Fourth Circuit Chapter 13 Debtors May Deduct Actual Mortgage Costs in Excess of Standards

Individuals who have tax debt may find themselves deliberating between bankruptcy and IRS programs (e.g., installment agreements or Offers in Compromise) as the optimal path to finding a measure of relief from their financial burdens. Many factors go into that decision-making process, and a recent Fourth Circuit ruling just added some more food for thought. 

On June 14, 2023, the U.S. Court of Appeals for the Fourth Circuit ruled that above-median income earners who filed for Chapter 13 bankruptcy may use their actual mortgage payments when calculating their disposable income (i.e., their ability to pay unsecured creditors).¹ Many applaud the alignment of the Fourth, Sixth and Ninth circuits on this issue now, and they project that the decision will increase the overall likelihood of plan completion for similarly situated debtors. In this article, we want to briefly consider this case and how it highlights the very different impact potentially experienced by bankruptcy debtors versus taxpayers in IRS collections.

Bledsoe v. Cook: Bankruptcy Debtors Can Deduct Actual Cost 

The facts in Bledsoe v. Cook are relatively straightforward. In 2021, Robert and Cheryl Cook (Debtors) filed for Chapter 13 bankruptcy. Debtors calculated their disposable income using the statutory formula known as the “means test;” however, they deducted their actual monthly mortgage costs in the amount of $2,233. Significantly, the actual amount exceeded the amount listed in the relevant version of the IRS-issued National and Local Standards. As a result, Debtors reported a monthly disposable income amount of less than $300. 

The Chapter 13 Trustee (Trustee) disagreed with Debtors’ calculation, arguing that the National and Local Standards serves as a cap on the amount a debtor may deduct for secured mortgage payments. According to the Trustee’s position, Debtors should have been limited to deducting about $1,100—which would have resulted in a greater amount of disposable income reported as available for unsecured creditors.

  The Bankruptcy Court overruled the Trustee’s objection. Upon the Trustee’s request, the Bankruptcy Court certified an appeal directly to the Fourth Circuit Court of Appeals under 28 U.S.C. §158(d)(2)(A). 

The U.S. Court of Appeals for the Fourth Circuit affirmed the Bankruptcy Court’s ruling, stating that “We join the Sixth and Ninth Circuits in holding the Chapter 13 means test permits above-median income debtors to deduct the actual costs of their mortgage payments when calculating their disposable income.”² The ruling was reflective of a “plain language” approach, and the Court emphasized that the statute permits debtors to deduct “the full amount of their ‘contractually due’ mortgage payments [or] any additional payments to secured creditors necessary for the debtor . . . to maintain possession of the debtor’s primary residence.”³ It was clear to the Court that if Debtors were subject to a cap on their mortgage payment, they might be unable to afford their primary residence—an outcome the Court believed to be in conflict with the straightforward reading of the Bankruptcy Code. 

IRS: Delinquent Taxpayers Can Deduct the Standard Amount

Delinquent taxpayers also use the IRS-issued National and Local Standards when calculating their ability to pay a tax liability. The calculation is reflected on financial forms, including (but not limited to) the Forms 433-A and 433-F for wage earners and self-employed individuals.

While the circuit courts may not all agree on the proper treatment of mortgage payments in the disposable income calculation, the IRS is consistent in its treatment:

The taxpayer is allowed the standard amount, or the amount actually spent on housing and utilities, whichever is less. If the amount claimed is more than the total allowed by the housing and utilities standards, the taxpayer must provide documentation to substantiate those expenses are necessary living expenses.⁴

So, unless the Debtors in Bledsoe v. Cook would have been able to substantiate their expenses as “necessary living expenses,” they would not have fared as well under the IRS’s approach. More specifically, they would not have been permitted to deduct their actual mortgage costs, because that amount exceeds the National and Local Standards amount. As a result, they would have been deemed to have more disposable income available with which to pay their unsecured creditors.

Conclusion

Bledsoe v. Cook leaves us with a couple of important takeaways:

1. Many expect that Bledsoe v. Cook will have a fairly significant effect on the Fourth Circuit bankruptcy courts. It is likely that the ruling will help debtors with actual mortgages costs exceeding the National and Local Standards allowances to create more reasonable budgets. In turn, that should result in high rates of plan completion. 
2. If you have tax debt and are trying to decide between bankruptcy and IRS programs as relief options, there many factors that should be considered. It’s important to remember that in the Fourth, Sixth, and Ninth Circuits, you may deduct the actual amount of your mortgage costs—even if they exceed the National and Local Standards amount. Whereas, the IRS will limit that deduction to the National and Local Standards amount—unless there is substantiation proving the expenses are “necessary living expenses.”

Frost Law attorneys offers cross-disciplinary guidance in taxation and bankruptcy, contact our team at (410) 497-5947 or schedule a confidential consultation.