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Stampeding Past the Self-Employed

posted by Bob Lawless

Will Congress just cut it out? Now, their inept drafting coupled with pandering to the religious right threatens the ability of the self-employed to fund chapter 13 plans. I thought we were supposed to like small business? As Melissa Jacoby reports, the Senate recently passed S. 4044 to protect charitable giving in bankruptcy. This bill comes on the heels of a bankruptcy court decision (In re Diagostino) where the bankruptcy court ruled that the 2005 bankruptcy amendments prevented above-median income chapter 13 debtors from making charitable contributions.

The need for congressional action is slim at best. It's a decision from one bankruptcy court that arguably misreads the statute (see a previous post). Bankruptcy court decisions don't create binding precedent, even for other judges in the same district. Senators Grassley, Hatch, and Sessions wrote a letter to the Executive of Office of U.S. Trustee's asking it to adopt a different rule as a matter of administrative enforcement. The political forces that have arrayed to attack this bankruptcy court decision are roughly the same coalition that sold a story about a bankruptcy system that was so rife with irresponsible debtors that it needed a major overhaul in 2005. Apparently, it's OK to stiff your creditors so long as you give that money to your church. In the stampede to pay obeisance to the religious right, the Senate has missed the fact that its actions could make it impossible for some self-employed debtors to fund chapter 13 plans.

To understand why this is so, one needs to understand the structure of chapter 13. Generally stated, a debtor must devote all of his or her disposable income to payments under the chapter 13 plan. Before the 2005 amendments, disposable income was income "not reasonably necessary to be expended" for (A)(i) maintenance or support of the debtor or the debtor's dependents (including alimony and child support), (A)(ii) for charitable contributions not to exceed 15% of income, and (B) for the payment  of expenditures necessary for the continuation, preservation, and operation of a business. (I have used the nomenclature of the statute, section 1325, to label the expenses.) The 2005 amendments stated that for above-median income debtors amounts reasonably necessary to be expended had to be calculated under "section 707(b)(2)," the complex means test that determines eligibility for chapter 7 and that refers to IRS guidelines to determine expenses. The Diagostino court reasoned that, because the IRS guidelines do not refer to charitable contributions, above-median income debtors may not deduct charitable contributions in calculating the income they have to devote to a chapter 13 plan.

The Senate bill would add just a few words to the requirements of the means test: "except as provided in subparagraph (A)(ii)." That would clearly allow above-median income debtors to make charitable contributions. Elsewhere, the means test clearly allows above-median income debtors to deduct amounts necessary for the support of the debtor and dependents, including alimony and child support. What clearly would not be allowed is item (B) in the list--expenditures for the continuation, preservation, and operation of a business. Moreover, there is a well known principle of statutory interpretation that when Congress expressly acts to include some things, it is an exclusion of other things.

Undoubtedly, some will offer reasons why a court should not reach this outcome. For the record, I don't think the statute compelled the decision reached by the Diagostino court (as I explained previously), but that is not the point here. Why create statutory pitfalls in the first place? If the statute passes in its present form, I would hope that bankruptcy courts would adapt and perhaps interpret the Code to allow the expenditure of ordinary business expenses but not extraordinary ones. In calculating "income," a court could interpret that as net of expenses for a self-employed individual (although such an interpretation makes the language quoted above unnecessary and surplusage in the statute). Rather than doing another slopply drafting job and relying on the courts to fix it, the Senate would be better off not to place any hurdles in the way of a small business owner reorganizing through chapter 13

As of this writing, there are no reports of any action in the House on this bill, and I hope it stays that way. If the bill does move forward, it needs to fix this problem. Congress' clumsy attempts at amending the bankruptcy laws have ceased to be amusing.

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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

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