Using Tax Debt To Pass The Means Test

Tax Debt May Help You To Pass The Bankruptcy Means Test

Published on June 16, 2012 by: Ian M. Falcone

One of the most challenging aspects of the revised Bankruptcy Code (BAPCPA) was the addition of the Means Test (11 USC §707(b)). When it first came out, practitioners were extremely concerned. No one likes a mechanical test that can determine a client’s fate under the Bankruptcy Code. To this day, more than six (6) years after BAPCPA’s implementation, we still get calls from potential clients claiming they are not eligible for to file for protection under Chapter 7 because they "have too much income." Most of these prospects, and very likely many attorneys with whom they have consulted, have looked only at the median income test to determine eligibility. Instead, they should be looking to see whether the test applies at all.

The Means Test applies only to debtors whose debts are "primarily consumer debts." The term "consumer debt" is defined at 11 USC §101(8) as a debt "incurred by an individual primarily for a personal, family or household purpose." This definition is crucial in determining whether the Means Test applies. Most debtor’s lawyers know to look for obvious business debts, some even inquire into the purpose of the credit card debt, but income taxes seem to be overlooked on a regular basis.

Although, at first glance, income taxes would seem to be "personal" and therefore "consumer debt", it is clear that they are not. The Sixth Circuit has examined this issued and concluded that income taxes are not consumer debt (at least for the purposes of determining whether the co-debtor stay applies to these types of debts). In re: Westberry, 215 F. 3d 589 (6th Cir, 2000).

In reaching its conclusion, the Court stated the following: "First, a tax debt is incurred differently from a consumer debt. . . .[Its] incurrence is not voluntary on the part of the taxpayer." The Court went on to note that a "consumer debt is incurred for personal or household purposes, as stated in the statute, while taxes are incurred for a public purpose." It would be hard to argue with this logic since, "The Supreme Court has long noted, in other contexts, the public purpose of the imposition of taxes. See, e.g. Loan Assoc. v. Topeka, 87 U.S. 655, 664, 22 L. Ed. 455 (1874) ("We have established . . . beyond civil that there can be no lawful tax which is not laid for a public purpose.")" Finally, the Court noted that "taxes arise from the earning of money, while consumer debt results from its consumption. See Greene, 157 B.R. at 497, Harrison, 82 B.R. at 558, Pressimone, 39 B.R. at 244."

Thus, if a prospective client comes to your office, depressed that they have plenty of tax debt, explain that this may be a blessing in disguise and could help them pass the Means Test and qualify for Chapter 7 treatment.