Bankruptcy Laws: Page 6

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• 12.  Effective date of new law

The changes made by S. 256 are generally effective only with respect to cases filed after its effective date – 180 days after the date of enactment (October 17, 2005). However, as noted above, the limitations on homestead exemptions set out in § 308, 322, and 330 are effective upon enactment, while the auditing requirements of § 603 are not effective until 18 months after enactment. Some of the retroactive elements of the homestead exemptions are already in litigation and many bankruptcy attorneys indicate that it will take 3-5 years for the courts to set forth more defined guidelines interpreting the various aspects of the new law.

Consumer cases under Chapter 7

12b. New § 707(b) — income means testing.

Section 707(b) of the Bankruptcy Code was amended to provide for dismissal of Chapter 7 cases or (with the debtor’s consent) conversion to chapter 13, upon a finding of abuse by an individual debtor with primarily consumer debts. Abuse can be found in one of two ways: first, through an unrebutted presumption of abuse, arising under a new means test (§ 707(b) (2)); and second, on general grounds, including bad faith, determined under the totality of the circumstances (§ 707(b) (3)).

Standing. New § 707(b)(1) generally allows any party in interest, as well as the court on its own initiative, to bring a motion seeking dismissal of a Chapter7 for abuse, but § 707 (b)(6) provides that only the judge, U.S. trustee or bankruptcy administrator may bring the motion if the debtor’s income does not exceed a defined state median. This means that mortgage creditors who already possess substantial income information on various debtors may be able to contest Chapter 7, cases based on this abuse standard. Moreover, under § 707 (b(7) the means-test presumption is completely inapplicable to debtors whose income is below that median. Standing limitations can be summarized in a table:

To apply the standing limitations, it is necessary to determine both “debtor’s income” and the applicable state median.

a) Debtor’s income. Generally, the debtor’s income, for purposes of standing to bring an abuse motion, is defined as the debtor’s “current monthly income” multiplied by 12.

b) Applicable median income. The median income applicable for determining standing to bring a motion under § 707(b) is as follows: (a) for a debtor in a household of 1 person, the median family income of the applicable state for one earner; (b) for a debtor in a household of two, three or four individuals, the highest median family income of the applicable state for a family of the same or fewer persons; and (c) for a debtor in a household of more than four individuals, the highest median family income of the applicable state for a family of four or fewer individuals, plus $525 per month for each individual in excess of four. Median income tables vary with location and they can be found at: www.census.gov/hhes/income/4person.html.

Finding applicable median incomes may require some effort, because the information (at least at the present time) is accessible on the Census Web site only through a custom search. However, it can be expected that the Executive Office for United States Trustees will publish median income tables.

The Census does not compile income figures by household size and state every year. Needless to say, there are myriad statistical issues that may be presented as to how these statistics should be adjusted. The currently available income by state and family size was reported in the 2000 census, reflecting data from 1999. These figures would therefore be increased by consumer price index adjustments beginning in 2001 (as long as the census figures were both “calculated and reported” in 2000).

Presumption of abuse under the means-test. The presumption of abuse, set out in a new § 707(b)(2), is governed by a means test, which is designed to determine the extent of a debtor’s ability to repay general unsecured claims. The means-test has three elements: (a) a definition of “current monthly income,” which measures the total income a debtor is presumed to have available; (b) a list of allowed deductions from current monthly income, for purposes of support and repayment of higher priority debt; and (c) defined “trigger points,” at which the income remaining after allowed deductions would result in the presumption of abuse.

a) Presumed income. “Current monthly income” is defined as a new § 101(10A) as a monthly average of all the income received by the debtor (and the debtor’s spouse in a joint case) — including regular contributions to household expenses made by other persons, excluding Social Security benefits and certain victim payments — during a defined six-month period. If a debtor files schedules with the bankruptcy petition, the six-month period ends with the last day of the calendar month before the filing.

b) Presumed deductions.The deductions from current monthly allowed under the means-test are set out in the new § 707(b)(2)(A)(ii)-(iv) and can be categorized as follows:

(1) Living expenses specified under standards of the Internal Revenue Service.

The IRS has developed living expense standards to provide guidance for its agents in negotiating consensual payment of overdue taxes. The IRS’s Web site, www.irs.gov/individuals/article/0,,id=96543,00.html, explains the standards and links to tables of allowed expenses.

The specified expense allowances are two types. First, “National Standards” establish allowances for food, clothing, personal care, and entertainment, depending on the taxpayer’s family size, on a national basis (except for Alaska and Hawaii, which have higher allowances). Under the means-test, debtors can deduct the National Standards amounts with an increase of up to 5 percent of the food and clothing allowance, if demonstrated to be reasonable and necessary.

Second, the IRS’s “Local Standards” establish allowances for transportation (on regional basis) and housing (on a country by country basis). It can be expected that the Executive Office for the United States Trustees will issue tables of the IRS standards applicable on each relevant geographical area.

In any event, the means-test requires that the amounts deducted by the debtor under the national and local standards be reduced by whatever portion of the allowance reflects payment of debt. Thus, repayment of a car loan would be deducted from the IRS Local Standards allowance for acquiring transportation. 

(d) Rebuttal. To rebut the presumption, § 707(b)(2)(B) requires that a debtor swear to and document “special circumstances” that would decrease income or increase expenses so as to bring the debtor’s income after expenses below the trigger points.

General grounds for abuse. The other basis for a finding of abuse, applicable under § 707(b)(3) in which the presumption does not apply or has been rebutted, is that the debtor filed the petition in a bad faith or that the totality of the debtor’s financial circumstances indicates abuse. As noted above, the U.S. trustee, bankruptcy administrator or judge can assert this basis for finding abuse in any case; creditors and case trustees are limited to asserting it in cases where the debtor’s income is above the defined state median.

Procedure. Section 707(b)(2)(C) requires debtors to file a statement of their calculations under the means-test as part of the schedule of current income and expenditures under § 521. If the presumption arises, then under § 342(d), the court is required to notify creditors within 10 days of the filing of the petition. In addition, under § 704(b), (1) the U.S. trustee or bankruptcy administrator is required to review the debtor’s materials and file with the court, within “10 days after the first meeting of creditors.” A statement as to whether the presumption of abuse arises, a copy of which the court must “provide to all creditors,” and (2) if the presumption arises, the U.S. trustee or bankruptcy administrator must file either a motion under § 707(b) or a statement explaining the reason the motion is not being filed.

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