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