If the most useful trick for beating the means test involves projecting health care expenses, the second most useful trick involves taxes.
Tax troubles drive the filing of a large percentage of bankruptcy cases these days. It makes sense: bankruptcy is a powerful tax tool and a bankruptcy judge can be a good ally when facing the IRS.
Even people who don’t currently owe back taxes often court tax trouble to pay other debts: they reduce their withholding to free up money to pay credit cards.
Taxes have two roles in the means test. First, you get to deduct from income the amount required to pay past, non dischargeable taxes and any tax liens secured by real value.
Second, you deduct your future tax liability from income. You want to get that number right so the means test doesn’t show you as having more money to pay debts than is real.
So, let’s do this: taxes and the means test.
How the means test works
Just to review, the means test looks at your income from all sources in the six months before you file bankruptcy and calculates an annual income from that.
If your annual income, for a family the size of yours, is below the median for your state, you are free to file the bankruptcy chapter of your choice.
However, if your annual income is above median, you have to apply the means test formula: future expenses compared to that historic income. If that formula says that you have $252 a month in discretionary income, then a Chapter 7 case is presumed to be an abuse of bankruptcy law.
The presumption is rebuttable, but who wants to go there?
So, I’ll pass you the cheatsheet, and let’s get you a qualifying score on the means test.
Get future taxes right
The no-brainer approach to the future tax line on the means test form just pulls the tax withholding from paystubs and puts it on line #16. Easy.
But perhaps not correct.
Since we’re looking at what you expect to owe going forward, we need to know two things:
- Do you usually get a refund, or do you owe money when you file your return?
- Will your tax situation change in the upcoming year?
First, if you are chronically underwithheld, and you end up owing money with your return, the tax withholding from your paystub understates your actual tax liability.
Add to the actual withholding an amount that makes the tax number equal your projected taxes, federal and state.
Then adjust your actual withholding so that reality matches the means test form.
But there’s more: if you are midway in the tax year, just getting the future withholding to reflect 1/12th of what you expect to owe doesn’t solve the problem. You are already in the hole for the portion of the tax year that is behind us, that portion of the year in which you didn’t withhold enough.
Add to your projected tax liability an amount that gets you caught up for this year.
It works the opposite if you get a fat refund each year: your withholding exaggerates your actual tax liability and you need to reduce the figure. Rough and dirty, reduce your monthly future tax liability by 1/12th of the refund you get, federal and state.
Second, if your income/deduction situation is or will be changing, make the corresponding change for means test purposes.
If you are losing a mortgage interest deduction, your taxes will go up (everything else remaining the same). If you expect a second job, or self employment, plug the expected additional taxes into the calculation.
If you’re retiring, taxes can be expected to go down.
Don’t forget property taxes for means test purposes. If property taxes aren’t escrowed in your monthly mortgage payment, property taxes belong as part of the obligations associated with the secured mortgage claim.
Past taxes and the means test
Since the means test is supposed to be testing whether you have money available to pay run-of-the-mill creditors, you get to deduct from future income what you already owe in taxes that aren’t dischargeable in bankruptcy.
Bankruptcy-speak for these deductible taxes is priority claims. Translate other bankruptcy terms into English.
Priority claims only encompass your liability for tax years that are closed. That’s why you need to address your expected liability for the year of filing as a projected tax expense as we did above.
Tax liens meet the means test
Priority taxes are usually recent taxes; it’s the older taxes who are most often secured by a tax lien.
The means test lets you deduct from future income the amount necessary to pay those liens that attach to your home, your vehicle or other assets that are necessary for your family’s support.
Again, don’t forget unpaid property taxes as a tax lien that needs to be addressed in the means test as well as future property taxes.
Means test isn’t suitable for do-it-yourself
I’ve walked you through this means test trick as though you were preparing your bankruptcy schedules yourself.
My advice is DON”T.
Not only is the means test the gateway to bankruptcy relief, but if you do it wrong or poorly, you can end up paying dearly.
Get the help of an experienced bankruptcy lawyer and then give your lawyer all the help you can in the form of back up documents so you get a passing grade on the means test.