Are You Really A High-Income Debtor?

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Many people with relatively high income assume they cannot file for Chapter 7 bankruptcy.  Usually this assumption is incorrect.  It is not unusual for a high-income debtor to file  Chapter 7.  In reality, high-income Chapter 7 bankruptcies are filed everyday.

What constitutes as high income depends on many factors, such as where you live, your living expenses, the size of your family, etc. For example: a salary of $80,000.00 for a family in rural Ohio goes a lot further than the same earnings in the city center of Columbus or Cincinnati.  With that being said,  a “high-income debtor” is a debtor with earnings above the state median income for the debtor’s family size.

The Ohio state median income per family size (determined by census figures) as of  2025 is as follows:

Individual Family of 2 Family of 3 Family of 4
$59,181 $74,739 $91,160 $108,950

*For each additional family member over four, add $9,900.

Why is the State Median Important?

Whether your income is above or below the Ohio state median income determines if you will be able to discharge all or most of your debts in Chapter 7, or be required to pay back at least a portion of your debt under Chapter 13.  If your average gross earning for the six months before filing for bankruptcy is at or below the state median for your family size, you may file under Chapter 7 (assuming you meet other requirements).

On the other hand, if your average gross earnings for the six months before filing is over the median, your attorney will perform a  “means test” to determine if you qualify for Chapter 7.  This means test considers your income minus certain allowable expenses.  Frequently, the results allow a debtor with substantial earnings but high expenses to file Chapter 7.

Are You Really a High-Income Debtor?

Before jumping to meet the means test, debtors need to determine if they are actually high-income debtors for the purposes of the test.  We often have clients with seemingly high earnings who are surprised that they fall below the state median. Many of these clients have not considered the size of their families. One of the most important factors in determining whether or not you are a high-income debtor is family size.

Even if the debtor is above the state median, it is often by much less than the debtor presumed.  The closer your overall earnings are to the state median, the easier it is to pass the means test.

What Type of Income is Counted in the Means Test?

If you appear to be over the median, you may still be able to avoid the means test, depending on what type of earnings you have.  Not all sources of money count as income for calculating gross earnings.  For example, under the Bankruptcy Code certain income, primarily social security, is excluded from your gross income for the purposes of the means test.  This exclusion will often bring a debtor’s gross earnings below the state median, thus avoiding the means test.  In addition, because the bankruptcy code focuses on “regular income”, some irregular earnings may not count as “gross income”.

Can I Pass the Test for Chapter 7?

Finally, even if you must take the means test, it is still quite possible that you will qualify for Chapter 7.  Very often, high-income debtors have high allowable expenses, including mortgage payments, vehicle payments, etc., that will offset their earnings.  Although the means test is complex and must be handled carefully, it is not at all unusual for high-income debtors to pass the test. However, failing to list income of any kind can lead to unpleasant consequences.  Attention to detail is the name of the game.

What about Chapter 13?

We have spent most of this blog discussing the initial qualification for Chapter 7.  However, it is important to note that even if you pass or avoid the means test, you do not automatically get to file  Chapter 7.  You must meet all other requirements, including a showing that after expenses, you have no significant disposable income to pay your creditors.  In addition, there may be a reason for choosing Chapter 13, such as saving a house from foreclosure or a car from repossession.  In some cases, a non-bankruptcy solution such as debt negotiation may be available.

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Does Bankruptcy Clear Tax Debt?

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There is a common misconception you cannot clear income tax debt in bankruptcy. The truth is you can clear tax debt for federal, state, and local income taxes in Chapter 7, Chapter 13, and Chapter 11. Penalties and interest are also dischargeable. Determining which back taxes are dis chargeable can be complex. However, it is possible to discharge significant income tax debt in bankruptcy if your tax debt fits within the following rules:

The 3 Year, 2 Year, and 240 Day Rules

The Bankruptcy code sets out specific time periods that determine if you can clear your tax debt, often called the 3-year, 2-year, and 240-day rules. Under these rules, you can discharge taxes that came due 3 years before filing for bankruptcy, as long as it has been at least 2 years since you filed the tax forms and 240 days since the taxes were assessed. These rules are complex and often misunderstood. You should meet with one of our attorneys to go over your tax records.

1. The 3-Year Rule. This rule states that to discharge your back income taxes, they must become due at least three years before you file for bankruptcy. Bankruptcy Code §507(a)(8)(A)(i). Typically, your federal and most state income taxes become due on or around April 15th of each year. In most cases, it is simply a matter of adding three years to this due date to determine the earliest date you can file for bankruptcy and still discharge your taxes.

Example: Joe’s 2022 federal income taxes are due on April 15, 2023. If Joe owes taxes for that year and wants to discharge them, the earliest he can file for bankruptcy is April 15, 2026 (April 15, 2023, plus 3 years).

Regardless of the initial due date, if you file for and receive an extension of time in which to file your taxes, the due date falls on the day the extension expires.

2. The 2-Year Rule. Under the 2-year rule, your income tax returns must have been filed at least two years before filing your bankruptcy petition. This requirement allows you to discharge your taxes, even if you filed your tax forms late, as long as you file them at least two years before filing for bankruptcy, §523(a)(1)(b)(ii).

Example: Jill’s income taxes were due on April 15, 2023. Jill did not get an extension. However, she did submit her tax forms late on June 1, 2023.  If Jill wants to discharge her 2023 taxes, she cannot file for bankruptcy until two years from the date she filed her taxes AND more than three years from the date the taxes were due.

What if you did not file? If you did not file an income tax return in a given tax year, any taxes assessed by the IRS for that year are not dischargeable. §523(a)(1)(b)(i). We sometimes see clients whose taxes would have been dischargeable, if only they had filed their tax forms. If your tax debt is significant, we may advise you to file your tax forms and wait to file bankruptcy.

Quick Point: If the IRS files a return on your behalf, it is not considered a filed return for the purposes of this rule. You must still file a tax form for that year.

3. The 240-Day Rule. Taxes must be assessed at least 240 days before you file for bankruptcy under this rule or not assessed at all. As a practical matter, the date of assessment is typically on or near the date you filed your income tax form (assuming the IRS and you agree on the amount of taxes owed). However, if you file a correction, or a change results from an IRS audit, the assessment date may be substantially later. §507 (a)(8)(A)(ii).

If you are in a dispute with the IRS regarding how much you owe and plan to file for bankruptcy, you should inform your bankruptcy lawyer of the dispute. A tax dispute can impact the assessment date.

Quick Note: If  back taxes are an issue, it may be necessary to order an IRS “account transcript” (sometimes called a “literal transcript”) for the tax years in question. The account transcript typically includes the assessment date. Note that this is not the same as a “tax return transcript”. You can order an account transcript from the IRS over the phone or online, or by using IRS Form 4506T.

Other actions can add additional time to some or all of the 3-2-240 time requirements, including (a) making an offer in compromise, (b) having filed for bankruptcy previously, or (3) obtaining a taxpayer assistance order. §507(a)(8)(A)(i). However, simply entering into a payment arrangement with the IRS does not toll the statute of limitations.

Other Issues to Clear Tax Debt

Tax Evasion and Fraud. If a taxpayer willfully evades taxes or commits tax fraud, the taxes involved are not dischargeable. §523(a)(1)(C). However, the Bankruptcy Code means deliberate tax evasion, not an honest mistake.

Penalties and Interest. Penalties and interest assessed by a taxing authority are dischargeable, along with the taxes. In other words, if the taxes are dischargeable, the penalties and interest attached to them are dischargeable as well.

Tax Liens. Discharging income taxes in bankruptcy does not remove a tax lien. You can certainly file for bankruptcy with a tax lien, and the underlying debt will be discharged, if you meet the requirements of the 3-2-240 rules. However, the lien against property you acquired before bankruptcy still stands. Discuss the implications of this with one of our attorneys.

For More Information on Clearing Your Tax Debt

The tax rules are complicated and the above discussion is not legal advice. We will need to spend some time with you and your tax records before we give you legal advice on how to clear your tax debt.

At Keegan & Company Attorneys we offer a free consultation with a knowledgeable attorney to discuss your individual situation. Call 513-752-3900 to schedule your free consultation at our office.