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. 




  1. Very informative post, as always. It makes sense that a tax refund relating to pre-petition earnings is part of the bankruptcy estate, but not one relating to post-petition earnings. Are there any particular cases on the issue you could recommend for a newbie? I’d be curious to see the court’s reasoning.

    • Cathy Moran says

      I don’t think the issue is whether the post petition refund is “property of the estate”. I think it’s whether it is disposable income that local rule or practice requires be committed to the plan.

      If you get the projected taxes right on B-22, then the dmi should define conclusively the plan payment to unsecureds.

      I’ll look for cases.

      • Thanks Cathy, your blog is the best. I misunderstood the issue(s) more than I thought.

        On a related note and as a possible future topic, it seems that Ch. 13 trustees take different stances on a number of issues like whether tax refunds from post-petition earnings are to be turned over, whether a debtor can deduct the UST old car expense from disposable income, whether voluntary 401K contributions are deductible from disposable income, etc.

        I don’t know about your other readers, but it would be really helpful to know what other issues I need to know the local trustee positions on so that I can manage client expectations about what they can or can’t do without getting objections.

        Thanks again for helping us newbies. : )