The Bankruptcy Court did not err when it confirmed a plan in which the debtor prorated her expected Earned Income Tax Credit and offset the income with projected reasonably necessary expenses. Marshall v. Blake (In re Blake), No. 17-2809 (7th Cir. March 22, 2018).
Below-median chapter 13 debtor, Denise Blake, proposed a plan under which she pledged her federal tax refunds but retained any Earned Income Tax Credit. Notwithstanding that Ms. Blake worked full-time, lived in subsidized housing and had three dependent children, the trustee objected, arguing that Ms. Blake must count the EITC as income and include it in her plan payments. The bankruptcy court ultimately confirmed a plan over the trustee’s objection in which Ms. Blake treated the tax credit as income prorated over the course of the year and offset it with reasonable expenses.
The Seventh Circuit allowed a direct appeal to determine the question of whether an EITC is properly considered disposable income under the Code, finding that under section 1325(b)(1) (disposable income is current monthly income less monthly expenses) and section 101(10A)(A) (current monthly income is income from all sources whether taxable or not) it is. Congress’s failure to exclude EITC from income, as it had done in other legislation, supported this conclusion.
Having found that the EITC is properly treated as income, the court turned to the appropriate treatment of that income in the plan. The trustee argued that the tax credit should be turned over to the estate for distribution to creditors, and that Ms. Blake should move to modify if her expenses later gave rise to a need for the funds.
The court disagreed. It found, rather, that the bankruptcy court dealt appropriately with the tax credit by allowing Ms. Blake to prorate it over the year and to offset it by reasonable expenses she would normally use the tax credit to pay. The court noted as an aside that, unlike the trustee here, two other trustees in the district where this case arose do not try to recover tax credits from low-income debtors.
The court found that the bankruptcy court’s order harmonized with the Supreme Court’s treatment of projected disposable income in Hamilton v. Lanning, 560 U.S. 505 (2010), by incorporating the virtually certain income of the tax credit. Contrary to the trustee’s arguments, the court found that Ms. Blake’s entitlement to the tax credit and its projected amount were no less certain than that her employment income would continue to be as expected. Additionally, nothing in the Code, which calculates average monthly income, prohibits prorating an annual lump sum, and it is not unusual for a debtor to prorate income that is not received on a monthly basis.
The court went on to find that, just as Lanning contemplates consideration of projected income, the same reasoning allows for consideration of projected expenses that might offset that income. In fact, the Code allows for calculation of reasonably necessary expenses rather than actual expenses. In this regard, the court noted that debtors on budgets as tight as Ms. Blake’s often use tax credits as an informal “savings account.” The bankruptcy court properly exercised its discretion to allow Ms. Blake to include such virtually certain expenses as those associated with her sons’ high school graduation.
The trustee argued that the Ms. Blake’s treatment of her tax credit and future expenses was “subject to manipulation,” and therefore her plan failed the good faith test of section 1325(a)(3). The court disagreed. It boiled the question down to whether the plan was fundamentally unfair and whether the debtor was “really trying to pay the creditors to the reasonable limit of [her] ability or is [s]he trying to thwart them?” Because the trustee did not raise the issue of bad faith before the bankruptcy court, the circuit court found that the bankruptcy court implicitly resolved the factual issue of good faith in favor of Ms. Blake. It was not necessary for the bankruptcy court to have held an evidentiary hearing to reach these factual conclusions. To the extent that she “manipulated” her expenses when she amended several times, it was to lower certain discretionary expenses, such as for clothing and furniture, to incorporate an increase in others, such as anticipated medical and graduation expenses, without changing the amount to be paid to creditors. The court found that, “[i]f anything, these amendments evince a good faith attempt to pay her creditors to the reasonable limit of her ability.”
The trustee next argued that because Ms. Blake would receive her tax credit in a lump sum, a plan based on a proration of that sum would be infeasible under section 1325(a)(6). The court rejected application of a per se rule with regard to lump sums and deferred again to the bankruptcy court’s factual determinations. To the extent that the tax credit income was offset by projected expenses it was neutral as to the question of feasibility. Moreover, debtors in general are frequently able to time certain expenses to coincide with receipt of the tax credit thereby reducing the likelihood of an expense undermining plan success.
The court ended with a look at public policy considerations beginning with the finding that one of the fundamental goals of bankruptcy is to afford the debtor a fresh start. Similarly, a goal of the earned income tax credit is to help low-income members of society meet the “basic costs of life.” The court concluded that the bankruptcy court’s decision advanced both public policies.
It affirmed.
Judge Manion concurred in part and concurred in the judgment, disagreeing with the majority’s decision to accept the case on direct appeal. Here, the case came to the circuit court upon certification by the bankruptcy court without the trustee having filed a petition for direct appeal under Federal Rules of Appellate Procedure 5. Judge Manion opined that the case would have been better addressed through normal channels of appeal to the district court. Judge Manion also maintained that the court should not have made any determination as to whether the EITC was “income” because that holding was unnecessary to its conclusion.
Blake 7th Cir opinion March 2018
Tags: Plan confirmation, Tax credit
