The Means Test Tax Projection When Taxes Aren’t So Certain

projecting taxes

Nothing is certain besides death and taxes. We know the old saw.

But what’s a bankruptcy lawyer to do when the amount of the future taxes is not so certain.

I wrote earlier about calculating the projected income tax deduction on the means test when the year of filing situation looks much like last year.

Now, let’s tackle the tax projection when things have changed.

Your job as a bankruptcy attorney becomes more complicated in the face of change.  It’s suddenly more than figuring the tax refund or the tax due and dividing by 12 to get a monthly projected tax expense.

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

Tax on changed income

The simplest changes to 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 only income, when 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 it may come with deductible expenses that reduce the taxable portion of the income,

One time events skew taxes

Singular transactions may distort the tax obligation for a single tax year. 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 tax expected going forward.  Using last year’s tax may overstate this year’s tax.

In calculating a projected expense, you may be able to look at the year before last’s return for a baseline tax.

It’s the reverse if those 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. Then hit the IRS tax tables for an assessment of whether the current withholding matches the expected tax.

Under withholding in filing year

A further complication arises when this year’s deposits are foreseeably inadequate.

  how do you build in the catch-up amount needed to have this year’s taxes paid by the end of this year?

If you project an increase in tax expense going forward sufficient to catch up for this tax year, the figure is probably larger than needed in subsequent years.

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

I think it important to confront the looming problem presented by underwithholding in the means test, or you’ll have a client paying old creditors through the plan with money that’s needed for paying this year’s taxes.

Loss of tax deductions

Look for 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.  And then there’s the new limitations on deduction of SALT expenditures.

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 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, and be engaged in helping the client stay on the good side of the tax folks going forward.