Tax Refunds, Actual Tax Expenses, and the Means Test

The Means Test reduces income by actual tax expenses, among other permitted reductions.  Problems arise when calculating an actual tax expense where there was a refund in the previous year.

A refund occurs when someone over-withholds from their income to pay their taxes.  No one has a crystal ball, of course, so no one can ever know what the final tax obligation will be at the end of the year.

On November 20, 2008, Judge Joel B. Rosenthal of the Massachusetts bankruptcy court ruled that the tax obligation income must be calculated for the six month income period in question. He agreed with In re Lipford (2008 Bankr. LEXIS 1279 (Bankr. M.D.N.C. Apr. 17, 2008)), which stated:

“When the six-month period of Section 101(10A) [of the U.S. Bankruptcy Code] occurs during a period for which federal and state tax returns already have been filed, it is reasonable for the debtor to use the rates indicated on those returns. If the six-month period is only partially covered by a previously-filed tax return, then the debtor should proportionately mix the rate on the return with the present year’s rate for the annualized income. For the period in the new tax year, the debtor should remove from the previous year’s return all actual changes, such as charitable giving, and non-recurring income, loss, and deductions, and add in any new changes that the debtor can demonstrate. This process does not require the debtor’s counsel to be a tax expert. Rather, it gives counsel the ability to accurately represent the debtor’s tax liability.”  2008 Bankr. LEXIS 1279, [WL] at *10.

This is an unfortunate, burdensome, and expensive requirement for an above-median income debtor to obtain bankruptcy protections and relief.  It effectively forces a debtor to pay for a mid-year tax return not otherwise necessary for tax purposes.