Court: Actual payments are not required for deduction

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An issue that has plagued bankruptcy attorneys and divided lower courts ever since the bankruptcy reform act was passed in 2005 has finally been settled by the Seventh Circuit.

The court held that an above-median-income debtor with no monthly vehicle loan or lease payment can nevertheless claim a vehicle expense deduction when calculating his disposable income.

At issue is 11 U.S.C. 707(b)(2)(A)(ii)(I), which defines “monthly expenses” as “the debtor’s applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor’s actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service for the area in which the debtor resides…”

Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), debtors with substantial disposable income must proceed under Chapter 13 -– making partial repayment of debt -– rather than Chapter 7 -– which allows for complete discharge of debt.

When Marvin Ross-Tousey and Deborah Tousey filed for bankruptcy in the Eastern District of Wisconsin, they owned two cars, but had no car payments.

Nevertheless, they sought to include expenses for the cars in their monthly expenses.

With the deduction from their monthly income, they qualified for discharge under Chapter 7; without it, they would not.

The bankruptcy judge allowed them to take the deductions, even though they had no monthly loans or leases on the vehicles. However, District Judge William C. Griesbach reversed.

Griesbach held that a debtor must have some monthly car payment to take the deduction, even if the actual amount is less, but that, if the debtor has no payment at all, he may not take the deduction.

The Seventh Circuit reversed on Dec. 17, in an opinion by Judge Joel M. Flaum, holding that no payment is necessary to take the deduction.

The court noted that the issue has been heavily litigated, and that courts are divided on how to interpret the statute. The two interpretations generally adopted have been labeled the “IRM approach” (actual car payment is prerequisite) and the “plain language approach” (no payment required).

Courts following the IRM approach reason that the ownership deduction should not be taken if the debtor has no car payment because the word “applicable” means that the deduction may only be taken if the deduction is “relevant” -– if the debtor has such an expense.

Courts following the plain language approach have interpreted “applicable” to refer to the appropriate geographic region and number of vehicles owned by the debtor.

The Seventh Circuit found the plain language approach better reasoned.

The court explained, “In order to give effect to all the words of the statute, the term ‘applicable monthly expense amounts’ cannot mean the same thing as ‘actual monthly expenses.’ Under the statute, a debtor’s ‘actual monthly expenses’ are only relevant with regard to the IRS’s ‘Other Necessary Expenses;’ they are not relevant to deductions taken under the Local Standards, including the transportation ownership deduction. Since ‘applicable’ cannot be synonymous with ‘actual,’ applicable cannot reference what the debtor’s actual expense is for a category, as courts favoring the IRM approach would interpret the word.”

The court also defended the “plain language approach” on policy grounds: “It is common sense that there are costs associated with vehicle ownership apart from loan or lease payments.”

In addition, a car owned outright may soon need to be replaced, so the owner may have actual car payments to make during the course of his bankruptcy plan.

Furthermore, the court found that limiting the deduction to debtors who make car payments would be arbitrary and unfair in two respects.

First, a debtor who completes his last payment just before filing would not be allowed the deduction, while a debtor with just one payment remaining would.

Second, it would punish debtors who drive older or cheaper vehicles and reward those who borrow money to obtain newer and more expensive cars.

Analysis

The opinion affirms what has been the accepted interpretation of bankruptcy judges in Wisconsin, and overturns what as been the accepted interpretation of district court judges reviewing and reversing those bankruptcy courts.

Bankruptcy judges in Wisconsin have been squarely in the plain language camp: In re Sawdy, 362 B.R. 898 (Bankr.E.D.Wis.2007); In re Grunert, 353 B.R. 591 (Bankr.E.D.Wis.2006); In re Clark, Case No. 07-23390 (Bankr.E.D.Wis., Feb. 14, 2008); and In re Long, 372 B.R. 467 (Bankr.W.D. 2007).

However, district court judges have been reversing those cases. In the case at bar, for instance, the district court reversed the bankruptcy judge. In re Ross-Tousey, 368 B.R. 762 (E.D.Wis. 2007).

The Sawdy case, cited above, was also reversed when appealed to the district court.

Grossman v. Sawdy, 384 B.R. 199 (E.D.Wis. 2008).

The Seventh Circuit opinion settles a long-running battle in the lower courts over this issue.