plans is the very purpose of the ACA. The transaction the statute is intended to

create is the transaction that gives rise to the claim.

Substantial support for this conclusion is found in DeRoche v. Ariz. Indus. Comm’n (In re

DeRoche), 287 F.3d 751 (9th Cir. 2002). There, an employer failed to carry required workers’

compensation insurance. An employee was injured at work on July 30, 1991, and received

compensation from a special workers’ compensation fund that protects employees where the

employer fails to maintain insurance. DeRoche, 287 F.3d at 753. Under the program, the state

workers’ compensation agency sent notice to the employer indicating that the employee had been

paid by this special compensation fund and assessing the employer the liability to reimburse the

fund. Id. The injured employee was entitled to a continuing award, and the workers’

plan with respect to which an applicable premium tax credit or cost-sharing reduction is allowed or

paid with respect to the employee,

then there is hereby imposed on the employer an assessable payment equal to the product of the

number of full-time employees of the applicable large employer described in subparagraph (B) for

such month and an amount equal to 1 /12 of $3000.

compensation amount grew from an initial award of approximately $4,000 to more than $22,000

over three years. The agency sent periodic assessments of the increased amounts. Id. at 754.

After the employer filed a petition under Chapter 7 on November 28, 1994, the state sought a

determination that the claim was not dischargeable pursuant to §523(a)(1)(A) as a priority claim

under §507(a)(8).9 The bankruptcy court held that each separate supplement and continuing

award was a transaction, and therefore awards that were assessed during the three-year period

prior to the petition fall within the period in §507(a)(8) and are nondischargeable under

§523(a)(1)(A). Id. at 754-55. The district court affirmed, and the Ninth Circuit reversed. Id. at

755.

In DeRoche, the Ninth Circuit examined what was the date of the “transaction” to

determine what taxes arose in the three-year priority and nondischargeable period.10 It noted that

the “transaction” in a workers’ compensation case is not so obvious. It recognized numerous

separate acts that needed to occur to impose liability on the employer: (1) the employer failed to

carry workers’ compensation insurance; (2) an employee was injured; (3) the employee filed a

workers’ compensation claim; (4) the Commission determined the employee was entitled to

compensation; (5) the government paid compensation to the injured employee; and (6) the

government assessed the employer for reimbursement of the compensation paid to the worker.

Id. at 755. “The assessment for reimbursement to the [Worker’s Compensation] Fund, which

comes at the end of this sequence of events, is the "excise tax" in question.” Id.

The court held that the transaction “is the act of employing a worker without carrying the

required insurance when the worker is injured. The date of the transaction is the date the

9 Section 523(a)(1)(A) makes nondischargeable a §507(a)(8) tax for the three-year period specified in that section.

10 In a prior case, the Ninth Circuit held that the reimbursement of the special compensation fund by an uninsured

employer was an excise tax under §507(a)(8). See Camilli v. Ariz. Indus. Comm’n, 94 F.3d 1330, 1333-34 (9th Cir.

1996).

employee is injured.” Id. at 753. Accordingly, because the injury occurred outside the three-

year period, none of the amounts were allowed. In reaching that conclusion, the court rejected

the state’s position that each assessment of an award was the relevant transaction for

§507(a)(8)(E) purposes, noting that a “transaction giving rise to a tax is ordinarily an act external

to the taxing authority.” Id. at 756. For similar reasons, the court rejected the employer’s

position that the transaction was either the state agency’s acceptance of the employee’s claim or

the various determination dates by the taxing authority.

The rationale of DeRoche applies here. Although an employee does not suffer a physical

injury, the harm to the employee that the ACA seeks to rectify is not being offered adequate

coverage in the workplace, necessitating the need for the employee to enroll in a qualified plan.

In DeRoche, the employee suffered a single injury and received compensation at different times

over a number of years. Here, the employee enrolls in a qualified plan and the ESRP is

assessable for any month of noncompliance. While the ESRP is assessed in monthly increments

after an employee enrolls in a qualified plan, the post-enrollment ESRP assessments nonetheless

relate back to the original transaction—the date the employee enrolls in the qualified plan—just

as multiple payments made in DeRoche related back to the date of injury. Thus, any ESRP

assessment attributed to an employee’s enrollment before the priority date will be unsecured

even if the employee’s enrollment in a qualified plan continues beyond the priority date. The

difference here is that the employer has the ability to terminate the ESRP by providing adequate

coverage. But while that difference may affect the employer’s ultimate liability, it does not

change the result under §507(a)(8)(E).

The IRS argues the transaction occurs when it sends the certification required by the

statute because the ESRP does not arise until the IRS sends the Letter 226-J. Like DeRoche, this

Court rejects any transaction date predicated on action by the taxing authority. Further, like

DeRoche, the final act by the taxing authority that imposes liability does not control. As the

Ninth Circuit noted, an excise tax requires “an act (or failure to act) by the taxpayer.” Id. at 757.

In addition, the IRS’s position that the date it sends the certification is the date the

transaction occurs could have devastating consequence to a bankruptcy case. Here, for 2016, the

IRS issued the certification required by the statute by letter dated December 19, 2018—almost

two full years after the tax year. ECF 881-1. For 2017, the IRS issued the certification by letter

dated October 3, 2019, some twenty-two months after the tax year. ECF 881-4. A determination

that the date of the certification is the date the transaction occurs could grant priority status to

claims that arise from employees enrolling in health plans as much as five years before the

petition date. That result is neither a narrow reading of a priority provision nor consistent with

the three-year limitation on the priority claim. In addition, the IRS’s view could grant post-

petition administrative claim status under §503(b) to claims that arise from employees enrolling

in health plans as much as two years before the petition date. Here, for example, if the petition

had been filed the day before the IRS sent the December 19, 2018 certification letter, under the

IRS’s view, the claim for 2016 taxes would be a post-petition claim. These results are not

consistent with either the purpose or spirit of §§507(a)(8) or 503(b).

The IRS next argues the transaction occurs as of April 15 of the year following the period

in question. It contends that this date is the date by which employees must file Forms 1040 and

is the final event of claiming the premium tax credit, thereby triggering the ESRP. ECF 881-1 at

p. 17. The Court disagrees that filing the tax return is the transaction under §507(a)(8).

Employees file tax returns on many dates other than April 15 in a given year. While

using April 15 might ease what is undoubtedly a substantial burden on the IRS, there is no

significance to that date other than it is often the un-extended deadline for filing Form 1040.

Moreover, claiming a tax credit on Form 1040 would not be considered a “transaction” in the

usual sense of that word, any more than reporting income or claiming a deduction on the form

would be the “transaction” that generated the income or the deduction. See Transaction, Black’s

Law Dictionary (11th ed. 2019) (“[t]he act or an instance of conducting business or other

dealings; esp., the formation, performances, or discharge of a contract”).

Further, central to the ACA’s effort to increase the number of Americans covered by

health insurance and decrease the cost of health care are the “Exchanges.” 42 U.S.C.

§18031(b)(1).

Exchanges are “governmental agenc[ies] or nonprofit entit[ies]” that serve as both

gatekeepers and gateways to health insurance coverage. See id. §18031(d)(1).

Among their many functions as gatekeepers, Exchanges determine which health

plans satisfy federal and state standards, and they operate websites that allow

individuals and employers to enroll in those that do. See id. §18031(b)(1), (d)(l )-

(d)(4).

Halbig, 758 F.3d at 394. Aside from being a marketplace for the purchase of health insurance,

the Exchanges can determine an individual’s eligibility to obtain advance payment of a health

insurance premium tax credit. Under 42 U.S.C. §18082, advance determination of the applicable

tax credit is made for individuals enrolling in qualified health plans. That section further

provides for the Secretary of the Treasury to make advance payments of the credit to reduce the

premiums payable by the individual. Accordingly, while filing the return may provide

verification of the premium tax credit, the statutory framework is designed to enable employees

to realize the economic benefit of the tax credit long before the return is filed, at the time of

enrollment. Therefore, filing the return is not the transaction under §507(a)(8)(E).

Finally, the Debtors rely on cases that hold that the individual shared responsibility

payment of the ACA is not an excise tax under §507(a)(8)(E) because there is no transaction—

the employee simply failed to purchase insurance. See United States v. Chesteen (In re

Chesteen), 799 Fed. Appx. 236 (5th Cir. 2020). But the individual shared responsibility payment

is not before the Court. As established at length above, the ESRP is triggered by a transaction—

the employee’s enrollment in a qualified plan. Further, as in DeRoche, the Fourth Circuit has

held that excise tax priority can be applicable where a party fails to carry insurance. New

Neighborhoods, 886 F.2d at 719 (“The obligation imposed upon employers [to carry workers’

compensation insurance] is imposed upon employers as a class and liability arises through the

transaction of act of employing.”); Motley, 925 F.2d at 745 (holding that the assessment imposed

on uninsured motorists is an excise tax for §507(a)(8)(E) purposes).

In sum, the petition date was April 23, 2020. The three-year period in §507(a)(8)(E)

begins on April 23, 2017. Any ESRP amounts arising from employee enrollments in a qualified

plan prior to that date are excluded from priority, and will be deemed general unsecured claims.

The Debtors also object to the claim to the extent it is asserted against RC. The IRS’s

amended claim lists both CHI and RC as debtors. Claim No. 175-2. The IRS did not file a claim

in RC’s bankruptcy case, only CHI’s. Because 26 U.S.C. §4980H imposes ESRP liability on

certain “employers,” whether the IRS is entitled to enforce its claim against RC will turn on

whether RC was the applicable employer. Throughout these proceedings, RC has maintained

that it is not an employer. Instead, the record shows that CHI had over 10,000 full- and part-time

employees, operating approximately 800 salons, while RC provided management services to

CHI. ECF 6 ¶¶ 4-5. The IRS has not advanced any evidence to refute this position. Therefore,

the IRS cannot sustain its claim against RC for ESRP liability and the objection to claim is

sustained as to RC.

Conclusion

For the foregoing reasons, the claim is disallowed in its entirety to the extent asserted

against RC. Further, the Court will sustain in part the objection to Claim No. 175-2 and Claim

No. 424-1 against CHI. The claim against CHI is entitled to priority under §507(a)(8)(E) only to

the extent it asserts an ESRP claim arising from employee enrollments in qualified plans after

April 23, 2017. Therefore, the claim for 2017 ESRP is allowed as a priority claim only to the

extent it arises from enrollments after April 23, 2017. The ESRP claim arising from employee

enrollments in qualified plans prior to April 23, 2017, is excluded from priority and is allowed as

a general unsecured claim. Therefore, the claim for 2016 ESRP is disallowed in its entirety as a

priority claim, and the claim for 2017 ESRP is disallowed as a priority claim to the extent it

arises from enrollments before April 23, 2017. A separate order will follow.

cc: Debtors

Counsel for Debtors

Counsel for IRS

United States Trustee

All creditors and parties in interest

END OF MEMORANDUM OF DECISION