As if the means test wasn’t illogical and opaque enough, consider  the unwritten provision for old cars.

Where do you find the unwritten allowance?  It’s not in the Bankruptcy Code but in the Internal Revenue Manual at 5.8.20.3. The IRS  allows a delinquent taxpayer with a paid for car more than 6 years old or with more than 75,000 miles to deduct an extra $200 for the expense of operating an older or high mileage vehicle.  And so, it appears, do bankruptcy judges.

Now, there is a whole other discussion about how or why the IRS’s manual for its collection agents should be grafted onto the Bankruptcy Code.  And if this aspect of the IRS’s application of its standards is incorporated into the means test, what other provisions might be next?  Dollars to doughnuts, it won’t be one that sorta benefits those foolish enough to have a paid for car.

Anyway, my thanks to attorney Roxanne Daneri of Sacramento who shared the online location of this provision with me.  Several times in the past years, I had gone looking for the URL for this provision without success.  The UST has long  offered  the “clunker allowance” as a sop for their position that with no debt on a car, the debtor didn’t get an ownership allowance.  That position has since, of course, been cemented by the Supreme Court in Ransom.

So, add to your client interview checklist the mileage on the client’s vehicles.  Perhaps the client needs to drive the car around the block a couple of times to make that 75,000 mile point.  Or wait to file to til the new model year.  That mileage or sheer age may eat up another $200 of CMI.  Then, join me in wondering if the means test doesn’t reward the wrong kind of debtor behavior?

Image courtesy of Bogdan Sunitu.

The client hadn’t revealed to the young lawyer bonuses that he had received in the means test look back period. The lawyer had a paystub for every period in the six months, but still missed this income.  When pressed on the issue, the client disclosed some, but not all, of the irregular income.  (The  debtor’s failure to come totally clean is an issue for another day).  The trustee had objected and the case was stalled.

Here’s where Fredrick’s double check would have exposed the client, and the problem:  Fredrick  takes the year-to-date income on the oldest paystub in the series, adds the gross income in the next paystub, and compares that sum to the year-to-date income in the pay stub in hand.  The two numbers should match.

If the numbers don’t match, there is compensation paid between the two, apparently sequential pay stubs.  It could be a bonus, a commission check, or benefits cashed out.  But something was paid between those two payment advices if the arithemetic doesn’t check out.

The bankruptcy lawyer is then on notice that the whole story does not appear in the papers in hand.  Back to the client for more information.

I have to say that lots about the presentation on due diligence seemed appropriate for a perfect world, where time and money are freely available; that isn’t where I practice.   But this little exercise is cheap, easy and within the mathematical skills  of a lawyer!   What excuse is there not to be at least this diligent?

Image courtesy of antwerpenR.

Drafters of the official bankruptcy forms have excised “household size” from the B-22 where we calculate the part A IRS standard allowances.  In its place is “applicable number of persons”, which the form indicates is the number of exemptions the debtor would currently be allowed on their tax return plus the number of other persons the debtor currently supports.

Did the courts reject “heads on beds” while I wasn’t looking?  So uniformly that the form takes a position in the tussle between tax rules and census definitions to determine household size?  The statute, 707(b)(6), still speaks of debtors whose income is less than the median state income for a “household” of that size.  So why the change?

There has always been a mismatch between the statutory language and the experiences of real-life debtors and their living situations.  The range of living arrangements, even when the household members are related, runs the gamut from the household member who is absolutely dependent on the debtor, to those to whom the debtor provides room and board but nothing else, to the roomer who perhaps only sleeps in the debtor’s home.

The “heads on beds”  measure is objective and captures the real cost of keeping a roof over people’s heads:  rent, heat, power, and water.  It is not necessarily a good measure of food, clothing and health care, depending on the arrangements among those living under that particular roof.

I hope I can scrounge up the back story on this change.

As  practitioners, if the form drafters’ approach is adopted by courts, I see a couple of ways to correct for any understatement of expenses this produces.

First, it suggests that money that a roommate or other non-tax dependent contributes is not money contributed for the debtor’s expenses, but for the expenses of the contributor. By taking that money out of the income equation, we get a more accurate result.

Second,  we look at line 35, “continued contributions to the care of household or family members” to capture the cost of  room, board and incidentals provided to others who live in the house but may not be dependents for tax purposes.

Living with BAPCPA over time does not seem to guarantee that things become easier.  I’m back to my theme that the means test is, first and foremost,  a platform for advocacy  by bankruptcy lawyers for their clients.

More on means test:

• The disappearing deduction
• Mean and meaningless
• Getting business income correct
• Means test and exemption see saw

Image courtesy of Flickr.

Yet as I reviewed a B-22 for a rookie bankruptcy lawyer, I found all of the corporation’s gross income included in the means test for the individual shareholder.  When questioned, the young lawyer replied that it was a sub Chapter S corporation and therefore he had included it in the debtor’s current monthly income.  Not in my book…

My approach to businesses conducted by corporations is based on these principles:

1. Legal entities are separate legal persons from their owners.
2. Tax treatment is just that, tax treatment.  Sub S status doesn’t defeat separateness.
3. Only the money drawn out of the corporation, as salary or draw, is includible on B-22.

Sole proprietorships are just the reverse.  They are indistinguishable from the owner.  The  business income is propertly treated as the debtor’s income.

Here in the 9th Circuit we have a  BAP decision, Wiegand, 386 B.R. 238,  that says the B-22 is wrong where it deducts business expenses “above the line” for determining median income.  According to the BAP, the debtor’s gross income is reported on line  4 , and the business operating expenses deducted below.  You need to see if Wiegand is followed in your circuit.

So, in the case of the struggling small corporation, regardless of the gross income of the entity, if none of that money is distributed to the owner, there is no business income reportable on b-22.  This can make a huge difference for the debtor, and it is consistent with the argument for the shareholder being separate from the corporation.

Watch for an announcement later this week on  my 2 hour video presentation on Mastering the Means Test.

What can my client do with non exempt cash or readily saleable items not protected by an exemption, the newbie asked.

As I looked down my list of things to do with excess cash, I saw an issue I hadn’t explored before:  some of best ways to use up non exempt cash may result in trouble on the means test.

My starting point in exemption planning is using the unprotected value to acquire something the client will need in the future.  It’s clear you could legally spend non exempt money on a fine night on the town or a vacation.  Most of my clients have unmet needs or uncertain futures, so I want any money we are spending down to benefit them in their post filing life to the greatest extent possible.

Here’s the list I posted earlier:

1. Fund IRA’s
2. Obtain cash value life insurance up to exemption limit
3. Repay 401(k) loans
4. Prepay home or auto insurance
5. Catch up on tax under-withholding
6. Get needed medical or dental treatment
7. Repair the things the client has
8. Tune-up car
9. Stock pantry &  freezer
10. Pay down student loans, delinquent support, priority taxes

Note that current year tax obligations, projected medical or dental treatment, delinquent support, and priority taxes are all expenses that are deductible on the means test. Thus, if you pay those expenses down to consume cash, you  reduce the deductions from current monthly income.  You may be solving the exemption problem but creating a positive number on B-22.

So, as in all things legal, the best course of action “depends”.  It depends on whether the client is above or below the median.  It depends on whether the client is filing Chapter 7, or Chapter 13, where the 401(k) loan would be deductible.  It depends how close to a presumption of abuse the calculations leave you.

1. Using the tax deductions from the pay stubs when your client traditionally owes taxes payable with the return
2. Using the tax deductions from the paystubs when your client traditionally gets a substantial refund
3. Using last year’s tax as the measure for the projected taxes when debtor has reduced deductions going forward
4. Using last year’s tax as the measure for projected taxes when debtor’s income has changed

Each of these means test mistakes is grounded in missing the fact that the tax expense we project is the future tax obligation.

Other Necessary Expenses: taxes. Enter the total average monthly expense that you actually incur for all federal, state and local taxes, other than real estate and sales taxes, such as income taxes, self-employment

taxes, social-security taxes, and Medicare taxes

The actual tax owed may be more or less than the debtor’s withholding.  So if you are simply  reporting what the debtor has withheld currently, you may not be capturing the correct number.

A frequent strategy for debtors is to reduce their withholding to increase their take-home pay to attempt to repay debts.  As their bankruptcy lawyer, you need to flush out that fact and calculate how much the actual tax owed will be come  next April. You need not only to get to a figure that would cover the liability for a year’s worth of taxes, you may need to calculate how to catch up on the portion of the year for which the debtor is already underwithheld.

Conversely, the debtor who uses overwithholding as a forced savings mechanism is withholding more than the tax actually incurred.  To get the means test right, you need to adjust downward the monthly withholding by 1/12th of the amount of the expected refund.

Don’t forget to look forward to changes in the debtor’s income and/or deductions to see if the historic rate of withholding matches the income and deductions expected going forward.  If the debtor is surrendering a home or stripping off a junior lien, the  mortgage interest deduction will be reduced and the tax incurred increased.

If the debtor has reduced income, last year’s total tax from the return may be greater than the tax incurred on lesser income.

Depending on the number of issues in play in any given case,  getting this calculation right can be a chore.  I end up making estimations and , as long as I can explain the reason and the process, I don’t have trustees often argue with my result on line 25.

Doesn’t the client have health care expenses, taxes, internet service, I asked?  The reply:  I’ve gotten to a negative number, so I stopped.

I’m sorry, but that doesn’t cut it. Why?

• What if you’ve made a mistake in the things you’ve put on the B-22 and the real numbers don’t yield a negative?
• As a bankruptcy professional, do you want to tell the client and the world you do only as much work as you think necessary?
• The client signs it under penalty of perjury.

Any one of these reasons justifies doing the job as well as you can.  I know that it seems to be an exercise in make-work, not necessarily connected to the real world.  But we’re stuck with it until Congress changes it.

It drives what our clients have to pay for five years.  Five years of our client’s life ought to be worth doing the job right.  If something changes, a mistake is found, or an item of income or expenses are disallowed, how are you going to put a good face on new numbers that vary wildly from your first filed B-22 when you include all the items called for on the form?