Do Large, Irregular IRA Withdrawals Count As Debtor Income In Means Test Calculation?

The definition of income is important in the administration of the "means test" to determine eligibility for Chapter 7 bankruptcy. Some sources of income are specifically excluded from "income" for means test purposes; social security is an example of income received by the debtor but excluded from the means test. Other than money excluded by the bankruptcy law, the means test cast a wide net to capture income available to debtors to pay their expenses and creditors. Almost any regular source of money available to pay household expenses counts as the debtor’s income.

A prospective debtor in my office presented an interesting issue about money to be included or excluded from a means test analysis. This debtor had an IRA which at the beginning of 2008 had a balance of approximately $100,000. During the past year, the debtor withdrew about $50,000 from his IRA to pay bills. The IRA was further reduced by the stock market crash to its present balance of about $20,000. Recognizing that he could not continue to pay bills from IRA withdrawals the debtor decided to file Chapter 7 bankruptcy. If his IRA distributions from the past six months were included the debtor could not pass the means test. The question presented is whether voluntary, large IRA distributions are counted as "income" in this debtor’s means test calculation.

I discussed the question with an attorney in the U.S. Trustee’s Orlando office. The U.S. Trustee is responsible to review bankruptcy petitions for eligibility under the means test rules. The U.S. Trustee explained that IRA distributions are included in the definition of income under the means test. In this case, the debtor will not be able to pass the means test given his large IRA distributions during the six month period used to calculate means test income. However, if the debtor explains on his petition the IRA withdrawals the U.S. Trustee likely would not seek a dismissal of the bankruptcy. The Trustee evaluates IRA income to determine whether substantial abuse is indicated. Where the remaining balance in the IRA suggests that large distributions cannot continue in the future, and where the IRA balance is small relative the debtor’s age and retirement needs, the U.S Trustee will often exercise its discretion to permit the Chapter 7 bankruptcy filing even though IRA or other retirement receipts technically cause the debtor to flunk the means test. It seems as if this U.S Trustee is applying a common sense approach to means testing when the debtor’s retirement income and savings are involved.

posted by Jonathan Alper, bankruptcy and asset protection attorney, Orlando, Florida