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Consumer vs Non-Consumer Debts in Bankruptcy

When declaring for bankruptcy, it’s important to understand the difference between a consumer and non-consumer debt. Having this information in order will help you be prepared for what to expect at your bankruptcy hearing.

The classification of a debt as a consumer or a non-consumer debt can have a significant impact on an individual’s bankruptcy case. The Bankruptcy Code defines consumer debt as “debt incurred by an individual primarily for a personal, family, or household purpose.” 11 U.S.C. § 101(8). Generally speaking, a non-consumer debt is generally a business-related debt, such as:

  1. investment real estate
  2. business vehicle loan
  3. debt incurred for motive for profit
  4. business utilities
  5. business credit
  6. business insurance

While business-related debts are classified as non-consumer debts, some courts will recognize other non-business related type of debts as non-consumer debts as well, like the following:

  1. automobile accident debts
  2. taxes
  3. student loans
  4. medical debts

Taxes

Most courts classify taxes, including income taxes, as non-consumer debts. In the case of In re Westberry, 215 F.3d 589 (6th Cir. 2000), the Sixth Circuit Court of Appeals rejected the application of the profit motive test to determine if personal income taxes are not consumer debts.

Rather, the Court found that personal income taxes were distinct from consumer debts for the following reasons:

  1. Tax debts are not incurred like consumer debts. Consumer debts are incurred voluntarily. Taxes are imposed.
  2. “Consumer debt” is defined in the Bankruptcy Code as being incurred for personal or household purposes. 11 USC sec 101(8). Consumer debts are incurred for personal and household purposes. Taxes are assessed for the public wealth.
  3. Taxes arise from the earning of money. Consumer debts result from consumption.
  4. Finally, unlike taxes, consumer debt typically involves the extension of credit.

Student loans

Most courts analyze whether a student loan is a business debt on a case-by-case basis. The primary inquiry is whether the debt was incurred primarily for a personal, family, or household purpose, which usually requires a trial.

When the lion’s share of student loans are used to pay living expenses, the student loan debt is often characterized as a consumer debt.

What does it matter?

So what does a non-consumer debt mean to a bankruptcy debtor? First, there is no co-signor or co-debtor automatic stay protection for non-consumer debts. Bankruptcy Code section 1301 provides co-signors and co-debtors stay protection for the duration of the debtor’s Chapter 13 case.

The Co-Debtor Stay is only available in a Chapter 13 case, and does not apply in Chapter 7 or 11 cases. The Co-Debtor Stay requires all creditors and collectors to stop collection activity and release any garnishments.

In the case of jointly owed taxes, most courts will not extend automatic Co-Debtor Stay protection to a non-filing spouse. If a husband files for Chapter 13 protection and the wife does not, and the couple owes federal income taxes, the husband’s bankruptcy will not prevent the IRS from garnishing or otherwise collecting from the wife. A lot of people don’t know this and the advice will be that the couple should consider a joint Chapter 13 if they owe a substantial tax debt.

The second significant implication of a non-consumer debt is its effect on the bankruptcy means test. The means test is a calculation intended to identify debtors with the ability to repay creditors and acts as a gatekeeper for Chapter 7 cases.

Debtors who “fail” the means test are presumptuously able to pay something to creditors during bankruptcy and are disqualified from Chapter 7. These debtors may only file under Chapters 11 or 13.

Debtors with primarily non-business debts are not required to complete the means test. Omitting the bankruptcy means test means that the debtor initially qualifies for Chapter 7, although the bankruptcy trustee may still argue that the debtor has the ability to pay creditors and should be forced into Chapter 13 by the bankruptcy court.

The bankruptcy courts have interpreted “primarily” non-business debts to mean more that 50%. Here is an example:

Examples of consumer debts

Home mortgage $300,000
Credit cards $40,000
Total $340,000

Examples of non-consumer debts

2012 Income Taxes $140,100
Investment Property $200,000
Total $340,100

In the above example the debtor has $340,000 in consumer debts, and $340,100 in non-consumer debts. As a result, the debtor has “primarily” non-consumer debts (more than 50%), is not required to complete the bankruptcy means test, and may file under Chapter 7.

If you have joint debts and are considering bankruptcy, speak to an experienced bankruptcy attorney to evaluate your debts. In many cases non-consumer debts can help you qualify for Chapter 7 bankruptcy and discharge all of your consumer and non-consumer debts without repayment.

An experienced bankruptcy attorney can help you analyze your financial situation and choose the best strategy for resolving your debt problems.