Tax Season Reminders

As your mailbox fills up with various W2s and 1099s, now is a good time for our annual reminder of certain tax-related issues in bankruptcy.
If you intend to file for bankruptcy (or think you might), do not use your tax refunds to pay unsecured debt until you have consulted with an attorney.  First – you would be wasting money on a debt that could be discharged.  Second – such a payment could be considered a preference and recovered by the Trustee for redistribution.  Third – using tax refunds to pay bankruptcy-related costs can help expedite your case to prevent things like creditor harassment, lawsuits, wage garnishments, bank levies, utility shut-offs, repossessions, and foreclosures.
Tax refunds are generally considered a contingent asset.  Most debtors can exempt their tax refunds and protect them from being seized by the Trustee.  Debtors who do not have sufficient exemptions to protect their refunds can plan their filing strategically to minimize the Trustee’s interest.  (For example, debtors using Wisconsin state exemptions to protect equity in real estate should file shortly after they have received their refund and deposited it, availing themselves to a depository account exemption.  Most other debtors can exempt their tax refunds with federal exemptions.)
All debtors who have filed Chapter 13 bankruptcy are required to submit copies of their tax returns to the Trustee.
Some debtors who have filed Chapter 13 bankruptcy may be required to submit 1/2 of their tax refunds to the Trustee.  Consult your bankruptcy attorney if your are uncertain about this obligation.
Debtors who plan to file under Chapter 13 (but haven’t yet) should plan to file their 2013 tax returns as soon as possible.   Cases filed after December 31, 2013 cannot be confirmed until after the 2013 tax returns are on file (even though they are not due to the IRS and state until 4/15/2014).
Debts discharged in bankruptcy are not income for federal tax purposes.  If you receive a cancellation of debt notice, show it to either your bankruptcy attorney or tax professional.
If you owe tax debt – certain debts more than 3 years old can be discharged in bankruptcy.  Tax debts entitled to priority status (generally, but not limited to taxes 3 years old or younger) can be folded into and paid through a Chapter 13 Plan with no interest.
If you owe tax debt and have already filed Chapter 13 Bankruptcy, notify your attorney immediately.  The IRS can file claims for post-petition taxes that will need to be funded.

Local Bankruptcy News

Some news this month on one of the more prominent bankruptcy cases pending in the Eastern District of Wisconsin.  The Archdiocese of Milwaukee filed a Chapter 11 Bankruptcy case in Milwaukee three years ago.  They had racked up over $11 million in legal fees to combat nearly 600 sex abuse claims.  This case is being considered the most contentious of 9 similar bankruptcy cases filed across the country.  You can read more details about the case here.

On the Means Test, is it my gross income or net income that is considered?

Probably the biggest change that came down with BAPCPA was the imposition of a Means Test – a long form used to determine disposable monthly income (aka – how much money, if any, a debtor in bankruptcy could afford to pay his or her unsecured creditors).
Below median debtors only have to complete the first three sections of Form B22A (Chapter 7) or B22C (Chapter 13), to show that they are indeed, below median.  If below median, the rebuttable presumption is that they cannot afford to pay anything to unsecured creditors.  Above median debtors must complete the remaining sections of the forms to determine what, if anything, they can afford to pay.
People tend to get angry when they learn how much we rely on their gross income figures, because obviously – after taxes and other deductions like health insurance – they are not seeing as much money as is being reported on their bankruptcy forms.
So why do we use gross income on the Means Test?  For purposes of comparing your income to the median income level, the reason is simple – so we can compare apples to apples, instead of apples to oranges.  The median income level figures are gross income figures, not net.  It would make no sense to compare your net income to the median gross income.
If and once we establish that you are above-median and move on to the rest of the Means Test to determine monthly income, we still start with gross income, and not net.  Why?  Because you can have income over-withheld for taxes, which artificially makes your income appear smaller than it is (resulting in a tax refund at the end of the year).
But – that doesn’t mean that your ability to pay is being determined without any due consideration for your tax withholdings or deductions.  As you proceed throughout the Means Test, most of the same deductions that appear on your paycheck (resulting in your net income) are factored back in – so long as they are necessary and valid deductions.  Your taxes are also deducted back out on the Means Test at Line 30.  However, we do not use your tax withholding numbers (since they can be artificially inflated) but instead, we use your estimated actual tax liability.  Theoretically, if the number is calculated accurately, and if your adjusted your withholdings accurately, you would have no tax refund at the end of the year, but you would have a little more net income, which would be more in line with the result on the Means Test.
When your attorney insists that your income documentation includes information regarding your gross income, it isn’t because we’re trying to inflate what you actually make.  We need to be able to compare like things – your gross income to the median gross income.  We also need to determine if your income has too much withholding for taxes.  Yes, we rely heavily on gross numbers when calculating disposable income, but that doesn’t mean that your tax and insurance deductions are being ignored.