Prior to 2005, bankruptcy courts across the nation were plagued by fraudulent bankruptcy filings by individuals who just wanted to get rid of their debt, but who did not necessarily qualify for such relief. To deal with the overwhelming number of abusive bankruptcy actions, Congress passed into law an act that created a new system for curbing bankruptcy abuse and thereby alleviating many of these concerns.
On April 20, 2005, President George W. Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”). The purpose of this new piece of legislation was to correct a number of abuses that were becoming apparent in the bankruptcy system. Many debtors were using the bankruptcy courts to eliminate their debt, even though their debt to income ratio would not normally scream I need debt relief. To curb these fraudulent filings, BAPCPA created what is called the “means test” for determining a debtor’s disposable income.
Forms B22A, B22B and B22C assist debtors in calculating their disposable income for Chapter 7, 11 and 13 actions, respectively. The forms take into account factors such as real and personal property ownership, vehicle expenses, marriage and living expense deductions and debt payments. In order to assist debtors in filling out the form, one point of reference for calculation is the Internal Revenue Service’s National Standards. A listing of the IRS’ standards can be found at http://www.irs.gov/individuals/article/0,,id=96543,00.html. The National Standards provide guidance on items that can be deducted from the disposable income calculation as well as items that are not subject to a deduction. All of these calculations taken as a whole yield a total monthly disposable income that the court’s use to determine whether a debtor is eligible for a Chapter 7 liquidation or a Chapter 13 reorganization.
Not long after enacting this new law, it became apparent that there were issues with vague language and missing definitions that made calculating disposable income difficult. In 2010, the U.S. Supreme Court heard two landmark cases for interpreting the language of the statute and creating a clearer standard for what items may and may not be deducted from a debtor’s total disposable income.
The first case before the Supreme Court presented the issue of whether a debtor’s income should be based solely on income received in the six months prior to the bankruptcy filing, or if other factors can be considered as well. In Hamilton v. Lanning, 130 S.Ct. 2464, 2470 (2010), Lanning filed a Chapter 13 bankruptcy action and calculated her projected disposable income based on the average amount of income received monthly from her employment. However, in the six months prior to her bankruptcy filing, Lanning received a one-time buyout from her previous employer that increased her normal monthly income. Id. The bankruptcy court determined that Lanning’s quoted disposable income was too low based upon her income prior to the bankruptcy filing and required the amount to be paid to her unsecured creditors be increased even though her average monthly income would not allow for such inflated payments. Id.
There are two approaches that courts have been using to determine a debtor’s disposable monthly income. The mechanical approach looks at the debtor’s past average monthly income and multiplies it by the number of months in the debtor’s plan. Id at 2471. The forward-looking approach takes into consideration any significant changes that are known or virtually certain and allows the court discretion to make adjustments based on these changes. Id. The Supreme Court was charged with determining which approach was the best method for calculating a debtor’s disposable monthly income.
First, the Court reviewed the plain language of BAPCPA. 11 USC § 1325(b)(1) does not specifically define “projected disposable income”, but 11 USC § 1325(b)(2) defines “disposable income” as the following:
(2) For purposes of this subsection, the term “disposable income” means current monthly income received by the debtor (other than child support payments, foster care payments, or disability payments for a dependent child made in accordance with applicable non-bankruptcy law to the extent reasonably necessary to be expended for such child) less amounts reasonably necessary to be expended—
(i) for the maintenance or support of the debtor or a dependent of the debtor, or for a domestic support obligation, that first becomes payable after the date the petition is filed; and
(ii) for charitable contributions (that meet the definition of “charitable contribution” under section 548 (d)(3)) to a qualified religious or charitable entity or organization (as defined in section 548 (d)(4)) in an amount not to exceed 15 percent of gross income of the debtor for the year in which the contributions are made; and
(B) if the debtor is engaged in business, for the payment of expenditures necessary for the continuation, preservation, and operation of such business.
The Court, in interpreting the meaning of “projected”, looked to outside sources for guidance. It determined the ordinary usage of the word “projected” does not assume that the past will repeat itself but that anticipated events will have an impact on the future. Id at 2471. Further, Congress uses the word “projected” in other statutes in a manner that does not suggest a simple multiplication of the past information. Id at 2472. Finally, prior to the enactment of BAPCPA, courts were following the forward-looking approach in determining a debtor’s disposable monthly income. Id.
The Court also found that using a basic mechanical approach was inconsistent with the meaning and purpose behind BAPCPA. 11 USC § 1325(b)(1) states that disposable income must be determined as of the effective date of the plan. Id at 2474. Further, the purpose of determining disposable income is to ensure that all amounts available are applied to make payments towards outstanding debts. Id. This language logically assumes that a debtor would actually be able to make the payments as stated in the confirmed plan. If factors outside the straight mechanical approach are not considered, it would be a frustration of the purpose of a Chapter 13 reorganization because the debtor would not be able to make the payments under the plan and end right back in the same situation he or she was in prior to filing for bankruptcy protection. Based on the foregoing analysis, the Supreme Court held that “when a bankruptcy court calculates a debtor’s projected disposable income, the court may account for changes in the debtor’s income or expenses that are known or virtually certain at the time of confirmation.” Id at 2478.
The other major Supreme Court decision for determining disposable income does not focus on the income itself, but rather the deductions that can be taken from the projected disposable income. In Ransom v. FIA Card Services, N.A., 131 S.Ct. 716, 723 (2011), Ransom filed for Chapter 13 protection and listed a vehicle he owned free and clear as one of his assets. He claimed a $471 car ownership deduction for this vehicle, even though he was not making any ownership or lease payments on it. Id.
The Supreme Court analyzed the meaning of the statute as well as the IRS’ National Standards guidelines in determining whether Ransom had claimed a proper vehicle ownership deduction. 11 USC § 707(b)(2)(A)(ii)(1) states:
The debtor’s monthly expenses shall be the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides, as in effect on the date of the order for relief, for the debtor, the dependents of the debtor, and the spouse of the debtor in a joint case, if the spouse is not otherwise a dependent. Such expenses shall include reasonably necessary health insurance, disability insurance, and health savings account expenses for the debtor, the spouse of the debtor, or the dependents of the debtor. [emphasis added]
The term “applicable” means “capable of being applied, having relevance or fit, suitable or right to be applied. Id at 724. This means that a deductable expense includes only those expenses that can actually be applied by the debtor. Further, the IRS’ National Standards separate vehicle expenses into ownership costs and operating costs. Id at 726. Upon review of the IRS’ explanatory guidelines for using the National Standards, the Court found that the IRS makes clear that individuals who own a vehicle, but do not make any loan or lease payments cannot, claim an ownership allowance. Id. In analyzing the plain language of the statute, and the IRS’ National Standards, the Supreme Court determined that unless there was actually a loan or lease payment being made, Ransom was not allowed to deduct for such ownership costs. Id at 730.
These two Supreme Court cases have provided the nation’s bankruptcy courts with great guidance in determining a debtor’s disposable income. Such a determination is key to deciding whether a debtor has filed a valid bankruptcy action and is not just using the system to eliminate debts he or she does not wish to pay. There will always be abuses to the bankruptcy system, but use of BAPCPA’s “means test” has provided a strong vehicle for reducing and possibly even eliminating many of those concerns.