Failure to Include Loan Repayments as Income Might be Bankrpuptcy Abuse

A U.S. Bankruptcy Court judge in Ohio has ruled that a 401(k) participant can't deduct $269 in monthly repayments for three plan loans from his monthly income to meet a legal showing that the debtor is not abusing federal bankruptcy laws.

According to the opinion written by U.S. Bankruptcy Judge Mary Ann Whipple of the U.S. Bankruptcy Court for the Northern District of Ohio Timothy Whitaker had failed to show the “special circumstances” necessary to avoid the bankruptcy abuse finding.

Whipple agreed with the U.S. Trustee that the case should be thrown out, but gave Whitaker 30 days to file a motion to convert his case to Chapter 13 or the case will be dismissed.

Whitaker filed a Chapter 7 case in October 2006, with $245,286 in debt and a monthly income of $3,643, not including his 401(k) loan repayments to a plan sponsored by General Motors Corp.

The U.S. Trustee argued that deducting loan payments to Whitaker’s 401(k) plan is improper under the Bankruptcy Abuse Protection Prevention and Consumer Protection Act (BAPCPA) means test. The trustee also argued that if the loan payments are not included as a deduction, a presumption of abuse arises.

The court had to decide whether Whitaker’s 401(k) plan loan repayments to GM were considered a proper deduction under the “Other Necessary Expenses” in the means calculation test set out in Section 707(b)(2)(A).

The Internal Revenue Manual does not include 401(k) plan loan repayments in the “Other Necessary Expenses” category, but does have a category for “Involuntary Deductions,” the court said. To qualify for this category, the expense must be a “requirement of the job,’ such as union dues, uniforms or work shoes. Whitaker said the payroll deductions for his 401(k) loan repayments were mandatory.

However, Whipple wrote that Whitaker’s decision to take out a loan against his plan account was discretionary.

The case is In re Whitaker, Bankr. N.D. Ohio, No. 06-33109, 7/25/07.

Under bankruptcy law, a Chapter 7 filing involves the liquidation of the debtor’s property and then selling it to repay his or her creditors. A Chapter 13 case, on the other hand, involves the debtor using future income to pay off debt under the court’s supervision.