Affirming Bankruptcy Judge Deborah L. Thorne on direct appeal, the Seventh Circuit held that a chapter 13 debtor can prorate an earned income tax credit in calculating disposable income and may offset the tax refund income with “reasonably necessary expenses to be incurred throughout the year.”
The appeals court rejected the chapter 13 trustee’s argument that the tax credit should be turned over in full to allow an extra payment to creditors, without deduction for any expenses.
The Poverty Level Debtor’s $4,000 Tax Credit
A single mother of three children, the below-median income debtor had an annual income of about $30,000, well below the median income threshold of $87,000 in Chicago. Calculating projected monthly income, the debtor included a proration for her anticipated earned income tax credit of about $4,000 a year.
After several amendments to her schedules, the debtor proposed a 48-month plan paying her creditors $74 a month, an amount equal to her calculation of monthly disposable income. Creditors would receive a total of about $6,000. In other words, the plan would have paid creditors three or four times more were the tax refunds earmarked in full for creditors, without deduction.
In calculating disposable income, the debtor in substance included several one-time expenses that she could not incur or pay without using the earned income tax credit, such as buying beds for her sons, who were sleeping on air mattresses. The appeals court said that the additional expenses allowed the debtor to “retain some, or even all, of her tax credits.”
Even with the extra income from the tax refund and the additional expenses, Judge Thorne found that the debtor had “a pretty skinny budget overall.”
The chapter 13 trustee objected to confirmation, arguing that the debtor should turn over the entire amount of the earned income tax refund when received to fund additional payments to creditors.
Consolidating three chapter 13 cases raising identical issues, Judge Thorne overruled the objections and confirmed the debtors’ plans in March 2017. Judge Thorne later certified an issue for direct appeal. The Seventh Circuit agreed to hear the direct appeal, saying there was no authority from the Supreme Court or the Seventh Circuit saying whether tax credits are disposable income.
Interestingly, the trustee and the debtor agreed that tax credits are disposable income. Prompting a dissent from one judge on the panel, the appeals court nonetheless went on to decide the next question: Can a debtor prorate tax credits to be offset by anticipated expenses?
The Seventh Circuit Opinion
In his March 22 opinion, Circuit Judge Joel M. Flaum agreed with the parties and held that tax credits are included in “currently monthly income,” as defined in Section 101(10A)(A) and referred to in Section 1325(b)(1).
Nonetheless, Judge Flaum said that including tax credits within currently monthly income “does not mean that the debtor must pay the entire tax credit to the trustee as disposable income.”
To retain some or all of the tax refunds, the trustee argued that the debtor must file a motion to amend the plan every time a refund comes in. Judge Flaum said that Judge Thorne rejected that idea “to alleviate the burdens that the motion-to-modify process imposes on trustees, debtors, and the court.”
Judge Flaum likewise rejected the argument, relying on Hamilton v. Lanning, 560 U.S. 505 (2010), where the Supreme Court adopted a “forward-looking approach” and said that “the court may account for changes in the debtor’s income or expenses that are known or virtually certain at the time of confirmation.”
Judge Flaum said that Judge Thorne “properly allowed Lanning to calculate [the debtor’s] projected disposable income,” because her receipt of the tax credit refund was “virtually certain.”
On the other hand, Judge Flaum said, the trustee’s argument “is just another version of the rigid mechanical approach the Supreme Court rejected in Lanning.” In contrast, Judge Thorne’s approach of offsetting expenses against anticipated tax refunds “is exactly the kind of forward-looking approach that the Supreme Court endorsed in Lanning.”
In a two-page opinion, Circuit Judge Daniel A. Manion concurred in part and concurred in the judgment, but not in a fashion undercutting the holding regarding the treatment of expenses to offset tax refunds.
Judge Manion said the circuit should not have accepted the case because the trustee and the debtor agreed on the issue that Judge Thorne certified for direct appeal. However, he concurred with the remainder of the opinion, holding “that the bankruptcy court did not abuse its discretion in overruling the trustee’s objections to the debtor’s chapter 13 plan.” He would have expressed no opinion “on whether the earned income tax credit qualifies as income under the Bankruptcy Code” because there was “no adverse briefing on the issue and the resolution would not affect the outcome.”