Bankruptcy Planning & The Means Test

The rookie bankruptcy lawyer reported her client had borrowed from his 401(k) and proposed to pay down some taxes before filing.  Two questions popped to my mind:

  1. Are the taxes which the client was worried about priority taxes?
  2. If so, would the absence of those taxes alter the results of the means test analysis?

Debtors frequently don’t grasp that some taxes are dischargeable. They have been so fixated on their vulnerability to tax collection tactics that they can’t imagine they have a choice about paying the tax.  Remember that income taxes that are not priority claims within the meaning of § 507(a)(8) are generally dischargeable.  (The rule is actually more complex than that but if the tax isn’t at least three years old, it isn’t dischargeable.)

If the tax is a priority, any pre petition payment of that tax isn’t likely a preference, since a transfer is a preference only if it allows the recipient to get more than it would have received as a distribution in the bankruptcy.

On the other hand, consider the consequences if the tax is a dischargeable tax. The debtor has just spent precious retirement dollars on a tax that would have become non enforceable with the bankruptcy filing.  Not an optimal result.

The second question to consider is whether the payment of the priority tax alters the means test results. Priority taxes (in deed, all priority claims) are deductible on form B-22.   If the client is above median and exposed to a presumption of abuse, you don’t want to eliminate debts that are deductions on the B-22 until you know that the client will not, as a result, trigger the presumption.

With complexities like these, it’s no wonder our clients think they have been subjected to a game of Twenty Questions writ large.  But without answers to such questions, you can’t deliver reliable advice.

More means test thoughts:

Does the means test apply?

Means test overstates the obligation

Don’t understate means test deductions

Image courtesy of CarbonNYC

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  • Great blog entry, Cathy. I’ve been a fan of your blog and appreciate your insight–a very valuable resource for us more junior practitioners.

  • Great tip Cathy! I’m going to have to make a mental note of this in case I encounter it in the future. Thanks for the resource for those of us newer to the bankruptcy field.

  • Richard

    I enjoy your blog too. Thanks for your efforts.