We welcome first time guest blogger Matt Sherman. Matt practices with the Tax Workout Group where he is the firm’s practice group leader for all tax-bankruptcy matters. The firm is based in Florida and focuses on civil and criminal tax controversy and tax resolution matters. He and Leta Wolfe (as contributing author) have written a post that focuses on the qualifications a debtor must have to pursue a bankruptcy discharge in a chapter 7 bankruptcy case. We have broken Matt’s post into two parts to make it more digestible for our format. The post provides a detailed walk through of the requirements of means testing in chapter 7 cases and the impact of the type of debt a taxpayer has. For bankruptcy purposes tax debt is different than consumer debt. This post will explain the difference that the type of debt makes and how a taxpayer might use that difference to their advantage depending on the type of debt they bring into the bankruptcy case. Keith
How does section 707 of the Bankruptcy Code (Code) apply to a situation where a debtor files for Chapter 7 bankruptcy seeking to discharge debt consisting of “primarily tax debt,” when the debtor has the means to pay some or all of the tax liability?
As tax professionals who specialize in bankruptcy tax issues, we are often asked about the applicability of the “means test” to tax debt, in Chapter 7 cases, when a debtor has “primarily” tax debt and has disposable income that could be used to pay off all or part of that tax debt. Specifically, the question is whether, in cases where the “means test” does not apply, is the debtor free from having the Chapter 7 case dismissed or converted to a Chapter 11 or 13 bankruptcy case? The answer to this question is no, the debtor is not “home free” from having the Chapter 7 case dismissed.
In 2005 Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat. 23 (BAPCPA or the Act). The purpose of the Act was to improve bankruptcy law and restore personal responsibility and integrity to the system, therefore ensuring a fair system for debtors and creditors alike. See H.R. Rep. No. 109-31(I), at 2. Congress enacted BAPCPA to reform the bankruptcy system and limit abuse by consumer debtors. See H.R. Rep. No. 109-31(I), at 5. Pre-BAPCPA, the bankruptcy law provided a presumption in favor of discharging debtors’ liabilities under Chapter 7, which resulted in consumer debt being virtually “unconditional[ly] discharge[able]” in a Chapter 7 bankruptcy. See 11. U.S.C. § 707(b) (2000); see also H.R. Rep. No. 109-31(I), at 10.The pre-BAPCPA exceptions to the “unconditional discharge” of consumer debt were for “cause” and, in cases where a debtor’s debts were primarily consumer debts, if discharge would result in a “substantial abuse” of the Chapter 7 provisions. See 11. U.S.C. § 707(b) (2000). In such situations the bankruptcy case could be dismissed. See id.
Post-BAPCPA law, however, eliminates the presumption in favor of discharging a debtors’ liabilities and allows a Chapter 7 bankruptcy case to be dismissed for “cause” (or converted to a Chapter 11 or 13 case with the debtor’s consent) where a debtor’s debts are “primarily consumer debts,” and granting relief would result in “abuse” of the Chapter 7 provisions. 11 U.S.C. § 707(b)(1) (2004 & Supp. Dec. 2005). To determine if “abuse” exists in Chapter 7 cases, BAPCPA incorporated the “means test.” See generally 11 U.S.C. § 707(b)(2). The “means test” was a major change to the Bankruptcy Code. Compare 11 U.S.C. § 707(b)(1) (2004 & Supp. Dec. 2005) with 11 U.S.C. § 707(b) (2000). The “means test” appears to have been enacted to assist with identifying debtors who have the financial means to repay creditors and to prevent them from obtaining Chapter 7 relief. See John Hennigan, Rousey and the New Retirement Funds Exemption, 13 AM. BANKR. INST. L. REV. 777, 798 (Winter 2005); see also Mary A. DeFalaise, Means Testing and Preventing Abuse by Consumer Debtors, U.S. Atty’s Bull. (July 2006, Volume 54, Number 5).
What exactly is the “means test” and how does it determine if “abuse” exists? The “means test” is outlined in 11 U.S.C. § 707(b) and, as indicated in the statue and confirmed by the Court in Piazza v. Nueterra Healthcare Physical Therapy, LLC (719 F.3d 1253, 1266 (11th Cir. 2013), only applies to debtors whose debt is “primarily consumer debt.” “Primarily consumer debt” is not defined in the Code under either 11 U.S.C. §§ 101 or 707(b). However, the Courts have defined the term by addressing it as two separate and distinct issues: (1) what is “consumer debt”; and (2) what is “primarily” a consumer debt.
“Consumer debt” is defined in the Code under 11 U.S.C. § 101(8) as “debt incurred by an individual primarily for a personal, family, or household purpose.” What constitutes “primarily” consumer debt has been defined by case law. However, there is no single consensus as to what constitutes “primarily” consumer debt. The majority view construes the word “primarily” to mean a majority. The Court in In re Hlavin, 394 B.R. 441 (Bankr. S.D. Ohio 2008), determined that the debts are considered “primarily consumer debts” when “the aggregate amount of a debtor’s consumer debt exceeds 50% of the debtor’s total liabilities.” The Court in In re Kelly, 841 F.2d 908, 913 (9th Cir. 1988) looked to Webster’s Ninth New Collegiate Dictionary 934 (1984) when defining “primarily” and determined that “primarily” means “the most part” and as such when the debtor’s consumer debt is for “the most part– i.e., more than half – of the dollar amount owed” the consumer debt is “primarily consumer debt.” Likewise, the Court in In re Stewart, 175 F.3d 796, 808 (10th Cir. 1999) defined “primarily consumer debt” as consumer debt that exceeds fifty-percent of the total amount of the debtor’s debts. However, the Court in In re Restea, 76 B.R. 728 (Bankr. D.S.D. 1987), determined that consumer debt consisting of fifty-three percent of the debtor’s total debt did not constitute “primarily consumer debt[].”
There are also several minority approaches. See In re Hlavin, 394 B.R. 441 (Bankr. S.D. Ohio 2008) (where the Court discusses various minority views of what constitutes “primarily consumer debts.”) The Court in In re Bryant, 47 B.R. 21, 26 (Bankr. W.D.N.C. 1984) concluded that a debtor’s obligations may be deemed “primarily consumer debts” if the aggregate amount of the debtor’s consumer debts exceeds the non-consumer debts but the Court also stated that debts may be deemed “primarily consumer debts” when the relative number of consumer debts exceeds the number of non-consumer debts. The Court then considered both the debtor’s aggregate debt and the debtor’s total number of debts when determining if the debtor’s debts were “primarily consumer debts.” The Court in In re Bell, 65 B.R. 575 (Bankr. E.D. Mich. 1986) considered “the relative dollar amount of consumer and non-consumer debt and, if those amounts are ‘approximately equal,’ the number of consumer and non-consumer debts as well.” Whereas the Court in Matter of Booth determined that “primarily” means “an overall ratio of consumer to non-consumer debts of over fifty percent” and the consumer debts should also “be evaluated not only by amount, but by their relative number.”
However, the Court in In re Vianese, 192 B.R. 61, 68 (Bankr. N.D.N.Y. 1996) held that a debtor has “primarily consumer debts’ only if the dollar amount of such debts exceeds 50% of the debtor’s total liabilities and, in addition, the consumer debts outnumber the non-consumer debts.” Still other Courts hold that a debtor has “‘primarily consumer debts’ only if the amount of consumer debt actually being discharged and not reaffirmed exceeds 50% of the debtor’s total liabilities.” See Restea, 76 B.R. at 734 (“[o]verall, therefore, consumer debt is approximately 53 percent of all applicable debt in this case. Mindful of the statutory presumption in bankruptcy of granting debtors relief and the underlying `fresh start’ policy basis, the Court cannot find that 53 percent constitutes the ‘principal’ debt”) (footnote omitted). The Restea Court held that this result was “supported by the fact that the debtors have reaffirmed their automobile ‘consumer’ debt[]” which made the percentage of consumer debt being discharged and not reaffirmed approximately 48% of the total debt.