Hiding Income: The Bankruptcy Marriage Penalty
There is a marriage penalty in bankruptcy law. Unmarried couples receive favored treatment, especially on the six-month income calculation called the Means Test.
A married debtor who lives with his or her spouse must list all gross income of their spouse on the income schedules. However, an unmarried debtor who lives with a partner must only show that person’s regular contribution to the household income.
This difference represents a significant disparity of treatment. Unless the bankruptcy trustee investigates the income of a debtor’s partner, a debtor may be able to claim their income is below median income levels and thereby qualify for Chapter 7, even if the partner has a six-figure income.
All Income vs. Regularly Contributed Income:
Reporting all income versus just reporting regularly contributed income. That difference is massive.
Bankruptcy Form 122-A is where we report a debtor’s household income received in the prior six months. This form determines who may enter the gates of Chapter 7.
Notice how Form 122-A requires a debtor to list the gross income of his or her spouse on Column B, however there is no requirement to list the gross income of a live-in partner, even if the debtor and his or her partner share children, real estate, debts, bank accounts and other financial obligations.
What is required is that a debtor report all regular income contributed to the household by the partner. But how can we be sure the debtor is reporting the correct contribution? Why is a live-in partner who is basically a spouse in every way treated so differently? How is this difference in treatment fair or proper?
Difficulty in Measuring Non-debtor Partner’s Contribution to Income:
Measuring the “contribution” of the debtor’s unmarried partner is difficult. The partner is not filing bankruptcy and is not the client of the bankruptcy attorney. Getting information from such individuals can be difficult.
How is the bankruptcy attorney able to accurately measure the income of the debtor’s partner? The unmarried partner signs no documents to verify income. The partner may very well maintain a separate bank account and the debtor may actually be unaware of the partner’s true income level.
So how does the attorney measure the contribution? We look to several factors:
- Bank Statements. We examine the deposits listed in the debtor’s bank statements and the expenses paid by the debtor from these accounts.
- Monthly Bills. Attorneys gather information on the total household rent, utility, food, insurance and educational expenses.
- Educated Guess: If the total monthly expenses of a household is, for example, $3,000 and the bank statements of the debtor show $1,500 of payments towards this total, it is reasonable to assume the debtor’s partner is regularly contributing the remaining $1,500.
What if the debtor is paying the majority of household bills but the non-debtor partner earns a significantly higher income that they keep in their separate bank account? This arrangement has the effect of minimizing the “regular contribution” towards household income that is disclosed on the Means Test. Is that fair and correct?
The means test does have a Marital Deduction for expenses of the non-debtor spouse, but those expenses are limited to completely separate expenses and cannot include expenses of the household. For example, if the non-debtor spouse pays for an expensive medical treatment, that expense cannot be claimed as a marital deduction since it is limited by the household expense limits of Form 122-A. However, if the non-debtor spouse contributes a large amount to their 401(k) account that deduction is allowed since it is not a shared fund. These distinctions tend to be technical.
The bankruptcy marriage penalty is stiff. Married debtors are more likely to be forced into filing a 5-year repayment plan in Chapter 13. Unmarried debtors can manipulate the system to report only “regularly contributed” income of their partner and thus qualify for Chapter 7 cases by hiding income from the court.
It seems like the US Trustee should focus more efforts to ensure the treatment of married couples is no different than the treatment of unmarried couples who share children, homes, accounts and debts together.
Image courtesy of Flickr and Shelley Rich