Above-Median Income Chapter 13 Debtors Must Subtract Actual Taxes, not Withholding Amounts, in Calculating Disposable Income
by TaeRa K. Franklin
New York City Law Department; New York
Recently, a bankruptcy court for the Eastern District of Wisconsin upheld the trustee’s objection to a proposed chapter 13 plan that subtracted the tax withholdings in calculating the debtor’s disposable income (In re Balcerowski, 353 B.R. 581 (Bankr. E.D. Wis. 2006)). This decision is noteworthy in that it (1) reflects the growing judicial acceptance of an approach allowing consideration of factors other than just the historical income, as required by the newly amended Bankruptcy Code, in determining disposable income and (2) mandates that debtors estimate actual tax expenses as best as they can in calculating their disposable income.
Disposable Income: Pre- and Post-BAPCPA
Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), chapter 13 debtors were required to contribute all of their projected disposable income as plan payments to unsecured creditors in order to withstand the trustee’s objection to confirmation under §1325(b). “Disposable income” was defined as “income that is received by the debtor that is not reasonably necessary to be expended for the [debtor’s or his dependents’] maintenance or support.” In re Zimmerman, 2007 Bankr. LEXIS 410, at *2-3 (Bankr. N.D. Ohio Jan. 29, 2007). The reasonably necessary expenses (RNE), usually stated in Schedule J, were deducted from the debtor’s actual income, generally determined from the numbers stated in Schedule I. Id. However, §1325(b) underwent significant alterations under BAPCPA, including a change in the definition of disposable income and the addition of a provision requiring an above-median income debtor (AMID) to determine RNE in accordance with §§707(b)(2)(A) and (B). 1 Such changes have led to confusion and conflicting decisions among courts. For instance, §1325(b)(1)(B) uses “forward-looking” language, such as “projected” and “to be received,” while the definition of disposable income is “backward-looking” in that it is calculated based upon the “current monthly income” (CMI), which is a historical figure. 2 Hence, courts disagree even on the question of whether disposable income is equivalent to projected disposable income. In re Zimmerman, 2007 Bankr. LEXIS 410, at *11-20. Further, courts are split on how to calculate disposable income under §1325(b)(1)(B) – some holding that disposable income is determined based solely on the historical CMI (e.g., In re Alexander, 344 B.R. 742, 748 (Bankr. E.D.N.C. 2006); In re Girodes, 350 B.R. 31, 36 (Bankr. M.D. N.C. 2006); In re Hank, 2007 Bankr. LEXIS 46 (Bankr. D. Utah Jan. 9, 2007)) and others ruling that it is not (e.g., In re Hardacre, 338 B.R. 718 (Bankr. N.D. Tex. 2006); In re Jass, 340 B.R. 411 (Bankr. D. Utah 2006); In re Kibbe, 342 B.R. 411 (Bankr. D. N.H. 2006); In re Risher, 344 B.R. 833 (Bankr. W.D. Ky. 2006)). The Balcerowki court follows the latter.
Balcerowski
Balcerowski involved an AMID who filed a plan proposing a 4 percent dividend to the unsecured creditors. The chapter 13 trustee objected, arguing that the plan failed to allocate all of the debtor’s projected disposable income to pay his creditors as required by §1325(b)(1)(B).The trustee asserted that the debtor’s use of tax withholding created an artificially low disposable income since the debtor’s tax withholding exceeded the actual tax amount owed based on the debtor’s income, the 2006 tax tables, deductions and exemptions.
The court first observed that under the current tax withholding system, which requires taxpayers to withhold the actual amount of taxes owed through estimation, “over-withhold[ing]” is “not uncommon” and the amount so withheld “is subject to manipulation by the taxpayer.” Balcerowski, 353 B.R. at 587. Hence, the withholding is not necessarily the actual tax incurred and any over-withholding- i.e., a tax refund, does not constitute RNE. Id. at 587 n.3. This holding was further buttressed by a review of §§1325(b)(3), 707(b)(2)(A) and (B), the IRS Manual and the Financial Analysis Handbook. 3 Therefore, the court concluded that the debtor “must subtract from his income the average monthly tax expense that he ‘actually incur[s]’” not his chosen withholding amount. Id.
Acknowledging the difficulties in accurately estimating the actual tax amount, the court required only that the debtor subtract his actual tax expense “as best he can estimate” and left it to the parties to “determine how best to make that estimate.” Balcerowski, 353 B.R. at 588-89.
Despite the fact that the debtor’s current Schedule I income was lower than the historical CMI, and that BAPCPA mandated that the debtors deduct their actual tax expenses from their historical income, the court held that the parties must consider both CMI and Schedule I income in determining disposable income, agreeing with those courts allowing the parties to consider future and current income, not just the historical CMI, in such determination. Id. The court reasoned that since many debtors undergo changes in their financial situations around the time of filing their petitions, looking only at the debtors’ average income for the six months prior to the petition filing would frustrate the congressional objective to determine “what debtors truly can afford to pay their creditors.” Id. at 590.
Conclusion
Balcerowski demonstrates how the courts are adjusting and coping with BAPCPA in the chapter 13 context. It shows the courts’ effort to harmonize conflicting statutory provisions in a manner consistent with the pronounced legislative intent and, at the same time, reach “fair and consistent resolution” of such conflict.
1 Under BAPCPA, chapter 13 debtors now must file schedules I and J as well as a Statement of Current Monthly Income and Calculation of Commitment Period and Disposable Income, known as Official Form B22C (B22C). B22C includes the “means test” calculations provided in 11 U.S.C. §707(b)(2). All chapter 13 debtors must complete parts I and II of B22C to determine “current monthly income.” Chapter 13 debtors with income greater than the median family income of the applicable state for a family of the same or smaller size, i.e., the above-median income debtors must also complete parts IV and VI of B22C, which contain the means test calculations, additional expense claims and part V, which is a “Determination of Disposable Income under §1325(b)(2).” Zimmerman, 2007 Bankr. LEXIS 410, at *2-3.
2 Id. at *10. Disposable income is calculated using CMI and deducting expenses as determined in accordance with §§707(b)(2)(A) and (B) for AMID. 11 U.S.C. §§1325(b)(2)and (3). CMI means the debtors’ average monthly income from all sources, except for certain benefits or payments, that the debtors receive over the six months prior to the filing of their bankruptcy petitions. 11 U.S.C. §101(10A). Hence, courts as well as commentators have observed that CMI is “neither current (as it deals with the income the debtor received in the six months prior to the month in which he filed bankruptcy) nor monthly (as it is an average of six months) nor income (as the debtor may no longer be receiving it).” Balcerowski, 353 B.R. at 589. Rather, CMI is a historical figure.
3 Section 1325(b)(3) allows an AMID to subtract from his CMI only the amount “reasonably necessary to be expended” in accordance with §707(b)(2)(A) and (B). Section 707(b)(2)(A)(ii)(I) permits the AMID to subtract “the debtor’s actual monthly expenses for the categories specified as ‘other necessary expenses’ issued by the IRS . . ..” The IRS Manual includes taxes in its “other expenses” category. The Financial Analysis Handbook of the Manual provides that taxes are necessary if they are “current federal, FICA, Medicare, state and local taxes.” Based on these sections, the court reiterated that the withholdings are “not necessarily the actual tax expense.”