Getting Means Test Tax Projections Right

tax calculator-flickr-salfalkoMention tax calculations to a bankruptcy attorney and 7 out of 10 freeze on the spot.

I’m not a tax attorney, they retort.

That’s right, but, if you are a bankruptcy attorney, that doesn’t relieve you  from knowing enough tax to get the means test right.

Not to mention not giving up your client’s tax refund to the Chapter 13 trustee.

Mistakes made simple

It’s so easy to go wrong, when it comes to taxes.

Your petition preparation software has you input the deductions from the debtor’s wages.  By default, those withheld taxes are carried over from the CMI look-back income to the projected future taxes incurred.

Great, no thinking required.

But wait!  Have you verified the connection between the taxes withheld and the actual tax liability?

If not, you’re courting a mistake.

Taxing questions

To figure out whether the withheld taxes are right, or close to right, going forward, you need to ask questions of the documents in your possession and of the client sitting across the table from you.

For the purposes of this exercise, let’s assume that the client tells you that things are essentially unchanged from the situation in the last tax year.

Did client get a refund last year?

A refund indicates that more money is being withheld from the client’s paycheck that he will owe in taxes.  Using the paycheck withholding for projected taxes incurred will overstate the allowable deduction for taxes.

Since we have determined that things are essentially unchanged from the prior year, you need to reduce the tax deduction by 1/12th of the refund received.

If this is a Chapter 13 and your local practice requires the debtor to turn over the tax refund to the trustee, you also need to advise the client to reduce the amount withheld to match the expected tax.  Otherwise, he’ll be living without the amount overwithheld during the year, and handing it to the trustee when the refund arrives.  Not smart.

Because Schedules I and J and the means test are both projections, your  means test income tax number should match the amount withheld for taxes on Schedule I.

Did client owe money last tax year?

If the client wrote a check with his last tax return, or worse yet, owed money and couldn’t write the check, you need to make changes to the tax projections on B-22.

The amount withheld on the pay stubs understates the taxes to be incurred post petition.

Getting a number good for the year as a whole simply requires that you add 1/12th of the amount owing in excess of withholding at the end of the tax year to the “taxes withheld” number from the pay stubs on B-22.

But the problem is a bit stickier.

Suppose it’s July 1 when you’re doing your calculation, and the client is $500 a month underwithheld.  You can add $500/month to his taxes, and going forward, that keeps him from falling any further behind.

But when April comes around, if the client has only added $500/month to withholding for the last half of the year, he’s still facing a $3000 shortfall representing January through June’s underwithholding.

It’s not clear to me whether you can add that amount to the means test deduction, but you certainly want to budget on Schedule J for a “current year income tax catch up” amount.

Otherwise the debtor faces a tax bill for which he has made no provision.

When things change

As we know, not all of our clients live lives without substantial changes.

Another time, we’ll walk through how to approximate the tax numbers when the current year and/or the years to come are not the same as the year represented in the prior year’s income tax return.

More on the means test

Means test and health insurance

Business income and the means test

Escaping the means test altogether

Image courtesy of Flickr and SalFalko. 



When The Means Test Is Not So Mean

Deduct necessary health insurance costs


It isn’t often that the newspaper provides ideas for this site, whose focus is polishing new bankruptcy lawyers.

But a story on the surge in cost for health insurance based on a study by the Commonwealth Fund reminded me to remind you:  the means test allows deduction for the cost of health insurance, even if the debtor doesn’t have health insurance!

The opportunity to deduct expenses that the debtor ought to have  is a gift to our clients from the late Senator Ted Kennedy who introduced this tweak to the  §707(b) list of allowable expenses when BAPCPA was taking shape in Congress.

This section embodies the idea that no filing is abusive unless there is money left after the debtor provides “reasonably necessary”  health insurance; disability insurance; and a health savings account.   On the B-22 A, this provision is found in Line 34.

Like most of BAPCPA, the statute  is not a model of clarity.  Here’s what the committee notes of the form drafters say:

In addition to the expense deductions allowed under the IRS standards, the means test makes provision—in subclauses (I), (II), (IV), and (V) of § 707(b)(2)(A)(ii)—for six special expense deductions. Each of these additional expense items is set out on a separate entry line in Subpart B, introduced by an instruction that tracks the statutory language and provides that there should not be double counting of any expense already included in the IRS deductions.
One of these special expense deductions presents a problem of statutory construction. Section 707(b)(2)A)(ii)(I), after directing the calculation of the debtor’s monthly expenses under the IRS standards, states, “Such expenses shall include reasonably necessary health insurance, disability insurance, and health saving account expenses . . . .” There is no express statutory limitation to expenses actually incurred by the debtor, and so the provision appears to allow a reasonable “monthly expense” deduction for health and disability insurance or a health savings account even if the debtor does not make such payments, similar to the way in which the National Standards give an allowance for food, clothing and personal care expenses without regard to the debtor’s actual expenditures. However, the statutory language might also be read as providing that the debtor’s “Other Necessary Expenses” should include reasonable insurance and health savings account payments. Since “Other Necessary Expenses” are limited to actual expenditures, such a limitation could be implied here. The forms deal with this ambiguity by allowing the debtor to claim a deduction for reasonable insurance and health savings account expenses even if not made, but also require a statement of the amount actually expended in these categories, thus allowing a challenge by any party who believes that only actual expenditures are properly deductible.

The last time I checked, there are no reported cases interpreting this provision of  707(b), so you are writing on a clean slate.  If challenged,  the debtor certainly has right and decency on their side:   no payments to unsecured creditors while the debtor is uninsured.

Given the cost increases in health insurance that the news story sets out, an allowance for health insurance for an above median debtor without should swing your means test results significantly.

Image courtesy of Carlos62