It’s a House(hold) Party! Determining Household Size for the Purpose of Means Testing

Means testing was introduced to the world of bankruptcy with the adoption of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The means test is set forth in 11 U.S.C. § 707‌(b)[1] and is applied to above-median debtors in chapter 13 through 11 U.S.C. § 1325‌(b). The means test has more than one direct use and contains many elements and nuances, but at its core, the primary purpose is to determine whether a consumer debtor has enough disposable income that would allow him/her to propose a viable repayment plan to his/her creditors.

A crucial element of the means test in determining whether a debtor (or debtors, in a joint case) has excess disposable income is the size of the household. This determines what deductions a debtor can take from his/her “current monthly income,” defined by the Bankruptcy Code as “the average monthly income from all sources that the debtor receives ... during the six-month period ending on the last day of the calendar month immediately preceding the date of the commencement of the case.”[2] The Internal Revenue Service (IRS) sets national and local standards for the amount of each deduction that is allowed based on similarly situated individuals or families. These deductions are then applied to the debtor’s income and work to reduce the disposable income by those amounts. The standard deduction amounts increase with each additional member of the debtor’s household, thus the size of the debtor’s household is the key to the amount that the debtor may deduct against his/her income.

It would be nice if it were so simple as to have a defined household size standard, but instead, courts have generally used three distinct tests to determine the size of a debtor’s household. Some courts have used the U.S. Census Bureau’s definition, which is based on the number of residents in a structure (known as “heads-on-beds”).[3] Other courts have based it on the IRS’s definition of “dependents,” determined by a six-factor test defined in the Internal Revenue Manual (IRM).[4] Other courts have used an “economic-unit” test,[5] which, unlike the other two tests, looks to the totality of a debtor’s financial situation as opposed to applying a bright-line rule. The application of one test over another can lead to varying results and can have a major impact on a debtor’s eligibility to file for chapter 7, or on determining the amount of repayment that they must make to their creditors in a chapter 13 repayment plan.

Illustrative Fact Pattern

A potential client comes in for a consultation in preparation for filing for bankruptcy in order to deal with a garnishment from her paycheck. She does not own any real property, and her car is owned outright with no liens. She has only unsecured debt and a judgment lien that has commenced a garnishment. She has a steady job that pays her well. She is divorced and has four children who are mostly grown. While she does have one child in her household full-time, her other three children have left home for college. Their ages range from 15-21. The three college-aged children (aged 18, 19 and 21 years old) are not working and are full-time students at a local university. They each live on campus; however, all three come home almost every weekend to do laundry, get some privacy from their prying dormmates, get some home cooking and spend time with their mother and younger sibling. During summers and extended breaks, all three children stay in the family home full-time. It is March 1 when your client comes to visit you, and the three college children have not been full-time residents of the home since the beginning of the college year the previous August. The children’s father lives out of state, and they do not spend much time with him. He pays child support, which the debtor has included in her monthly income, and he and the debtor have an agreement to each claim two dependents on their taxes each year.

Heads-on-Beds

Adopting the Census Bureau’s test, or the heads-on-beds test, in the case of In re Ellinger, the court found that “[t]‌he Census Bureau defines ‘household’ as ‘all of the people, related and unrelated, who occupy a housing unit’ ... family or non-family.”[6] Using this definition, the court determined that the debtor, who lived with another adult to whom she was not married, had a household size of two for the purposes of means testing. The trustee, on the other hand, argued that the IRS test should apply, by which the debtor would be unable to claim the other adult in her household as she was not a “dependent” for the purpose of tax filings. By the court’s adoption of the heads-on-beds analysis, the debtor benefited by gaining the additional deduction.

In contrast to the benefits to debtor in Ellinger, in the case of In re Smith, the court applied the heads-on-beds test and found that the household size was smaller than the debtor had alleged. The debtors were a married couple with grown children; one daughter and her child (the debtors’ grandchild) lived in their home full-time, their son kept a room with them where he spent limited time, and another daughter was in college and lived in the home with the debtors when she was not at school. The court reasoned that “[a]‌lthough the Census Bureau’s definition is not controlling, it does have relevance for purposes of interpreting Section 1325‌(b)‌(4)‌(A)‌(ii) since that agency’s statistics are to be used to determine the ‘median family income’ also referenced in that subsection.”[7] Based on this logic, the court only permitted the debtors to claim a household of four on their means test, excluding the two adult children who were not full-time residents.

Applying the above findings to our fact pattern, the question of household size as determined by the heads-on-beds test would seem to indicate only two: the debtor and her underage daughter, thus excluding the three college-aged children. This may seem like the incorrect outcome, as the debtor has consistently financially supported her college-aged children. The heads-on-beds analysis does not permit leeway to look into what impact that financial support affects the debtor’s finances, leading to an incomplete picture.

IRM Test

The IRM test looks at household size based on how the IRS would determine eligibility to claim a dependent on the debtor’s tax return. “The IRM does not define household, but indicates that the number of persons allowed under the national standard expenses should generally be the same as the number of dependents on the taxpayer’s latest income tax return.”[8] The IRM test is used by a handful of courts to determine household size, with the two most-cited cases being In re Frye and In re Law.[9] The Frye court outlined the IRM test as having six factors, all of which must be analyzed: (1) a relationship test; (2) an age test; (3) a residency test; (4) a financial support test; (5) a joint-return test; and (6) a special test for a dependent child of more than one person.[10] These factors provide an elemental analysis, which provides a generally simple test to determine a debtor’s household size.

In the Frye case, the debtor claimed a household of four, including her two 19-year-old daughters and her 20-year-old son-in-law. The court determined that both of the debtor’s adult daughters qualified as dependents using all six factors, but that her son-in-law did not qualify under the relationship factor, as he was not a “‘son, daughter, stepchild, foster child, or a descendant of any of them…’ of the filing taxpayer.”[11] Thus the household size was determined to be three, and not four as debtor had claimed. Although the debtor was financially supporting her son-in-law, she was not permitted by this bright-line test to include him as a household member for the purposes of means testing. As with the heads-on-beds test above, the IRM test may not lead to a complete picture of a debtor’s financial situation.

Looking again at the aforementioned illustrative fact pattern, the hypothetical debtor would likely only be permitted to claim two dependents for the purpose of the IRM test, as she and her ex-husband split the children for tax-dependent purposes. This leaves the debtor with a household size of three, and seems to omit the actual expenses that she pays to support all of her children. Like the heads-on-beds application, the result under the IRM test may not properly account for the debtor’s actual economic situation, excluding persons who are functionally members of the debtor’s household, affecting the debtor’s financial situation.

Economic Unit Test

The economic unit test states that a debtor’s household size should be based on “those [persons that] the debtor financially supports.”[12] It is the least-easily defined of the three tests, but may paint a more accurate picture of a debtor’s financial reality. The court in Johnson v. Zimmer stated that “[n]‌either the income tax dependent nor the ‘heads-on-beds’ approach best reflect the purposes of the Code — and specifically the BAPCPA amendments ... as to how a debtor’s disposable income [should] be calculated.”[13] Generally, courts that have adopted the economic unit test have sought to consider all aspects of a debtor’s financial situation without hard-and-fast definitions regarding how that should be done.

Courts utilizing this test have found that it truly does most consistently comport with the Bankruptcy Code, as “it seems the most consistent with the purpose of Form 22A, which is a means test designed to determine a debtor’s disposable income.”[14] “Focusing on the size of the functional economic unit serves as the most realistic basis for determining the size of a debtor’s household.”[15] In In re Skiles, the court found that “[t]‌he ‘economic unit’ definition best aligns with the purposes of the Code, comports with the statutory language, and gives the court flexibility to adapt to a debtor’s unique living situations.”[16] The Johnson court found that the seminal decision in Hamilton v. Lanning[17] supports the use of the economic unit test: “This result is consistent with the Supreme Court’s recognition in Hamilton that bankruptcy courts possess flexibility to look beyond a mechanical application of § 1325‌(b)’s calculations in order to account for the variations readily apparent in the record, even after the BAPCPA.”[18]

In applying the above to the debtor in the hypothetical illustration, she might be permitted under the economic unit test to claim all four children, leading to a household of five. Again, this test aims to consider who the debtor actually supports. Based on the heads-on-beds definition, a debtor only “lives” with one of her dependents, but the three college-aged kids regularly spend time there with her, and since they are full-time students, the debtor pays for most, if not all, of their expenses. Under the heads-on-beds test, the debtor finds herself with a household size of two; the IRM test likely leads to a household of three, ignoring the fact that the debtor is financially supporting the two children whom she is not able to claim on her tax return as dependents.

The outcome under the economic unit test seems to most accurately reflect the debtor’s economic reality and unique living situation. Since the adult children frequently live in the debtor’s home and they rely on her for financial support, they would likely be permitted as dependents on the debtor’s means test. As such, the debtor would have a household of five on her means test, accurately reflecting her financial situation.

As we can see from the fact pattern and one potential debtor’s financial situation, the three tests for determining household size can lead to drastically different results. Since household size and resulting deductions affect a debtor’s disposable income, one thing is clear: The test that is applied by the court could make or break the success of your client’s bankruptcy. Some jurisdictions may have adopted strict use of only one test, so your hands may be tied. However, if there is no locally adopted standard, then you might be able to apply any one of the three tests based on your calculations of the benefit to your client. It is up to you as the consumer debtor’s attorney to maximize their benefits when filing either chapter 7 or 13, and these different tests give you options.