Tuesday, October 21, 2008

Self-Employed Ch. 13 Debtor Can't Deduct Business Expenses to Determine Whether Debtor Has Above/Below Median Income, and Thus a 3 or 5-Year Plan

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Drummond v. Wiegand (In re Wiegand)
9th Circuit BAP No. MT-07-1431 JuPaD, 2008 WL 1733148 (9th Cir. B.A.P. 2008)
April 3, 2008

A 9th Circuit Bankruptcy Appellate Panel (which included Judge Randy Dunn) has ruled that a self-employed Chapter 13 debtor may not subtract business expenses from gross business income in arriving at "current monthly income," even though Form 22C clearly provides for this subtraction. So individual debtors must use their gross monthly business income to calculate whether they are above or below median income, which in turn determines whether their plan's applicable commitment period is 3 years or 5 years.

The BAP's Analysis

In this post-BAPCPA statutory construction case, the BAP used a combination of "the plain meaning rule" and "a holistic approach" to resolve the new law's lack of clarity in its definition of "current monthly income" in § 101(10A)," whether for a self-employed debtor this term includes all monthly gross business receipts or rather only net business income after deducting business expenses.

The Court put much weight on the "plain and unambiguous" § 1325(b)(2)
, which defines "disposable income" to be "current monthly income" minus, "if the debtor is engaged in business, the payment of expenditures necessary for the continuation, preservation, and operation of such business." If the Code clearly defines "disposable income" to be "current monthly income" minus business expenses in § 1325(b)(2), then "current monthly income" itself must include all business income before deducting business expenses. Otherwise, "[I]f business expenses are deducted from gross receipts to determine a chapter 13 debtor’s current monthly income, then there would be no need for § 1325(b)(2)(B), which provides for the same deductions."

In addition, "current monthly income" is defined in § 101(10A), as the “average monthly income from all sources that the debtor receives . . . without regard to whether such income is taxable income.” After acknowledging that the Code does not define "income," the BAP "conclude[d] that the plain language of the statute demonstrates that the bankruptcy court’s reliance on the Tax Code and Form 1040 to determine the meaning of income under § 101(10A) was misplaced. The phrase “without regard to whether such income is taxable income” in § 101(10A) reflects a clear congressional intent that Tax Code concepts for determining taxable income are inapplicable to a determination of current monthly income."

Practical Consequences on the Use of Flawed Official Form 22B

But what about Official Form 22B, promulgated by the U.S. Judicial Conference last November and effective January 1, 2008 (just 4 months prior to this Wiegand opinion)? In its Section I "Report of Income" used to determine the "applicable commitment period" of 3 or 5 years in Part II, the form explicitly has debtors with "Income from the operation of a business, profession, or farm" subtract their "Ordinary and necessary business expenses" from their "Gross receipts"in order to arrive at their "Business income." Here the BAP holds that "[t]his mandate compels us to conclude that Form 22C ought to be changed to comply with the statute."

But Form 22C was not on the list of Official Forms that were approved at the U.S. Judicial Conference last month to be effective this December. What to do in the many months or even years in the meantime? The BAP made the following suggestion in its final footnote:
Until Form 22C is changed, one possible solution is for below-median debtors to subtract the business deductions allowed under § 1325(b)(2)(B) on Schedule J from their current income. Above-median debtors should fill out the remainder of Form 22C and utilize the Internal Revenue service standards under §§ 1325(b)(3) and 707(b)(2)(A)(ii)(I) for “Other Necessary Expenses,” as specified in the Internal Revenue Service Financial Analysis Handbook. Arnold, 376 B.R. at 654-55. We leave open the possibility that bankruptcy courts may take other approaches to redress the inconsistency of Form 22C with Code §§ 101(10A) and 1325(b)(2)(B).
Interestingly, the successful appellant in this case, the Chapter 13 Trustee in Montana, Robert Drummond, has subsequently provided his own subsequent analysis of the case, and on this Form 22C matter states:
The judicial conference will have to reconsider Form 22C and determine the appropriate portion of the form which should allow the deduction of business expenses. Business expenses should not be deducted under Part I of the form when computing current monthly income - and the judicial conference should revisit the form for the purpose of revising and correcting the place for the deduction of business expenses.
Impact of 9th Circuit's In re Kagenveama

This Wiegand opinion was decided two months before before the 9th Circuit's In re Kagenveama, in my view the most important 9th Circuit bankruptcy opinion of the year. Kagenveama applied a strict reading to BAPCPA's new terms, "projected disposable income" and "applicable commitment period," with the result that an above-median income debtor who had a negative income on Form B22C, and thus no "projected disposable income," had no requirement to pay unsecured creditors and no requirement to pay into the Chapter 13 plan for 5 years, or for any other particular period of time. (Please see my Bulletin of 9/3/08 on Kagenveama.) It is beyond the scope of this Bulletin to definitively analyze the impact of Kagenveama on Wiegand, but here are some thoughts.

There appear to be some aspects of Wiegand that are not perfectly consistent with Kagenveama--for example the BAP's reference in a footnote that "[w]e have found the applicable commitment period to be a temporal requirement.". But in my judgment Kagenveama did not effectively overturn Wiegand. There is no direct reference to Wiegand in Kagenveama, because oral arguments in the latter occurred many months before Wiegand was published. And Weigand did not rely on the only 9th Circuit BAP opinion which Kagenveama expressly overturned, In re Pak, 378 B.R. 257, 267 (9th Cir. BAP 2007).

But the cases do overlap, slightly but with potentially huge consequences for a certain population of debtors. Wiegand deals with how a Chapter 13 business owners calculate their "current monthly income" in order to arrive at their "applicable commitment period," whereas Kagenveama interprets "applicable commitment period" in the limited context of above-median income debtors who show negative "monthly disposable income" after deducting expense at the end of Form 22C. Wiegand will push more Chapter 13 business owners above median income in Part I of Form 22C, which paradoxically will qualify them for the huge potential benefits of Kagenveama, IF their expenses in Part IV (apparently including some business expenses per the BAP's suggestion above) exceed their income.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys

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