People with a good income and a big IRS bill often assume Chapter 7 is off the table. They have heard about the means test, they know they earn more than the median, and they stop there. That can be an expensive assumption.
The means test has a threshold question built into it, and tax debt changes the answer.
The means test only applies to consumer debtors
The means test lives in 11 U.S.C. § 707(b). Section 707(b)(1) allows the court to dismiss (or, with the debtor's consent, convert) a Chapter 7 case filed by an individual debtor "whose debts are primarily consumer debts" if granting relief would be an abuse. The formula in § 707(b)(2) and the "totality of the circumstances" review in § 707(b)(3) are both tools for deciding abuse under § 707(b)(1).
So the first question is not "what is my income?" It is "are my debts primarily consumer debts?" If the answer is no, the § 707(b) means test does not apply.
Is tax debt a consumer debt?
The Bankruptcy Code defines "consumer debt" in 11 U.S.C. § 101(8) as debt incurred by an individual primarily for a personal, family, or household purpose. Income taxes fit that definition badly.
The leading appellate discussion is In re Westberry, 215 F.3d 589 (6th Cir. 2000). The question there was the Chapter 13 codebtor stay, which also turns on "consumer debt," and the court held that federal income and self-employment taxes are not consumer debt. Its reasons:
- Taxes are not voluntarily incurred the way consumer debt is.
- Taxes are imposed for a public purpose, not a personal or household one.
- Taxes arise from earning money, while consumer debt comes from spending it.
- Consumer debt normally involves an extension of credit; taxes do not.
The court also noted that the bankruptcy courts addressing the question had, almost without exception, reached the same result. Westberry was decided under a different section, and it is a Sixth Circuit case, not binding in Florida. But § 707(b) uses the same defined term, and the reasoning carries over. Business debts generally fall outside the definition too, since they are incurred for a profit-making purpose rather than a household one.
How "primarily" is measured
Courts commonly measure "primarily" by dollar amount: if more than half of your total debt, by dollars, is non-consumer debt, your debts are not primarily consumer debts. Some courts also look at the number of debts or other factors, so check how your district handles it.
Here is how that plays out. Suppose you owe $90,000 in income taxes and $40,000 on credit cards and a car loan. By dollar amount, about 69 percent of your debt is tax debt, so your debts are not primarily consumer debts. Flip the numbers and the means test is back in play.
Two wrinkles to watch:
- Money borrowed to pay the IRS. If you paid taxes with a credit card or a loan, the IRS debt became a card or loan balance. Whether that debt is consumer or not is less settled. It also has its own discharge problem under § 523(a)(14); see paying the IRS with a credit card or loan.
- Mortgages and secured debt. A large home mortgage can swing the percentage toward consumer debt. Whether it counts, and how much, is a question for your specific facts and district.
How you tell the court
Chapter 7 debtors file Official Form 122A-1, Chapter 7 Statement of Your Current Monthly Income. If your debts are not primarily consumer debts, you check the box saying so on Form 122A-1Supp, Statement of Exemption from Presumption of Abuse Under § 707(b)(2), and you generally do not need to complete Form 122A-2, the means test calculation. The forms are on the U.S. Courts bankruptcy forms page.
Expect the U.S. Trustee to look at your schedules and see whether your classification holds up. List the tax debt accurately, by year and amount, so the percentage is obvious from the paperwork.
If the means test does apply, taxes still help
Even when your debts are primarily consumer debts, tax debt is not irrelevant. Under § 707(b)(2)(A)(iv), your allowed expenses include payment of all priority claims, calculated as the total amount of debts entitled to priority divided by 60. Recent income taxes are usually priority claims under § 507(a)(8). A large priority tax balance creates a large monthly deduction, which can bring an above-median filer under the presumption of abuse.
That deduction exists precisely because those taxes will not be discharged in Chapter 7. The Code assumes you will have to pay them, so it lets you count the payment.
Passing the means test is not the same as getting rid of the tax
This is the part people blur together. Escaping the means test gets you into Chapter 7. It does nothing to make a particular tax year dischargeable. That still depends on the three-year, two-year, and 240-day rules and on whether there was fraud or evasion.
A non-consumer debtor whose tax years are all recent can qualify for Chapter 7 and still walk out owing the IRS every dollar. Run the years through the discharge calculator and read priority vs. general unsecured tax claims before you celebrate.
Also keep two other doors in mind. Section 707(a) still allows dismissal of any Chapter 7 case for cause, consumer or not. And if you end up in Chapter 13 instead, the disposable income rules in § 1325(b) and Forms 122C-1 and 122C-2 apply regardless of whether your debts are consumer debts. The comparison is laid out in Chapter 7 vs. Chapter 13 for tax debt.
For a wider view of how the firm approaches IRS problems before and after bankruptcy, visit getirshelp.com.
Find out which test you actually face
A high income and a big IRS bill is not the end of the Chapter 7 conversation; sometimes it is the beginning. Call Darrin T. Mish, tax attorney, at (813) 229-7100 to go through your debts and your tax years together. Every case turns on its own transcripts and dates; this page is general information, not legal advice for your situation. The means test cannot fail you if it never applied to you.