“(T)he code is more what you’d call ‘guidelines’ than actual rules.”(1)
The Supreme Court has agreed to hear a case which raises the issue of whether the collection standards contained within the IRS Financial Analysis Handbook (2), as incorporated into the Chapter 7 Means Test (3), are more of a code than a guideline(4). Three circuits and a Bankruptcy Appellate Panel have held that under a “plain meaning” reading of the Code, a debtor may claim an ownership expense deduction under the Means Test regardless of whether there is a debt or lease payment with regard to the vehicle (5), while the Ninth Circuit, adopting what is known as the IRM approach, has reached a contrary result (6). However, another way to describe the split is whether the IRS Collection Standards (hereafter IRS Standards)(7) as incorporated into the Means Test are more of a Code (the plain language approach) or a guideline (the IRM approach)(8). This article will examine how the search for an objective standard may lead to unintended consequences.
The Search for an Objective Standard
Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), a debtor’s bankruptcy case could only be dismissed based on a finding of “substantial abuse,”(9) a standard which was not defined in the statute. BAPCPA changed this standard to one of “abuse” and provided for a presumption of abuse based on a formula that has become known as the Means Test (10). The purpose of the Means Test “is to determine if the debtors can repay a portion of their debt” (11). The Means Test applies to debtors with primarily consumer debts whose “current monthly income” exceeds the median income for a family of their size (12).
The Means Test is based on an elaborate formula found at 11 U.S.C. §707(b)(2). A bankruptcy filing is presumed to be abusive if the debtor can afford to pay the lesser of 25% of his nonpriority unsecured debts or $7,025, whichever is greater, or $11,725 (13). The Means Test determines this ability to pay by taking the debtor’s “current monthly income” and deducting categories of allowed expenses and multiplying by 60 (14). Like prior case law under the substantial abuse test, the Means Test looks at the debtor’s ability to pay his debts (15). However, the Means Test does not rely on the debtor’s current monthly income and expense. Instead, it uses an average of the debtor’s income for the preceding six months (16) and subtracts certain defined expenses.
Among other things, the Means Test allows deduction of
. . . 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. . . . Notwithstanding any other provision of this clause, the monthly expenses of the debtor shall not include any payments for debts.(17)
Separate provisions of the Means Test allows the debtor to deduct payments for secured debts scheduled to come due during the 60 months after the petition date as well as priority claims divided by 60(18).
The Means Test represents an attempt to replace the subjective “substantial abuse” test with a more objective standard. The IRS standards refer to such sources as Census Bureau and Bureau of Labor Statistics data (19). However, as used by the IRS, they are more of a guideline than a code (20). According to the Financial Analysis Handbook:
The standard amounts set forth in the national and local guidelines are designed to account for basic living expenses. In some cases, based on a taxpayer's individual facts and circumstances, it may be appropriate to deviate from the standard amount when failure to do so will cause the taxpayer economic hardship (see Note below bullet list). The taxpayer must provide reasonable substantiation of all expenses claimed that exceed the standard amount.(21)
The National and Local standards consist of tables of data. However, they are used in the context of the Financial Analysis Handbook which provides guidelines as to how they should be applied.
Furthermore, the standards consist of aggregate amounts for categories, including debt payments(22). However, the Means Test considers secured debts separately. This means that a debtor with a high mortgage payment or car payment could be allowed to deduct more than the amount allowed under the standards.
The Problem of Vehicle Ownership Expenses
Vehicle ownership expenses pose a potential conflict between the language of the Means Test and the IRM. Under the Means Test, the debtor may deduct
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. . . . (23)
The Local Standards include both ownership and operating expenses (24). The IRM specifies that in determining a taxpayer’s ability to pay "[t]axpayers will be allowed the local standard or the amount actually paid, whichever is less."(25) In the specific case of vehicle payments, the IRM states "(i)f a taxpayer has a car, but no car payment [sic] only the operating cost portion of the transportation standard is used to figure the allowable transportation expense."(26)
The conflict arises because the statute refers to the Local Standards. The Local Standards consist of a table of expenses broken down by number of vehicles owned (27). Furthermore, under the Means Test, ownership costs and debt payments are separate allowances. Thus, since ownership costs and debt amounts are distinct allowances, it would be possible to have an ownership costs without a debt payment. However, the purpose of the Means Test is to "to ensure that debtors repay creditors the maximum they can afford."(28) The IRS standards have a similar purpose. Since the IRM would not allow an expense which was not an “actual” expense, neither should the Means Test.
What Expenses Are Applicable?
Both approaches seek to apply the plain meaning of the statute, particularly the word “applicable.”(29)
The Ninth Circuit quoted its Bankruptcy Appellate Panel as stating:
The ordinary, common meaning of "applicable" further impels us to this conclusion. "Applicable," in its ordinary sense, means "capable of or suitable for being applied."(Citation omitted). Given the ordinary sense of the term "applicable," how is the vehicle ownership expense allowance capable of being applied to the debtor if he does not make any lease or loan payments on the vehicle? In other words, how can the debtor assert a deduction for an expense he does not have? If we granted the debtor such an allowance, we would be reading "applicable" right out of the Bankruptcy Code (30).
In contrast, the Seventh Circuit applied “applicable” to mean:
707(b)(2)(A)(ii)(I) is more strongly supported by the language and logic of the statute. In order to give effect to all the words of the statute, the term "applicable monthly expense amounts" cannot mean the same thing as "actual monthly expenses." Under the statute, a debtor's "actual monthly expenses" are only relevant with regard to the IRS's "Other Necessary Expenses;" they are not relevant to deductions taken under the Local Standards, including the transportation ownership deduction. Since "applicable" cannot be synonymous with "actual," applicable cannot reference what the debtor's actual expense is for a category, as courts favoring the IRM approach would interpret the word. We conclude that the better interpretation of "applicable" is that it references the selection of the debtor's geographic region and number of cars.(31)
Thus, two circuits have reached diametrically opposed views of what the word “applicable” means in the applicable statute.
Going Beyond Applicable
If the plain meaning of the word “applicable” is not sufficient to resolve the debate, what other factors might illuminate the issue?
The courts taking the “plain meaning” approach add several other arguments in favor of their position. Among them, a prior version of the bankruptcy reform legislation included an express reference to the Internal Revenue Manual, a provision which was not included in the final bill (32); the Internal Revenue Manual itself includes a disclaimer that it is only to be used for tax collection purposes and not for purposes of bankruptcy (33); that it would be prudent to allow a debtor with no car payment to save for a new vehicle (34); that it would be absurd to allow a debtor with $1 in debt against the vehicle to take the ownership expense while denying it to a debtor without a car payment (35); and that the Bankruptcy Code provided for both an ownership expense and a secured debt deduction as separate items (36).
On the other hand, the Ninth Circuit looked to the purpose of the deduction. It quoted its Bankruptcy Appellate Panel as stating:
Congress has deemed the expense of owning a car to be a basic expense that debtors can deduct in calculating what they can afford to pay to their creditors. However, in making that calculation, what is important is the payments that debtors actually make, not how many cars they own, because the payments that debtors make are what actually affect their ability to make payments to their creditors.
The statute is only concerned about protecting the debtor's ability to continue owning a car, and if the debtor already owns the car, the debtor is adequately protected . . . . When the debtor has no monthly ownership expenses, it makes no sense to deduct an ownership expense to shield it from creditors. (37)
It also looked to the general purpose of BAPCPA.
This approach also is arguably supported by Congress's intent in implementing the means testing as part of BAPCPA--"to ensure that debtors repay creditors the maximum they can afford." (38)
Finally, it questioned the wisdom of allowing a debtor to subtract a “fictitious expense not incurred by the debtor” under the Means Test (39).
Finding an Answer
The ownership deduction cases illustrate the practical difficulties in using the IRS Standards as the basis for calculating an above median income debtor’s eligibility for chapter 7 or determining the amount that an above median debtor must pay under a chapter 13 plan. While the reference to tables of data based upon Census Bureau and Bureau of Labor Statistics figures appears objective and therefore practical to apply, the Internal Revenue Manual within which they appear is full of nuances. To further complicate the matter, Congress included numerous modifications to the IRS Standards within the text of Section 707(b). It is safe to say that Congress created ambiguity when it sought to graft a guideline into a Code.
In the conclusion to its opinion, the Ninth Circuit recognized the difficulty of the issue and suggested that Congress take action to clarify the legislation.
The "correct" answer to the question before us, which the courts have been struggling with for years--at the unnecessary cost of thousands of hours of valuable judicial time--depends ultimately not upon our interpretation of the statute, but upon what Congress wants the answer to be. We would hope, in this regard, that we the judiciary would be relieved of this Sisyphean adventure by legislation clearly answering a straightforward policy question: shall an above-median income debtor in chapter 13 be allowed to shelter from unsecured creditors a standardized vehicle ownership cost for a vehicle owned free and clear, or not? Because resolution of this issue rests with Congress, we have taken the unusual step of directing the Clerk of the Court to forward a copy of this opinion to the Senate and House Judiciary Committees.(40)
The Ninth Circuit makes a good point. While Congress may have intended the more parsimonious approach adopted in Ransom, numerous courts have concluded that the language they used does not accomplish that result. Thus, the unintended consequence of seeking an objective standard is that in this one case, debtors may receive a more generous allowance than they would have been granted under the Internal Revenue Manual or prior bankruptcy law.
Pending an answer from Congress, the Supreme Court will have to untangle the legislative knot. On April 19, 2010, the Supreme Court agreed to consider the following question:
Whether, in calculating the debtor's "projected disposable income" during the plan period, the bankruptcy court may allow an ownership cost deduction for vehicles only if the debtor is actually making payments on the vehicles.(41)
While this will be the third case that the Supreme Court has accepted with regard to BAPCPA, it will likely not be the last(42).
1. Pirates of the Caribbean: The Curse of the Black Pearl, quoted at http://www.imdb.com/title/tt0325980/quotes. The quote originally appears near the beginning of the movie when Elizabeth Swann invokes the Code of the Brethren to Captain Barbossa. Throughout the movie, characters use the guideline reference as a rationale to disregard the Code.
2. Internal Revenue Manual, §5.15.1, found at www.irs.gov/irm.
3. 11 U.S.C. §707(b).
4. In re Ransom, 577 F.3d 1026 (9th Cir. 2009), cert granted, 2010 U.S. LEXIS 3359 (2010).
5. In re Washburn, 579 F.3d 934 (8th Cir. 2009)(with dissenting opinion); Tate v. Bolen, 571 F.3d 423 (5th Cir. 2009); In re Ross-Tousey, 549 F.3d 1148 (7th Cir. 2008); In re Kimbro, 389 B.R. 518 (6th Cir. BAP 2008).
6. In re Ransom, supra.
7. The Collection Standards consist of the National Standards, Local Standards and Other Necessary Expenses.
8. The two approaches are described in more detail below.
9. In re Rudler, 576 F.3d 76 (1st Cir. 2009).
10. “The heart of the bill’s consumer bankruptcy reforms consists of the implementation of an income/expense screening mechanism (‘‘needs-based bankruptcy relief’’ or ‘‘means testing’’), which is intended to ensure that debtors repay creditors the maximum they can afford.” Report on the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, H.R. Rept. 109-31, 109th Cong., 1st Sess. (April 8, 2005).
11. Tate v. Bolen, at 425.
12. The requirement that debts be primarily consumer debts is found in 11 U.S.C. §707(b)(1), while exclusion for below median income debtors is contained in §707(b)(7).
13. 11 U.S.C. §707(b)(2)(A)(i). These amounts are adjusted for inflation and were most recently adjusted on April 1, 2010.
15. In re Goble, 401 B.R. 261 (Bankr. S.D. Ohio 2009).
16. 11 U.S.C. §101(10A) containing definition of “current monthly income.”
17. 11 U.S.C. §707(b)(2)(A)(i)(I).
18. 11 U.S.C. §707(b)(2)(A)(iii) and (iv).
19. IRM, §184.108.40.206.
21. IRM, §220.127.116.11.6.
22. For example, the standards for housing state:
Housing and Utilities. Housing expenses include: mortgage (including interest) or rent, property taxes, necessary maintenance and repair, homeowner's or renter's insurance, homeowner dues and condominium fees. The utilities include gas, electricity, water, heating oil, bottled gas, trash and garbage collection, wood and other fuels, septic cleaning, telephone and cell phone.
23. 11 U.S.C. §707(b)(2)(A)(i)
24. IRM §5.15.1.
25. IRM §18.104.22.168.
27. In re Kimbro, at 527.
28. H.R. Rep. 109-31(I), at 1.
29. In re Ransom, at 1030 ("As did our BAP, we decide this issue not on the IRS's manual, but instead on the "statutory language, plainly read."); In re Ross-Tousey, at 1158 ("To analyze this issue, we begin with the language of the statute. When the language is plain, the sole function of the courts is to enforce the statute according to its terms.”).
30. In re Ransom, at 1030-31.
31. In re Ross-Tousey, at 1158.
32. In re Ross-Tousey, at 1159; Tate v. Bolen, at 427.
33. In re Kimbro, at 527.
34. Tate v. Bolen, at 428; In re Ross-Tousey, at 1160.
35. In re Ross-Tousey, at 1161.
36. In re Kimbro, at 523.
37. In re Ransom, at 1030-31.
38. In re Ransom, at 1030.
39. In re Ransom, at 1030.
40. In re Ransom, at 1031-32.
42. The others are Milavetz, Gallop & Milavetz, P.A. v. United States, 559 U.S. __ (2010) and In re Lanning, 545 F.3d 1269 (10th Cir. 2009), cert. granted, 2009 U.S. LEXIS 7655 (2009).