Projecting Means Test Tax Expense When Things Change

means test taxes

Bankruptcy means test tax projections get more complicated when the year of filing situation looks much different than the last year.

If the financial situation is essentially unchanged and all you have to do is adjust for a tax refund or a tax liability, it’s little more than dividing the refund or tax due by 12 and making that adjustment to the current withholding.

But what if things aren’t the same year over year?

Mindful that we’re not preparing a tax return, we’re estimating future expense, what do we look for to get a meaningful projection?

When income changes

The simplest changes to means test projected tax expense come from changes in employment between the last tax year and the current one.

If the income appears on a W-2, all you need to assess is whether the debtor’s chosen level of withholding is commensurate with the likely tax due. 

Watch for artificially inflated numbers of dependents designed to put more money in the debtor’s pocket prepetition.

Somewhat more complicated is the situation of multiple jobs or gig work.  In the case of multiple jobs, it’s likely that each employer assumes that what he pays the debtor is the debtor’s only income, when in reality, multiple jobs may push the taxable income into a higher tax bracket.

Gig income is insidious in that it represents taxable income, while relying on the worker to make tax deposits.  ‘Nuff said about that likelihood.

And there’s the issue of business expenses required to execute the gig.

Ferreting out one time events

Singular transactions may skew the tax obligation. Think

  • Retirement fund withdrawal
  • Capital gains from property sale

If those tax-triggering events occurred last tax year, last year’s obligation may be larger than the liability expected going forward. Consider looking at the year before last’s return for a baseline tax.

It’s the reverse if those singular events occurred in the current year, swelling this year’s tax over last year’s.  You need to ask, probably futilely, if the debtor made tax deposits other than through paycheck withholding.

Catching up on withholding

The complication when this year’s deposits are foreseeably inadequate is:  how do you build in the catch-up amount needed to have this year’s taxes paid by the end of this year?

Fail to recognize the problem of the tax due for the year of the bankruptcy filing and you leave the client at risk of brand new post petition tax debt.

If you project an increase in tax expense going forward sufficient to catch up, the figure is probably larger than needed in subsequent years.  That artificially reduces disposable income.

But, if you fail to confront and adjust for the looming problem presented by underwithholding in the means test, you’ll have a client paying old creditors through the plan with money that’s needed for paying this year’s taxes.

Not to mention that you risk a motion to dismiss by the taxing authorities for failure to pay post petition taxes.

Loss of tax deductions

Another issue is historic tax deductions that may not be available going forward.

If a client is surrendering (or has already lost ) property that entitled him to interest or property tax deductions, or depreciation on rental property, the future taxes may well be greater than the tax owed when those deductions were in play.

Similarly, retirement contribution deductions may no longer be available in future years.

Increased tax deductions

The news isn’t always bad:  your client may have increased deductions available if the number of tax dependents increases.

Don’t forget to allow for an increased home mortgage deduction if mortgage arrears will be paid through the Chapter 13 plan.  I have long argued that the portion of the trustee’s payment on the debtor’s behalf on mortgage arrears generates an interest deduction for the portion of the lender’s claim that is delinquent interest.

The same analysis applies to deductions for delinquent property taxes, employment taxes, or business expenses paid through the plan.

Business variables

Debtors with small businesses present a myriad of issues making expense projections complex.

  • Is income declining or increasing?
  • Is the business itself a tax paying entity, where all you have to address for the debtor is the debtor’s withdrawals.
  • Or, is there pass through income (or loss) to consider?

If you are not comfortable making informed guesses, get the debtor’s tax preparer involved.  Or get the debtor a tax advisor if they don’t have one.

Accept the challenge

Getting tax projections right can go a long way to insuring the success of a client’s Chapter 13.  Ask questions, understand the changed circumstances, don’t forget state taxes, and be engaged in helping the client stay on the good side of the tax folks going forward.


The means test and the annual bonus

The means test for high income individuals

When the means test doesn’t apply