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By Michael S. Anderson of Anderson Tax Law logo for Arizona tax attorney Michael S. Anderson P.C.
  • Bankruptcy Means Test – High Tax Debt May Be the Key to Avoid It

    super duper test-thumb-375x250-55236The Bankruptcy Code requires the taking of a test to determine “means” or ability to pay debt. If the test is failed, a Chapter 7 bankruptcy can’t be filed unless…a designated exception exists. We will get back to that later.

    First, lets be clear about the Bankruptcy Means Test.

    Many people pass it. Not just those with low income. If a bankruptcy filer has relatively high income but also has a large mortgage debt, car loans, priority tax debt, child support, spousal maintenance, high medical expenses, or some combination of the above, he or she may be rewarded with a passage of the test and entrance into the world of Chapter 7 Bankruptcy.

    In fact, the upper income earner may be able to pass the means test more easily than a middle-income earner who has been careful not to incur certain debts.

    Yes…it happens.

    There is even a way to avoid the means test altogether. That’s right…. just avoid the whole stinking thing and step right into a Chapter 7 Bankruptcy without having income and budget closely scrutinized.

    How?

    Make sure that the majority of your debt is “Non-Consumer”.

    What is “Non-Consumer” Debt? Lets define it in a backwards fashion.

    If the money borrowed was than used to pay a personal, family or household expense or to purchase personal, family or household goods, it is probably a consumer debt.

    Otherwise, it is probably “non consumer”.

    Debts used for business purposes are non-consumer debts.

    Tax Debt is non-consumer debt because it is not incurred voluntarily to pay for household expenses.

    To be repetitive: A person with more tax debt or business debt or a combination of both than all other consumer debt… can avoid the means test in Arizona.

    Example:

    Fred has a home that is worth $100,000.00. The first mortgage debt is $200,000.00. He has $50,000.00 in credit card debt, a car loan for $20,000.00 and a $75,000.00 income tax debt as a result of a failure to properly calculate income taxes for a few years when he was in business. (Penalty and interest have doubled it).

    The tax debt meets the requirements for discharge if a Chapter 7 Bankruptcy can be completed.

    Fred has a steady job that has been paying a good income and he has decided that the house isn’t worth saving. He didn’t like it anyway and want’s to “short sell” it.

    Fred also has a large payment plan with the IRS because when he negotiated it the IRS limited his budget to it’s own standards and didn’t use the amounts that Fred actually spent per month to determine his ability to pay. They didn’t allow for the credit card payments either.

    The IRS payment plan is making his life miserable and he has fallen behind on the credit card payments as a result. The calls have started to arrive.

    He begins to think about bankruptcy. He does some research online and takes a means test on a means test calculator he found. He thinks he failed the means test and cannot file for chapter 7 Bankruptcy.

    At a party, his friend refers him to an attorney who suggests that the home be short sold so that the overall consumer debt from the mortgage, credit cards and the car loan is reduced to an amount that is lower than the potentially dischargeable debt. Fred was going to sell the home anyway and rent.

    Fred later files for bankruptcy and discharges his legal obligation on the credit cards and the tax debt.

    End of Example

    If you have serious tax debt and consumer debt and are starting to contemplate a chapter 7 Bankruptcy, but you are concerned that you will not qualify to file because of the bankruptcy means test…determine exactly what debts you have and what is owed. Look at whether the tax or business debt totals are greater than all of your consumer debt by at least 1 red cent.

    If it is – you may be on your way to a fresh start.