Four Means Test Mistakes: Taxes

Are you guilty of any of these means test mistakes dealing with taxes?
  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.


  1. Kelly Bresso says

    This tax stuff is so over my head. Ever think about a CLE on taxes for bankruptcy attorneys? It doesn’t have to be too tax-attorney complicated, but it would be helpful to get tips on calculating the actual taxes incurred. Or, for example, how do you calculate the future tax liability for debtor who was getting a deduction for a 2nd mortgage but won’t have it once the second mortgage is stripped? I think I may have said that wrong, see? A CLE for clueless attorneys like me would be great.

  2. Cathy Moran says

    You know that Morgan King is doing a half day CLE for BASF this fall? Don’t miss it.

    In terms of calculating it, the net effect of losing the deduction is to add the years worth of interest deduction that disappears to taxable income. Find a tax calculator on line, or figure out what the marginal rate on those additional dollars (federal and state) and add 1/12 of it to the monthly means test tax deduction.

  3. mike mcenroe says

    with respect, i have sat through morgan king and shapiro three times, and bought king’s 650 page book. i find it all incomprehensible. someday, it will make sense to me. i just cannot understand liens, and i cannot figure out how the different categories go into a chap 13 plan.

    • Cathy Moran, Esq. says

      Think of it as a sorting game: liens in one pile, priority claims in another pile, and non priority claims in another.

      Stack the lien claims and see if any part of the claim is unsecured? If so, and there was no lien, would the unsecured portion be a priority claim or a general unsecured claim?

      Usually, your plan must provide for enough money to satisfy the secured claim with interest, and the priority claim, without interest.

      I use an electronic spread sheet, and make free use of the “comment” feature so I can reconstruct where the number in the cell came from.