IN RE:  JACKIE WAYNE BISHOP        CASE NO. 07-50431   OPINION AND ORDER tax expense for purposes of the means test calculation





JACKIE WAYNE BISHOP                                                                CASE NO. 07-50431




          The issue before the court today involves the question of what constitutes an appropriate and deductible tax expense for purposes of the means test calculation, which individual debtors seeking relief under Chapter 7 of the Bankruptcy Code must complete for the stated purpose of preventing abuse of the bankruptcy process. The matter under submission arises from the United States Trustee’s (“UST”) Motion to Dismiss the above-styled Chapter 7 proceeding filed by Debtors Jackie Wayne Bishop and Vickie Lynn Bishop (“Debtors”) pursuant to 11 U.S.C. 707(b)(2) or, alternatively, 11 U.S.C. 707(b)(3) [Doc 25]. As grounds for the motion, the UST asserts that upon performing the means test calculation required by section 707(b)(2)(A)(i) of the Code, the Debtors’ current monthly income, when reduced by allowed deductions and multiplied by a factor of 60, exceeds the permitted maximum of $10,000.00 such that there arises a presumption of abuse of the provisions of Chapter 7, should bankruptcy relief be granted. The Debtors’ Response to the UST’s motion to dismiss [Doc. 26] is that there is no presumption of abuse under section 707(b)(2) because the Debtors’ monthly tax expense was properly calculated and upon deduction of the tax expense, the presumption of abuse does not arise in this case.

          The parties executed an Agreed Order [Doc. 35], entered on July 9, 2007, in which they set forth Joint Stipulations of Fact, framed the issue to be decided and deemed the matter ripe for submission to the court without requirement of an evidentiary hearing. In addition to the UST’s motion, the Debtors’ Response and the parties’ Joint Stipulations, the court has carefully reviewed and considered the following items of record: Debtors’ Objection to Statement of Presumed Abuse [Doc. 19]; various Supplemental Documents submitted by Debtors, including copies of their federal income tax returns, without schedules, for the years 2002 through 2006 [Docs. 28, 29, 39 - 47]; UST’s Reply to Debtors’ Response [Doc. 30] and the UST’s Response to Court’s Order [Doc. 38] in which were submitted copies of all documents reviewed by the UST which resulted in the determination that the presumption of abuse arises in this case. Based on its review of the record, the court concludes, for the reasons discussed herein, that the UST’s position is well-founded. The court agrees that jurisdictional requirements are met pursuant to 28 U.S.C. 1334(a) and (b) and 28 U.S.C. 157(a) and (b), and that this is a core proceeding as provided by 28 U.S.C. 157(b)(2)(A) and (B).

Venue is correct under 28 U.S.C. 1408 and 1409.

          The Debtors filed their joint voluntary petition for relief under Chapter 7 on March 5, 2007. [Doc. 1]. According to their petition, the Debtors are married with two children. Mr. and Mrs. Bishop have been employed at their current jobs for ten (10) and four (4) years, respectively, and the parties agree that the Debtors’ annualized current monthly income is $71,001.12. See Debtors’ Response to Motion to Dismiss, Doc. 26. Where the parties’ positions significantly diverge, however, is in calculation of “allowed deductions” for purposes of the means test, specifically Line 25 of Form B22A “Other Necessary Expenses: taxes.” According to the UST, the Debtors have inappropriately claimed an amount on Line 25 of Form B22A that exceeds their actual tax expense, instead deducting an amount based on federal income tax withholding rather than actual federal tax liability. No issue has been made by the UST as to the amounts deducted by Debtors for other deductible tax expenses relating to state, local, or FICA taxes. A review of the Debtors’ federal income tax returns for the years 2002 through 2006 confirms that the Debtors have a history of withholding sums from their paychecks which substantially exceed their federal tax liability.

          Prior to the birth of their two children, for the tax year 2002, the Debtors reported adjusted gross income of $40,826.00. They claimed a total of two exemptions, one for each of them, and utilized the standard deduction, rather than itemizing deductions, to determine their tax liability. Debtors’ return reflects a small federal tax overpayment in the amount of $160.00. However, once the Debtors’ children were born, beginning in tax year 2003 and for years thereafter, the Debtors made no adjustment to their practice of claiming only one exemption each, and presumably an equal number of allowances, for themselves and one each for their first, and then second, child. Accordingly, with sizable credits applied to their tax liability without any corresponding adjustment to their withholding allowances, the amount withheld from the Debtors’ paychecks began to substantially exceed their actual tax liability. Figures retrieved from Debtors’ federal tax returns reveal the following over-withholding:

Tax year 2003 – Adjusted gross income, $46,895.00; Total tax owed, $2,493.00 (after applicable credits); Amount over-withheld, $1,224.00

Tax year 2004 – Adjusted gross income, $55,414.00; Total tax owed, $2,105.00 (after applicable credits) ; Amount over-withheld, $2,602.00

Tax year 2005 – Adjusted gross income, $50,446.00; Total tax owed, $1,414.00 (after applicable credits); Amount over-withheld, $2,617.00

Tax year 2006 – Adjusted gross income, $66,434.00; Total tax owed, $3,286.00 (after applicable credits); Amount over-withheld, $2,962.00.

          According to the parties’ Joint Stipulations and Agreed Order [Doc. 35], the Debtors listed the amount of $1,435.13 on line 25 of their form B22A, representing the average monthly expense they incurred for all federal, state, and local taxes, other than real estate and sales tax. Joint Stipulation number 3, Doc. 35. On their Schedule I, Debtors stated that they received an income tax refund of $2,700 (there is no discussion by either party of the apparent inconsistency between Debtors’ stated tax refund on their Schedule I, $2,700, and the amount shown on their 2006 Federal Income Tax Return, $2,962), allegedly consisting of a $2,000 child tax credit and a $398 child care credit. Joint Stipulation number 4, Doc. 35. The UST recalculated the means test, subtracting $225 from the Debtors’ proffered monthly tax expense of $1,435.13 which the UST alleges is an inappropriately included tax refund rather than a tax expense (the $2,700 refunded divided by 12 months equals $225 per month). Using the Debtors’ figure, including the higher amount for monthly tax expense, Debtors show negative disposable monthly income of -$21.53 and the presumption of abuse does not arise. Joint Stipulation number 6, Doc. 35. Using the UST’s figure, without the $225 per month the UST attributes to over-withholding, Debtors have $194.14 per month in disposable income and the presumption of abuse does arise. Joint Stipulation number 7, Doc. 35.

          UST’s position is that the sum over-withheld for payment of income taxes results in a sizeable income tax refund that should be taken into account as disposable income available for payment of unsecured creditors. Debtors’ respond to UST’s argument that their income tax refunds are not overpayments due to miscalculation of allowances but rather due to tax credits for their children to which they are entitled and are essentially “gifts”, according to Joint Stipulation number 10 in Doc. 35, regardless of the amount withheld from their paychecks. Debtors fundamentally misunderstand how the tax credits, to which they are indeed entitled, are applied.

          A clear explanation of how the tax credits operate is ably provided by the 8th Circuit Bankruptcy Appellant Panel in In re Law, 336 B.R. 780, 782 (8th Cir. BAP 2006):

The Child Tax Credit (“CTC”) was enacted in 1997 to give parents of dependent children a financial break. It allows parents with an adjusted gross income below a threshold amount to claim a $1,000 tax credit for each child under the age of 17. The credit is reduced to zero on a graduating scale for families whose income is above the threshold amount. The credit is refundable to the taxpayer to the extent it exceeds tax liability. See 26 U.S.C. Sec. 24.

Consequently, the child tax credits and the child care expense credit, also claimed by Debtors, operate to reduce tax liability and consequently are subtracted from the amount of tax due. Because the Debtors’ federal income tax liability always exceeded the sum of their child tax credit, no part of such credit was refundable to Debtors. Child and childcare expense credits are not sums of money available to be simply refunded to Debtors, irrespective of tax liability. Nor are the credits like the earned income tax credit, which may in fact result in a refund to certain qualifying taxpayers who owe little or no income tax. Child and child care expense credits serve to reduce tax liability and must be taken into account in determining how much to have withheld.

           UST’s reference to IRS Publication 505, which in turn refers to IRS Publication 919 (March 2007), among others, is instructive as to how taxpayers should check their withholding:

After you have given your employer a Form W-4, you can check to see whether the amount of tax withheld is too little or too much. See Publication 919 on page 8. If too much or too little tax is being withheld, you should give your employer a new Form W-4 to change your withholding.

IRS Publication 505 (February 2007), at page 4. Similarly, IRS Publication 919, at page three (3), advises taxpayers of several scenarios that indicate a good chance of over-withholding on the part of the taxpayer: First, receipt of a large refund with income, adjustments, deductions and credits remaining about the same as the previous year; second, income remains about the same as the previous year, but adjustments, deductions or credits increase significantly; and third, receipt of a refund with income, adjustments and deductions remaining about the same as the previous year, but the taxpayer qualifies for one or more tax credits that he/she did not qualify for in the previous year. A review of the Debtors’ tax returns for the previous five (5) years shows that they in fact shared many of the circumstances listed in Publication 919, page three (3), indicating that too much tax was being withheld.

          For bankruptcy purposes, an apparent majority of post-BAPCPA cases hold that the allowable amount of a debtor’s tax liability to be deducted on line 25 of Form B22A (or on line 30 of Form B22C) is the debtor’s actual tax liability, and not the amount withheld from the debtor’s paycheck. In a case from the Western District of Kentucky, the court considered a similar objection from the Trustee in a Chapter 13 case. In re Risher, 344 B.R. 833 (Bankr. W.D.Ky. 2006). The Risher Chapter 13 Trustee objected to certain provisions in several different proposed plans that the court was asked to review, including proposals to exclude future tax refunds from distributions to unsecured creditors. Risher, supra, at 834. The court agreed with the Trustee that taxes actually paid are not equivalent to what is withheld from a debtor’s paycheck for taxes. “Tax refunds are amounts over-withheld and thus, constitute additional income” that must be submitted to the Chapter 13 Trustee for distribution to unsecured creditors. Id., at 837.

Other cases holding that the amount of tax to be entered on Line 30 (and on Line 25, for Chapter 7 cases) is the actual tax liability, and not the amount withheld from wages, are In re Lawson, 361 B.R. 215 (Bankr. D.Utah 2007), In re Balcerowski, 353 B.R. 581 (Bankr. E.D.Wis. 2006) and In re Johnson, 346 B.R. 256 (Bankr. S.D.Ga. 2006).

          This court is persuaded that the position advocated by the UST, and upheld by the apparent majority of bankruptcy courts taking up the issue, is correct. While there is nothing improper outside of a bankruptcy proceeding about the practice of paying more to the government in withholding for taxes than what is owed, the UST and the courts so holding are correct to limit a debtor to the actual monthly tax liability incurred for purposes of completing Line 25 of Form B22A, or Line 30 of Form B22C for cases in Chapter 13. To the extent a debtor is entitled to a tax refund, those funds must be included as disposable income in completing the means test to determine whether or not the presumption of abuse of the bankruptcy system arises in a given case.



          For the reasons set forth in the foregoing Memorandum Opinion, the court HEREBY ORDERS AS FOLLOWS:

          1. The Debtors shall have ten (10) days from the date of entry of this Memorandum Opinion and Order within which to amend their Chapter 7 Statement of Current Monthly Income and Means-Test Calculation (Form B22A) so as to conform to the provisions of this Opinion, utilizing the figures agreed upon in the Joint Stipulations and Agreed Order and deducting as monthly tax expense their actual tax liability and not including amounts over-withheld from their paychecks.

          2. In the event the amended Calculation reveals that the presumption of abuse arises, that the Debtors have disposable monthly income from which payment to unsecured creditors may be made and absent a demonstration of special circumstances under section 707(b)(2)(B), the Debtors shall be afforded an additional ten (10) days from the date of filing the Amended Chapter 7 Statement (Form B22A) within which to convert their bankruptcy case to one under Chapter 13. If the Debtors fail to comply with the deadline to amend their Chapter 7 Statement (Form B22A) as set forth in paragraph 1 of this Order, or if conversion is appropriate and not undertaken by Debtors within the stated deadline, an order dismissing the Debtors Chapter 7 case will be entered immediately.

Copies to:

Kevin Palley, Esq.

Rachelle Williams, Esq.