Bankruptcy

Can You Deduct an Expense for a Car You Own?

By Bob Lawless

The news came today that the Supreme Court has granted cert in Ransom v. MBNA Bank. The issue is whether the Bankruptcy Code means what it says. OK, I'm giving away what I think is the right answer.

The question is whether an above-median income chapter 13 debtor, in calculating "projected disposable income," can deduct an ownership expense for a car even if the debtor owns the car free and clear such that the debtor is not making an debt or lease payments on the car. The Fifth and Seventh Circuits said the plain meaning of the statute clearly allowed the debtor to do so. The Ninth Circuit said the statutory language directed a different result. If you're wondering how so many federal judges can differ over the "plain meaning" of a statute, you're obviously not a lawyer.

We were talking about this issue on Credit Slips back in 2006 (and also here). Section 707(b)(2)(A)(ii)(I) of the Bankruptcy Code states, "The debtor's monthly expenses shall be the debtor's applicable monthly expenses amounts under the "National Standards and Local Standards" (referring to IRS Guidelines). And, the IRS Guidelines give an ownership deduction. And, "shall" means "shall." As I wrote on a related issue:

The problem stems from how Congress used the IRS Guidelines. The IRS, which I understand is less-than-thrilled that these Guidelines are now enshrined in the Bankruptcy Code, established the Guidelines as informal agency operating procedures to determine when to compromise a tax debt based on inability to pay. The IRS Guidelines were intended as a ceiling, used to determine when a taxpayer could afford to cut back on expenses and repay a tax debt. They also were intended as guidelines, not hard-and-fast rules. Congress, however, has used the IRS Guidelines as a hard-and-fast floor for the Bankruptcy Code. The Guidelines establish minimum amounts of expenses to which debtors are entitled to deduct in determining their eligibility for chapter 7, and the Bankruptcy Code then allows debtors to deduct some expenses above those minimums. The Guidelines do not work well when applied to situations where debtors have hypothetical as opposed to actual expenses, but those are the rules that Congress chose.

The statute seems pretty clear. Courts like the Ninth Circuit, however, fall into a trap of thinking about the phantom ownership deduction as some sort of unwarranted benefit for bankruptcy debtors. In fact, by not allowing an ownership deduction even when the debtor owns a car free and clear, the court creates incentives for further borrowing and possibly even irresponsible behavior. In a world where a new car loan decrease chapter 13 payment obligations but keeping the old clunker does not, debtors will have even more reason to buy a new car before filing bankruptcy.

And, yes, it's a goofy system, but it's the system we got out of the 2005 bankruptcy law. The law used to provide--and still does for debtors earning below their state's median income--that the bankruptcy judge should determine amounts "reasonably necessary" to be expended for the support of the debtor or the debtor's dependents. Under the old system, the judge uses his or her judgment and discretion to apply individualized justice in each chapter 13 case. Congress tried to remove that judgment and discretion, with the predictable result that we will have a lot of cases that fit like square pegs in the round hole of the statutory language. The Supreme Court now has to decide whether to square off that hole or stick with the language that Congress used.

Full post as published by Credit Slips on April 19, 2010 (boomark / email).