The BR Means Test, Part 3: What’s Wrong with How It Handles Expenses

This could be a very quick post. The way Bankruptcy “Reform” defines and dictates expense levels in it Means Test should be completely and totally scrapped in favor of the current approach, which (gasp) looks at what filers reasonably need to spend to maintain a decent level of existence.

The dictated expense scheme of B-”R” that you will see described here is a joke that would be hysterically funny if some think-tank wonk proposed it and nobody tried to do anything with it. But since it will have such an unfair, uncalled-for, and adverse effect on individuals and families in a deep financial hole, it isn’t comedy–it’s an impending tragedy. And because, barring a near-miracle, it is on the verge of becoming law, and because there are so many people who have no idea just how draconian this element of the Means Test is, we need to get into a lot of the gory detail. There are so many problems in this area that this post could be a mile long if I’m not careful (some of you may think it is anyway), but I’ll keep it at as high a level as practical without compromising your understanding.

If/when B-”R” passes, the IRS will define the allowed amounts for most expenses in a bankruptcy filing.

The Internal Revenue Service’s Collection Financial Standards mandate allowed expenses for delinquent taxpayers. These defined allowances are the starting points, and in many cases the ending points, for listing expenses in the B-”R” Means Test. In most cases, it doesn’t matter what you really spend, or if you have overspent in the past, what a prudent person should spend. The Means Test assumes that you won’t spend any more than you are allowed.

(As an aside, the courts don’t have any control over what the IRS does, so if the IRS decides to totally redesign how it deals with expenses in its delinquent tax collection efforts, no one has any idea how the courts will react, or even if they can react in the absence of revised legislation.)

The specific broad spending categories are:

- (Uniform) National Standards for Allowable Living Expenses for different family sizes.

- Local Standards for Housing and Utilities, detailed down to the state and county level.

- Local Standards for Transportation, identified for each major metro area and by region for those who don’t live in a metro area.

- What are called Other Necessary Expenses (link changed in 2006 to reflect relocation of page at IRS web site) in the law, but are referred to by the IRS at the linked page (scroll down about a third of the way to paragraph 5.15.1.10) as “Other Expenses.”

- Finally, there are additions allowed by the B-”R” law that are intended to give a veneer of respectability to the process. But some of these have problems of their own, and don’t in any way make up for the shortcomings of the IRS-driven allowances.

National Standards for Allowable Living Expenses

So here are the uniform and national living expenses allowances (i.e., they are the same for anyone living anywhere in the Lower 48 states) for a family of 3:

I will look at FOOD, ALL OTHER LISTED LIVING EXPENSES, and ITEMS THAT SHOULD HAVE BEEN LISTED.

FOOD–A quick comparison of the IRS standards for Food to the Bureau of Labor Statistics 2002-2003 Consumer Expenditure Survey (CES) that is done annually for families with average earnings in each region (i.e., reality) is revealing. The Consumer Expenditure Survey presents only one set of figures for an “average family size” for each overall region reported. The four regions are: Midwest, Northeast, South, and West.

The chart below divides the sum of “Food at Home” and “Food Away” in each regional Survey by 12, corrects for family size, adds 5% to roughly account for inflation in the 2 years that have passed since the survey, and compares the result to the 2005 IRS family-of-3 standard above.

Even if you take it as a given that people in financial trouble should be in significant-cutback mode, the IRS and B-”R” food allowances are absurdly low in every region except the Midwest, which is borderline.

The food allowance can be increased an additional 5% in B-”R” (IF you can prove it), but we’re only talking about differences of about $30, which do not meaningfully change the results.

ALL OTHER LISTED LIVING EXPENSES–I took a detailed look at the rest of the living expense items, and made similar adjustments where appropriate for family size and inflation (believe me, you don’t want to see the detail). Here’s how it shakes out:

As with food, the “apparel and services” (clothing) category can be raised by 5% (again, IF you have proof), but in this case its impact would be no more than $10 per month–big whoop. Also as with food, the allowances for other living expenses are absurdly low in every region except the Midwest, which again is borderline.

ITEMS THAT SHOULD HAVE BEEN LISTED (here and elsewhere)–The following line items listed on the CES were ignored, aren’t considered elsewhere, and should therefore have been considered at least to some extent as part of Living Expenses:

- Household furnishings and equipment–It would be easy to argue that the $1500-$1800 per year found in each of regional CES stats is way too high for someone to claim as an allowance in a bankruptcy filing, but it would be ridiculous to claim that the number should be zero. Nevertheless, B-”R” totally ignores this item.
- Alcohol and tobacco–B-”R” also ignores the roughly $700-$800 per year found in the each of the regional surveys. To be sure, this is a debatable item, but it’s also unrealistic to assume that everyone who files will totally abstain from smoking and drinking.

To be conservative and avoid needless controversy, I’m going to assume that these exclusions ignore a very low $50 a month on average of real and necessary spending.

So if you add up the three areas, the allowances understate reality for average earners by the following amounts:

Midwest–$277 (149+78+50)
Northeast–$475 (280+145+50)
South–$348 (197+101+50)
West–$393 (199+144+50)

Finally, certain individual metro areas within regions have much higher living expense cost structures than the rest of their region (think Boston and New York in the Northeast, San Francisco in the West, etc.). Too bad–The IRS allowances will still be the same in those cities for the same income.

Local Standards for Housing and Utilities

These standards appear at first blush to be reasonably fair:

- First, you get to include your actual house payment (including taxes and insurance).
- Next, you subtract that payment from the allowance amount in the IRS table.
- Any leftover amount is the allowance for utilities.
- You could get lucky and have the leftover amount be more than you actually spend on utilities (I believe this will be pretty rare, and if it’s too obvious, creditors will probably challenge it).
- It will be more typical that you spend more than the leftover amount for utilities. Not to worry–you can claim more as long as you can prove it.

The mechanics may work out a bit differently than I described, but it appears that a filer will in “normal” circumstances not be shortchanged here (but see “two other potential problems” in the second following paragraph).

There is, however, one major omission: home repairs. The regional CES reports do not have a line item for home repairs. We’ve already seen that “Home Furnishings and Equipment” in the CES reports was not picked up in Living Expenses; it’s not picked up in Housing and Utilities, either. Most experts suggest that adequate home maintenance, upkeep, and reserving for major repairs requires 1%-2% of a home’s value each year (obviously this depends heavily on home prices and an individual home’s age and condition). In a $150,000 home this would require a minimum of $125 a month ($150,000 x 1% divided by 12).

Two other potential problems are, first, how many months of utility bills you would be allowed to submit. One would hope that the answer is twelve to take care of seasonal ups and downs. Second, looking back at prior utility bills doesn’t deal with the reality that future bills for the same usage will be higher if fuel costs continue their seemingly relentless increase.

Local Standards for Transportation (Vehicle Payment and Operating Costs)

The nearly-passed B-”R” law dictates that vehicle loan payments continue, since those debts are secured. As to vehicle operating costs, the IRS identifies allowable amounts for each region and the largest 20 or so metro areas for no-vehicle, 1-vehicle, and 2-vehicle situations (apparently if you have a third vehicle all of its costs must be ignored).

The recently released annual AAA Cost Survey (click on link on the left to download the survey) indicated that the operating cost for a typical car in 2005 excluding depreciation, but including fuel (costs used appear to be current), repairs and maintenance, and tires, is about 14 cents per mile for passenger vehicles, and 16 cents per mile for SUVs and passenger vans.

If each vehicle in a 2-vehicle family consisting of one passenger vehicle and one SUV is driven 16,000 miles per year (a reasonable average based on reviewing this page from the US Department of Energy web site), total vehicle operating costs will be $4,800 (15 cents per mile average times 32,000 miles), or $400 per month. This alone is higher than the permitted allowances in eighteen of the metro area or regional listings at the IRS link, and the metro areas with higher listings appear to mostly be ones with toll road systems. So it appears that most of the allowances are low for average drivers.

Additinally, the IRS allowances totally fail to accommodate the following:

- Long-commute driving. The same DOE link notes that 27% of drivers expect to drive 25,000 miles or more this year. If one driver in the above example drives 10,000 more miles, that will for most metro areas or regions generate real costs of $125 per month (10,000 miles x 15 cents divided by 12) that will not be reportable in the means test.

- There is no parking allowance for those who must pay to park and who do not have access to public transportation.

- For people in bankruptcy, the higher costs for vehicle insurance charged by carriers who use credit reports and credit scores in their underwriting.

So while it’s difficult to quantify, it’s clear that the Transportation Allowances will in most cases understate reality by moderate to large amounts.

Other Necessary Expenses (link changed in 2006 to reflect relocation of page at IRS web site)

Certain items here are for the most part not controversial. The bankruptcy filer will claim appropriate monthly amounts for federal, state, and local income taxes; state and local personal property taxes; Social Security and Medicare taxes; health care; and (it appears, based on a surprising override written into the law) charitable contributions of up to 15% of gross income.

Other items will be hotly disputed by creditors, and one can only imagine the shouting matches that will occur between creditors, filers, and bankruptcy officials.

That’s because the first paragraph in this section at the IRS web site defines what is “necessary” (my bold):

Other expenses may be considered if they meet the necessary expense test - they must provide for the health and welfare of the taxpayer and/or his or her family or they must be for the production of income. This is determined based on the facts and circumstances of each case.

If B-”R” incorporates the IRS’s definition of what is “necessary” (and I don’t see any evidence that it doesn’t), creditors will question anything they can using health-and-welfare and production-of-income arguments, and I believe they will ordinarily prevail.

Here are some examples of challenges creditors could make (the arguments they could use are in italics):

- Accounting and legal fees (they can do their taxes themselves)
- Child care (they should be forced to put their child in a less “luxurious” facility)
- Wireless phones, pagers, and extra services on landline phones (they’re unnecessary frills)
- Internet services (make them go to the library)
- Newspaper and magazine subscriptions (the library argument again)

In response, filers will eliminate most things but keep others they feel are too important (e.g., a wireless phone for a teenager for safety purposes) despite their disallowance as a Necessary Expense.

Additions Written Into the Law

As noted earlier, these additions are designed to impress cursory reviewers that the bill isn’t as rough on debtors as it really is. On closer examination, the alleged generosity is less than meets the eye:

- There is an allowance for actual costs of taking care of elderly, chronically ill, or disabled family members, but it doesn’t address what would happen if this person required long-term care in a nursing home (to be careful, I’ll note that Medicaid coverage may be automatic in cases like these).

- Another allowance enables filers to buy health insurance if prior insurance has lapsed, but does nothing to address problems with pre-existing conditions that ordinarily cause individual applicants to be rejected. Language in the law limiting the premiums for the new coverage to being “not materially larger than the cost the debtor previously paid” may cut off access to the very expensive high-risk pools created by many states for those whose pre-existing conditions prevent the purchase of individual or one-family coverage. Filers who were uninsured at the time they filed may therefore remain uninsured.

- Finally, there is an allowance of $1,500 for private school tuition. Most parents with kids in private school pay much, much more, and as a practical matter will have to pull their kids out and place them in public schools–an odd choice, to say the least, for conservatives (who don’t even try to disguise their contempt for “government schools”) to force onto parents who have been making the sacrifices involved for private education.

* * * * *

All things being equal, people who are considering bankruptcy after the law takes effect, are currently spending what most people would consider to be average amounts in their daily lives, and have above-median incomes, must recognize that:

- The IRS-dictated allowance amounts, not what you actually spend, even if you are frugal, will be used as part of the determination as to whether money is available to pay creditors, and therefore to determine whether the filing will be a Chapter 7 or Chapter 13.

- If you are a Chapter 13, it will be assumed that any amounts that you currently spend above what the Means Test allows will be available to pay against unsecured debts.

- The only way to make the Chapter 13 payments will be to cut back by those amounts.

- If cutting back by those amounts each and every month is not possible, your attempt at carrying through with Chapter 13 will fail.

So there you have it. It’s clear after going through the expenses allowed by the Means Test that the last thing the bill’s authors had in mind was to an honest attempt to estimate what debtors can really afford to pay unsecured creditors in a bankruptcy filing. If that were the intent, they would have mandated that the expenses used be based on the reality of the situation–which the current law, perhaps awkwardly but usually conscientiously, happens to do a fair job of.

What we have instead is a deliberately cockeyed, inflexible, and incomplete scheme that will recast reality, typically to the tune of forcing debtors to underreport real expenses by $400-$600 per month (but often by much more), and then will force that pretend reality on the courts.

Why was it done this way? What are the bill’s authors trying to accomplish with the Means Test? We can now see three clear reasons:

- As noted in Part 1 (definition of “income”), supporters want to discourage (most, they hope) people from filing, so they can claim victory when the bankruptcy stats go down.

- As brought out in Part 2 (definition of “statewide median income”), they want to force as many of the poor souls who do file as possible into Chapter 13’s payments regimen.

- Finally, as proven in this part which covered “expenses,” they want to force those who are in Chapter 13 to pay so much every month that they have to radically adjust almost everything in their lives–in other words, the bill’s authors want to PUNISH them.