Most of us have an idea of what income is for federal or state tax purposes.   Wages are income, as are gains on the sale of stock.  Dividends and interest also qualify.   We know that.  It’s intuitive and easy to understand.

The classic definition of income is that it’s the return on labor or capital.  In fact, if you look through the kinds of things which are considered income in the Tax Code, the “usual suspects” appear in section 61: rents, interest, compensation, alimony, annuity, pensions, among others.

But then comes bankruptcy world

When we get to bankruptcy world, it’s not so intuitive.  Various things are income in bankruptcy world that the Tax Code would not consider income.  For example, an inheritance, a gift, child support, and disability payments–even those not taxed–are income for bankruptcy purposes.

The bankruptcy world definition of income I use is this: “anything that comes in.”  (Get it?  In….Come.)  If if hits your hands or your bank account, it’s income.  That gift from mom for $2000 to help you make ends meet, contributions to your household expenses, an inheritance, child support, you name it.  There are some exceptions to this rule, but you need to tell your bankruptcy lawyer about everything you’ve received so that “income” can be disclosed.

Don’t worry about the exceptions

There are some income sources which are not part of your CMI (“current monthly income”) such as Social Security and, depending on the views of your particular judge, unemployment.  Also, I don’t know of anyone who would consider all the money you’d received from the sale of an asset as income.  Only the gain would be income.  Most of the time, assets are never sold at a gain. Likewise loan proceeds would not be considered income.

But don’t worry about the exceptions.  Your job is to tell your lawyer everything.  Don’t exclude something just because it’s not taxed.  

     A Chapter 13 bankruptcy debtor may deduct the full IRS Standards vehicle allowance even though the actual payment may be less,  per a decision by Bankruptcy Judge Laura Grandy in the Southern District of Illinois case of In re Scott, 10-32582 (August 8, 2011).

     When the Supreme Court ruled in Ransom v. FIA Card Services, 131 S. Ct. 716, 723-24 (2011) that an over median income debtor could not take an I.R.S. Standards Ownership Cost deduction against Disposable Income, (11 U.S.C. 1325(b)(1)(b)), for a vehicle if the debtor did not have an “applicable” vehicle payment, the Supreme Court refused to indicate whether a debtor could take the full amount of that deduction if the actual vehicle payment was less than the amount of the I.R.S. Standards.  The Supreme Court commented in footnote 8 of Ransom at page 727:

“The parties and the Solicitor General as amicus curiae dispute the proper deduction for a debtor who has expenses that are lower than the amounts listed in the Local Standards.  Ransom argues that a debtor may claim the specified expense amount in full regardless of his out-of- pocket costs.  Brief for Petitioner 24–27.  The Government concurs with this view, provided (as we require) that a debtor has some expense relating to the deduction.  See Brief for United States as Amicus Curiae 19–21.  FIA, relying on the IRS’s practice, contends to the contrary that a debtor may claim only his actual expenditures in this circumstance. Brief for Respondent 12, 45–46 (arguing that the Local Standards function as caps).  We decline to resolve this issue. [emphasis added] Because Ransom incurs no ownership expense at all, the car-ownership allowance is not applicable to him in the first instance. Ransom is therefore not entitled to a deduction under either approach.”

     In Scott, Judge Grandy was asked to confirm a Plan that deducted the full I.R.S. Standards vehicle allowance on Form B22C over the objection of the chapter 13 trustee.  The trustee suggested the Judge should limit the amount of the deduction to the actual amount of the vehicle loan payment amortized over a 60 month period.  A ruling in favor of the trustee would have required debtors to increase the amount of money paid to unsecured creditors during the life of the Plan.  Because this decision would affect the calculation of Disposable Income for all over median income debtors with unconfirmed plans in that Bankruptcy District, the practical effect of such a requirement would have caused several active cases to fail in which debtors were already paying as much as they could afford.

     Judge Grandy refused to disallow “standard expense deductions for anything that could be considered a debt payment”, an interpretation proffered by the trustee of 11 U.S.C. 707(b)(2)(A)(ii)(I)’s “notwithstanding sentence”.  “Notwithstanding any other provision of this clause, the monthly expenses of the debtor shall not include any payments for debts”.  Instead, Judge Grandy focused on the B22C form.  Judge Grandy noted the history of the form as being created by the Judicial Conference of the United States – the principal policy making body concerning the administration of the United States Courts comprised of the Chief Justice of the United States, the chief judge of each judicial circuit, the Chief Judge of the Court of International Trade, and a district judge from each regional judicial circuit, with a number of committees and members appointed by the Chief Justice to advise on a wide range of subjects, including rules of practice and procedure and deriving its authority from federal statute 28 U.S.C. 331 [Pretty much her words, not mine].  Judge Grandy also noted the Official Forms prescribed by the Judicial Conference “shall be construed to be consistent with [the Rules of Bankruptcy Procedure] and the Code.”  Fed. R. Bankr. P. 9009.”  [Again, better said by her than me].

     Form B22C directs debtor to list the applicable I.R.S. Standards vehicle ownership expense on line 28a.  From that amount the debtor is directed to deduct the actual amount of the vehicle loan payment on 28b.  The resulting amount on 28c is subtracted from the amount of money a debtor is presumed to be able to pay to unsecured creditors.  The amount subtracted at line 28b is added back at line 47, in effect giving debtor a full deduction of the I.R.S. Standards no matter the amount of the vehicle loan payment, provided there is a loan payment.  [Per Ransom, a debtor is not permitted to claim the I.R.S. Standards if debtor does not have a vehicle loan payment.]

     Because the Official Form permitted a debtor to deduct the full allowance, and based on the history and authority behind the form, Judge Grandy accepted the form as an advisory opinion on how to calculate Disposable Income.

If you’re considering filing bankruptcy, you probably already know how important it is to properly complete Form B22, the bankruptcy means test, which determines whether you are eligible to file chapter 7, or whether you must instead file a repayment chapter 13 case.  The means test also affects how much you must pay into a chapter 13 plan each month towards repaying your debts.

Conventional wisdom has long held that no matter how many motor vehicles you have in your household, you are limited to claiming operating expenses for only two vehicles on the means test form.  Now there is good news for debtors, as a Florida bankruptcy court has ruled that expenses can be claimed for any number of vehicles in the household, so long as such vehicles are reasonably needed by the family.

In re Johnson, case no. 8:11-bk-00810-MGW (Bky.M.D.Fla. July 8, 2011), allowed the debtors to claim the standard $239.00 operating expense allowance for three vehicles, as long as the three vehicles were necessary to the family, as well as an extra $200.00 operating/ownership expense for third vehicle.  This would allow the debtors to “pass” the means test and remain in chapter 7, rather than being forced to convert to chapter 13.

The debtors in Johnson owned three vehicles, two of which were subject to loans.  The third was owned free and clear of liens, and it was used by their teenage daughter to assist in transporting her and her siblings to school, medical appointments and other activities.

The U.S. Trustee objected to the debtors including all three vehicles’ operating expenses on the means test in the amount of $239.00 each, pointing out correctly that the means test form only provides for two vehicles, which in turn implied that only one vehicle could be claimed for each of the two married debtors.

The debtors countered that the U.S. Supreme Court’s recent ruling in Ransom v. FIA Card Services, 131 S.Ct. 716 (2011), mandated a broad reading of the term “applicable number of vehicles” in the means test form.  If they owned and operated three vehicles, they argued, then the applicable number of vehicles for which an operating expense could be claimed was indeed three, regardless of the language appearing on Form B22.  It was, after all, only a form.

The court agreed and allowed an operating expense for all three vehicles, as long as it could be shown that all three cars were reasonable necessary for the debtors to have in their household.

If other courts follow this reasoning, it will be easier for chapter 7 debtors with more than two vehicles in their households to pass the all-important bankruptcy means test.

An individual same-sex married person who files bankruptcy faces a choice whether to include spousal income for purposes of determining how much unsecured creditors could receive from the bankruptcy case.  This choice is not available to the heterosexual married debtor due to an intended consequence of Congressional legislation that requires the heterosexual married debtor include such income.

Moreover, the decision is independent of whether same-sex married couples can file joint bankruptcy, as is occurring in more courts today.  And, this analysis does not consider community property states, though perhaps it should if Congress persists with its definition of marriage.  Caution, this is opinion and the laws of your state may vary.

Logic
From Alice’s Adventures in Wonderland by Lewis Carroll:
[Alice] “Would you tell me, please, which way I ought to go from here?”
“That depends a good deal on where you want to get to,” said the Cat.
Background
Income over certain limits can prevent a bankruptcy debtor from obtaining a chapter 7 discharge of debt and can extend a 3-year chapter 13 case into a 5-year case, thereby increasing the amount paid to unsecured creditors and the trustee.
Bankruptcy Form B22, both B22A in chapter 7 and B22C in chapter 13, requires a married debtor to include spousal income to determine how much debtor must pay unsecured creditors.  Depending on various factors, the amount of spousal income added to the calculation can be reduced on account of some spousal expenses, though not all expenses qualify.
The Defense of Marriage Act [DOMA] is a federal law, found at Title 1 U.S.C. 7, which defines marriage as being only between spouses of the opposite sex.

Discombobulating
Attorney General Eric Holder wrote a letter informing Speaker of the House John Boehner that the President of the United States believed DOMA could not withstand a constitutional test against discrimination against gays.  “[T]he legislative record underlying DOMA’s passage contains discussion and debate that undermines any defense under heightened scrutiny.  The record contains numerous expressions reflecting moral disapproval of gays and lesbians and their intimate and family relationships – precisely the kind of stereotype-based thinking and animus the Equal Protection Clause is designed to guard against.”
Is DOMA dead or isn’t it?  It is too soon to tell.  Here is more from the Holder Letter, “Notwithstanding this determination, the President has informed me that Section 3 will continue to be enforced by the Executive Branch.   To that end, the President has instructed Executive agencies to continue to comply with Section 3 of DOMA, consistent with the Executive’s obligation to take care that the laws be faithfully executed, unless and until Congress repeals Section 3 or the judicial branch renders a definitive verdict against the law’s constitutionality.”

Conundrum
Despite recent bankruptcy court cases criticizing DOMA and permitting same-sex married couples to file joint bankruptcy cases that have been ordinarily reserved only to heterosexual married couples; DOMA has not been ruled unconstitutional.  It remains the law of the land, at least for now.
The Department of Justice will continue to enforce DOMA until and unless Congress or the Court system says otherwise.
Same-sex marriage or civil union exists under various state laws.
In bankruptcy, state law and federal law are in conflict on the issue of marriage.

The Choice
A married person filing an individual bankruptcy must complete Form B22, the form that calculates how much money, if any, must be paid to unsecured creditors.  A heterosexual married debtor filling out Form B22 has to include income received by a spouse on that form.
By definition, marriage under federal law is limited to heterosexual couples, according to DOMA.  Consequently, a person who is same-sex married under state law and who files bankruptcy should not be compelled to include spousal income on B22, because DOMA does not recognize that person as being married.  And as Attorney General Holder indicated in his letter to Congress, the government will continue to enforce the Defense of Marriage Act.
Even though that person is married under state law, DOMA protects the gay or lesbian married debtor from having to include spousal income for distribution to creditors in bankruptcy because federal law, according to DOMA, does not recognize that person as being married.  To rule otherwise, a court would have to overrule DOMA.
In practice, a same-sex married debtor could voluntarily choose to include spousal income when determining whether that income should be used to pay creditors.  In that case any challenge would have to come from an unlikely source – a creditor, the trustee or the court.  It would be highly unusual that any one of the three would try to prevent a debtor from paying more money to creditors than required, regardless of the definition of marriage.

If you are an “above-median income” debtor, you may wonder if you can still file Chapter 7.   The answer to this question is “yes,” but your case will be more complicated.

Although the phrase “means test” suggests a single calculation, in fact, means testing involves several calculations – it would be more accurate to describe these calculations in the plural, i.e. means tests.  Like a double elimination softball tournament, if you lose round one of the means test, you can still qualify for Chapter 7 in round two.

Part one of means testing is the “median income” calculation.  Here, you write down your gross income, month by month for the six months preceding the current month.   I am writing this blog post in June, 2011, so I would be concerned about my client’s gross income for December, 2010 through May, 2011.

Next, you add up your gross income figures for the six month look-back and divide by 6 to get an average, which is called your current monthly income (CMI).  If this average is below the median income number for your household size in your state, you have passed the means test.

If the CMI is above the median income number for your household size in your state, then you move to round two to see if you can qualify for Chapter 7 under a more detailed budget evaluation, the purpose of which is to determine whether you have any “disposable income.”

In my practice I use a median income + 20% rule of thumb.  Generally, if my client’s CMI is no more than 120% of the state median, there is a fairly good chance I will be able to show that my client has little or no disposable income, and thus would be eligible to file a Chapter 7.

I have represented clients whose CMI is double the state median number, but who could still qualify for Chapter 7.  This is unusual, but it does happen.

There is both an art and a science to means testing calculations.  Sometimes, waiting a month or two can make a huge difference because of the change in the months used in the look-back period.   There is also a growing body of rules about how you treat the income of a non-filing spouse, self-employment income and other unique situations – this is where the counsel of an experienced consumer bankruptcy lawyer can be essential.

An important point to remember – even if you think that you earn too much to qualify for a Chapter 7, you will not know for certain until your lawyer plugs your income and expense numbers into the means test and analyzes the results.

If you’re filing for bankruptcy, do you still have to pay back creditors?  Depending on how your local court looks at it, that old car may save you $200 a month.

When you file for bankruptcy, you’ve got to pay unsecured creditors an amount equal to the projected disposable income available to you during a three to five year period.  The amount varies on a case by case basis, and can be as little as $0 up to 100 per cent of the total unsecured debt.

Before we dive deeper, let’s recap the idea of projected disposable income.  As my colleague, Binghamton bankruptcy lawyer Peter Orville said in a previous article here on Bankruptcy Law Network:

The result of the means test is called your “projected disposable income”.  If it is less than $166.66 per month, you have overcome the presumption of abuse, and should be able to file a Chapter 7.  If you cannot overcome the presumption of abuse, you may be limited to a Chapter 13 with a payment plan over a 5 year period.

To get through the means test, your lawyer’s going to compare your income and your expenses.  Depending on your income level, that comparison takes different forms.

If your income during the 6 months immediately prior to filing for bankruptcy is below the state median income for a household of your size then we look at actual income and subtract reasonable expenses to determine the amount of disposable income available to pay creditors.

If, on the other hand, your income during the 6 months immediately prior to filing for bankruptcy is above the state median income for a household of your size then we look at your income and subtract expense standards used by the Internal Revenue Service to determine ability to pay delinquent taxes (not that you owe any taxes, it’s just the standards the U.S. Bankruptcy Court uses for these sorts of calculations).  Specifically, National Standards and Local Standards tables show allowed deductions and IRS collection guidelines explain how to apply the standards, though courts are unwilling to rely on the guidelines to interpret bankruptcy law.  These standard deductions could be more or less favorable than actual expenses incurred by a debtor.

One of the expense categories had to do with automobiles.  Car expenses are divided into two categories, one for ownership expenses associated with the vehicle, and one for operating expenses for the vehicle.  If you owned or leased a car you got a standard expense associated with operating it, and a second one for ownership.

The Supreme Court decided a recent case that cleared up our ability to deduct certain car-related expenses in our calculation of projected disposable income.  In Ransom vs FIA Card Services N.A. the Court decided a debtor has to have a loan or lease payment to be able to also deduct an ownership expense under those IRS standards.

But what Ransom clarified, it also left murky.

The ownership segment was designed to cover the cost of a lease or car finance payment, but even if you didn’t owe money on the car you could still take an additional $200 for car expenses if the vehicle was either more than six years old or had at least 75,000 miles.

This special expense didn’t appear on the books, but the IRS allowed it as a way to account for the fact that people who were driving around older cars probably had some extra expenses associated with keeping it road-worthy.

But now even that extra $200 expense isn’t uniformly accepted.

The Central District Bankruptcy Court of Illinois case of In re VanDyke rejected the supplemental $200 old car expense on the basis that the expense is not specifically part of the National or Local Standards as required by the Ransom decision.

But the U.S. Bankruptcy Court Montana disagreed in the case of In re Baker, holding the deduction as valid.  Noteworthy in the Illinois case is that the vehicle was inoperable, though the bankruptcy judge pointed out an allowance could be appropriate if debtor intended to repair the vehicle to running condition during the course of the bankruptcy case.

So will you be able to deduct that extra $200 for your old car?  It depends on where you live – and it may be a fight your bankruptcy lawyer will need to take on for you.

Image credit: Bogdan Suditu/Flickr

Yesterday, the United States Court of Appeals for the Fourth Circuit (Maryland, Virginia, West Virginia, North and South Carolina) affirmed the bankruptcy court’s decision to dismiss the debtors’ Chapter 7 case based on the totality of the circumstances under 11 U.S.C. § 707(b). 

The court noted that the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was intended to “relax[ ] the standard for dismissing a petition brought under Chapter 7 and characterized as abusive.”  An essential element is the “means test” formula in order to determine those debtors who can repay a portion of their debts and debtors who cannot.  When a family’s household income exceeds the applicable State median income, the means test formula is applied to create a rebuttable presumption of abuse.  The “means test” takes into account the debtor’s monthly income and allowed expenses under IRS collection standards and other authorized expenses.  If there is sufficient income to pay creditors according to a statutory formula, then the presumption of abuse arises and the case is subject to dismissal.

In Calhoun v. United States Trustee, the debtors were a retired couple seeking to discharge over $100,000.00 in unsecured debt.  The husband debtor received approximately $7,313.00 a month from two retirement plans and an additional $1,459.00 in Social Security benefits.  After taking into account the authorized expenses and other allowed deductions, there was insufficient income remaining to trigger the presumption of abuse under the “means test.”  However, the bankruptcy court then looked to § 707(b)(3) which allows a court to consider whether a bankruptcy filing is abusive based on “bad faith” or whether “the totality of the circumstances” of the case demonstrate abuse.

Here, the Fourth Circuit agreed with the bankruptcy court’s determination that the debtors’ filing was abusive based on the totality of the circumstances.  The court specificially noted that the debtors’ had previously made payments to unsecured creditors of almost $2,700 a month prior to filing bankruptcy; that there was not sudden illness, calamity, disability or unemployment necessitating bankruptcy and that the debtors’ budget bordered on the “extravagent” and leaves “ample room for reduction.” 

Of particular note and cause of concern is the Court’s questioning of $930.00 a month for food, clothing, housing supplies and personal care claiming that such expense was excessive when the expense is expressly authorized under the IRS Collection standards.  The court complained also that $439 a month was paid on a life insurance policy for which the spouse was the beneficiary even though upon husband debtor’s passing, wife would receive 75% of his monthly income yet life insurance is expressly authorized under the means test.  The court was further bothered by the fact that the debtors were paying their unsecured creditors for a period of 22 months before filing for bankruptcy protection.

For attorneys in the Fourth Circuit, the court declined to expressly overrule In re:  Green which sets forth five factors in identifying whether a chapter 7 case constitutes “substantial abuse.”

A federal appeals court has added its voice to the growing number of cases which hold that a debtor who converts a chapter 13 case to chapter 7 is still subject to section 707(b)’s income eligibilty standards for filing chapter 7.  Left unanswered, however, is the question of what time period must used for the means test’s six month look-back period for calculating income: is it the six months prior to filing the chapter 13 case, or the six months prior to converting to chapter 7?

In this consolidated appeal of two Iowa and Minnesota cases, In re Chapman and In re Cruse, Nos. 10-6046 and 10-6047 (8th Cir. BAP Mar. 11, 2011), the debtors had filed chapter 13 after the 2005 Bankruptcy Reform Act.  After changes in circumstances, they converted their chapter 13 cases to chapter 7, asking for a discharge of their debts prior to completion of their chapter 13 plans.  The U.S. Trustee objected to their chapter 7 cases under bankruptcy code section 707(b).  This section requires that debtors file chapter 13 rather chapter 7 if their income, as calculated under the byzantine “means test” formula, shows they can afford a payment toward their debts in chapter 13, or if their actual income and expenses show that as well.

The debtors argued that under the actual language of 707(b), that section only applied to a debtor who filed her case under chapter 7, and not to a debtor who converted her case to chapter 7.  They also argued that Congress did not intend to subject a debtor, who had made a good faith effort to repay her debts in a chapter 13 case only to have her plans derailed by changes in circumstances, to either the strictures of the means test, or the actual income and expenses test, of section 707(b).

The bankruptcy courts agreed with the debtors, ruling that section 707(b) only applied to cases originally filed under chapter 7, not to conversions to chapter 7.  The U.S. Trustee appealed, and the bankruptcy appellate panel ordered the two cases consolidated for the appeal.

The appeals court noted there was a split of authority on this question, with six reported cases allowing conversion to chapter 7 without consideration of section 707(b), and five reported cases applying section 707(b) even to cases that were converted to, rather than filed under, chapter 7.

In ruling against the debtors, the appeals court held that under long-standing Eighth Circuit federal appeals court precedent, the term “conversion to chapter 7″ means the same thing as “filed under chapter 7.”  The court was not swayed by the debtors’ argument that such precedent was pre-Bankruptcy Reform Act and thus was no longer valid.  However, the appeals court did not address the time periods to be applied in the means test for debtors converting to chapter 7, making further litigation on this question likely.

The shocking realization is that your spouse might have to contribute to your Means Test-required payments even if you file alone.   You aren’t happy about this at all.  ”But they’re my debts.  Why should my husband or wife have to contribute?”  Because that’s the law.  Your income includes all regular contributions to the household expenses of yourself and your dependents, including those from your marital partner.

The Marital Adjustment is how we get to deduct your spouse’s separate expenses from your income.  They must truly be separate, like accurate payroll withholdings.  But it’s not enough to say that the s/he has separate credit card charges.  For example, a charge for food, clothes, furniture, or even gasoline or car repairs could be a regular contribution to the household expenses of yourself or your dependents.

How about separate mortgage payments by your spouse for a home you live in but don’t own?  OUCH !!  Courts are giving us different decisions, even if in they are in the same state (although different districts).  Compare In re Trimarchi, 421 B.R. 914 (Bankr. N.D. Ill. 2010) (is part of the debtor’s income) with In re Clemons, 2009 Bankr. LEXIS 1959 (Bankr. C.D. Ill 2009) (deducted separate expense).

An angry husband or wife might simply refuse to cooperate, but you cannot file your bankruptcy case without the that income and expense information.  The information must be accurate, of course, because the Means Test form is signed under penalties of perjury.  Documents must be provided or there’s no Marital Adjustment deduction.  See In re Dugan, 2008 Bankr. LEXIS 2813 (Bankr. D. Kan. 2008). 

Are you ready to subpoena your angry partner?  I hope that your spouse, instead, will see the benefit to your entire family of you getting out of debt.

I’m a big fan of Home Depot.  I love the rows of lumber, the acres of tools and doo-dads.  Honestly, it makes me feel macho just being there.  It’s as if I could go out and build a home like Michael Landon in Little House on the Prairie.

I mean, just look at all the do-it-yourself books on home renovation and repair!  Shelves and shelves of easy-to-read guides will tell you how to grout, spackle, tile, shingle and do all manner of electrical and plumbing jobs without the need for costly contractors.  Majestic!

But my parents didn’t raise a fool.  I know full well that I’d most likely construct a rickety shack that would blow down in a weak wind.  In fact, I learned my lesson about a decade ago when I decided to strip the old paint off a closet door.  Half a door and three days later, I gave up.  The half-stripped door taunted me for years until I finally re-painted it in shame.

There’s a difference between a how-to book and knowing how to do something.

If you surf online for more than 5 minutes you can find a bunch of sites with do-it-yourself means testing.  Take just a few short minutes and you’ll be able to see if you qualify for Chapter 7 bankruptcy.  If you don’t qualify, you’ll learn how large your Chapter 13 bankruptcy Plan payment will be.

Sounds awesome, right?  The problem is that these calculators don’t come with enough knowledge to help you fully understand all of the deductions and allowances that you can take.  Some of the calculators aren’t up-to-date, and others are just flat out wrong.

In the past few months I’ve had countless consumers come through my doors waving the results of their DIY means testing calculators triumphantly, only to learn that they did not qualify for Chapter 7 bankruptcy at all.  These people end up not only disappointed but also frustrated that wasted their time sitting behind a computer when they could have gotten some answers from me more quickly.

I’ve even taken the liberty of running my own clients through these calculators after manually doing a means test on their behalf.  The results range from laughable to absurd, though once the DIY folks came fairly close to hitting the mark.

So if you’re considering doing a do-it-yourself means test, remember that it’s a useful exercise to get a sense of your financial situation – but don’t rely on it.  Doing so may lead to bad things in your bankruptcy case.

Image credit:  seanfraga/Flickr