Tithing When You’re Bankrupt

Can bankruptcy trustees recover charitable contributions made by bankrupt debtors?

Bio

State: Colorado
Categories: Bankruptcy, Charitable Contributions

Key point 9-09. Bankruptcy trustees are prohibited by the federal Religious Liberty and Charitable Donation Protection Act from recovering contributions made by bankrupt debtors to a church or other charity prior to declaring bankruptcy, unless the contributions were made with an intent to defraud creditors. This protection extends to any contribution amounting to less than 15 percent of a debtor's gross annual income, or more if the debtor can establish a regular pattern of giving more. In addition, the Act bars bankruptcy courts from rejecting a bankruptcy plan because it allows the debtor to continue making contributions to a church or charity. Again, this protection applies to debtors whose bankruptcy plan calls for making charitable contributions of less than 15 percent of their gross annual income, or more if they can prove a pattern of giving more.

A bankruptcy court in Colorado addressed the authority of bankruptcy trustees to recover charitable contributions made by bankrupt debtors within a year of filing a bankruptcy petition. A married couple (the "debtors") filed for Chapter 7 bankruptcy relief on December 31, 2009. In 2008, the debtors' gross earned income was $6,800 and they received $22,036 in Social Security benefits. Throughout 2008, the debtors made 25 donations to their church totaling $3,478. In 2009, the debtors' gross earned income was $7,487 and they received $23,164 in Social Security benefits. Throughout 2009, the debtors made 7 donations totaling $1,280 to their church.

The bankruptcy trustee attempted to avoid these charitable contributions and have the church return them to the court on the basis of a provision in the Bankruptcy Code that empowers a trustee to recover any transfer of funds or assets by a debtor for less than "reasonably equivalent value" within a year of filing a bankruptcy petition. The church cited section 548 of the Bankruptcy Code, which was amended by the Religious Liberty and Charitable Donation Protection Act of 1997 ("RLCDPA") to provide a defense against a bankruptcy trustee's power to recover transfers by debtors within a year of filing a bankruptcy petition. Amended section 548 provides: "A transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be a [voidable] transfer in any case in which—(A) the amount of that contribution does not exceed 15 percent of the gross annual income of the debtor for the year in which the transfer of the contribution is made."

The court addressed two questions: (1) Are Social Security payments included in gross annual income for purposes of the section 548 exception; and (2) if transfers exceed 15 percent, is the entire transferred amount voidable or just the transferred amount that exceeds 15 percent?

Social Security payments

The court noted that the plain language of section 548 was ambiguous as to whether "gross annual income" should include Social Security benefits. It also noted that the Bankruptcy Code does not define the term "gross annual income," and no court has defined the term within the meaning of section 548. However, the court noted that the Bankruptcy Code does exclude Social Security benefits when calculating current monthly income, and, the Internal Revenue Code only includes Social Security benefits in gross annual income if the taxpayer's modified adjusted gross income for the taxable year, plus one-half of Social Security benefits received during the taxable year, exceeds a "base amount" ($32,000). As a result, the court concluded that Social Security benefits are not included in computing gross annual income under section 548, and as a result only 15 percent of the debtors other income was shielded from the bankruptcy trustee.

voidable amount

If a debtor contributes more than 15 percent of gross annual income to a church, is the entire contribution recoverable by the bankruptcy trustee, or only the portion that exceeds 15 percent of gross annual income? The court concluded that only the excess above 15 percent is recoverable. It observed:

The RLCDPA was created to reverse the trend among the courts allowing avoidance actions to recover funds contributed by debtors to churches. The House Report states, "the safe harbor protects annual aggregate contributions up to 15 percent of the debtor's gross annual income." The term "up to" indicates an intent by Congress to bifurcate the avoidance amount beyond the 15% threshold …. It is doubtful that Congress would protect a debtor's right to donate 15% of their gross annual income to a charitable organization, but allow a trustee to avoid all donations if one cent over the 15% threshold is donated. From the church's perspective, voiding entire transfers above 15% of a debtor's gross annual income would place an undue burden upon churches. If the entire donation amount is voided churches would be obligated to investigate a donor's financial background in order to use funds within two years of receipt.

What This Means For Churches:

This case is significant because it represents the only court to address the question of whether Social Security payments are included in computing "gross annual income" for purposes of applying the section 548 exclusion. The court concluded that gross annual income excludes Social Security benefits, meaning that Social Security beneficiaries' contributions to their church are more likely to be recoverable by bankruptcy trustees. But, the court also ruled that if a bankruptcy debtor contributes more than 15 percent of gross annual income to his or her church, the bankruptcy trustee can recover only the contributions in excess of 15 percent of gross annual income. In re McGough, 2011 WL 2671253 (D. Colo. 2011).

Legal Developments

Protection of Charitable Donations

Court rules that charitable contributions made by bankrupt church member cannot be recovered.

Richard R. Hammar, Attorney, CPA

Bio

State: California
Categories: Bankruptcy, Charitable Contributions

Church Law & Tax Report

Protection of Charitable Donations

Court rules that charitable contributions made by bankrupt church member cannot be recovered.

Richard R. Hammar, J.D., LL.M., CPA

Key point 9-09. Bankruptcy trustees are prohibited by the federal Religious Liberty and Charitable Donation Protection Act from recovering contributions made by bankrupt debtors to a church or other charity prior to declaring bankruptcy, unless the contributions were made with an intent to defraud creditors. This protection extends to any contribution amounting to less than 15 percent of a debtor’s gross annual income, or more if the debtor can establish a regular pattern of giving more. In addition, the Act bars bankruptcy courts from rejecting a bankruptcy plan because it allows the debtor to continue making contributions to a church or charity. Again, this protection applies to debtors whose bankruptcy plan calls for making charitable contributions of less than 15 percent of their gross annual income, or more if they can prove a pattern of giving more.

A federal court in California ruled that a bankruptcy trustee could not recover charitable contributions made by a church member to his church in the year preceding his filing of a bankruptcy petition, since the amount of his contributions were less than 15 percent of his gross annual income. A physician filed a Chapter 7 bankruptcy petition that listed $90,000 in assets and nearly $600,000 in debts. Shortly after the bankruptcy petition was filed, the bankruptcy trustee brought an adversary proceeding against the physician’s church, seeking to recover $18,000 in charitable contributions he made to the church during the previous year.

The court noted that the Religious Liberty and Charitable Donation Protection Act of 1998 (“RLCDPA”) amended the Bankruptcy Code to protect certain contributions to qualified religious or charitable organizations by debtors. The RLCDPA prevents bankruptcy trustees from recovering a charitable contribution to a qualified religious or charitable organization if (1) the amount of the contribution was not more than 15 percent of the debtor’s gross annual income; or (2) the amount of the contribution exceeded 15 percent of the debtor’s annual income but was consistent with the debtor’s practices of making charitable contributions.

The trustee claimed that the physician’s contributions for the prior year exceeding the 15 percent limitation. He further argued that donations for the two years before that consisted of 12 percent of his income for each year, so the donations in the most recent year were not consistent with his practice of contributing 12 percent. The church argued that the amount of the physician’s contributions fell below 15 percent of his gross annual income, and, even if they exceeded 15 percent of his income they were consistent with practice of making charitable contributions.

The court rejected the trustee’s claim that “gross annual income” meant annual income less expenses, or “disposable income.” It concluded:

This court’s refusal to apply the definition of disposable income is buttressed by the fact that this term was in existence before the enactment of the RLCDPA in 1998. When Congress [enacted] the RLCDPA, it was aware of the term “disposable income” and chose not to use this term. Instead “gross annual income” was used. In addition, Congress also amended [the Bankruptcy Code] to deduct from disposable income “charitable contributions that do not exceed 15 percent of the debtor’s gross income.” Congress could have easily used the term “disposable income”; however, it chose to use “gross income” in both [contexts]. As a result, because “disposable income” was defined as income less reasonably necessary expenses to live and continue to operate a business, “gross annual income” must mean something different. If Congress wanted to have business gross income reflect deductions for operation of a business, it would have used the term “disposable income” … when the RLCDPA was passed. It decided not to do so ….

The court added that the policy behind the RLCDPA supported its definition of gross annual income: “The legislative history of the RLCDPA states that the act ‘protects religious and charitable organizations from having to turn over to bankruptcy trustees donations these organizations received from individuals who subsequently file for bankruptcy relief. In addition, the bill protects the rights of debtors to continue to make religious and charitable contributions after they file for bankruptcy relief.'” The court noted that its interpretation of “gross annual income” furthered this policy “by allowing a higher earner to give more money to charitable organizations without fear of that organization surrendering the money in an avoidance action in the event that the higher earner files for bankruptcy.”

Since the physician’s charitable contributions during the year preceding the filing of his bankruptcy petition were less than 15 percent of his gross annual income, they could not be recovered by the bankruptcy trustee.

“Tithing is not per se unnecessary and unreasonable.” [A federal bankruptcy court, in a case addressing the discharge-ability in bankruptcy of a church member’s debts who insisted on continuing to tithe to his church. In re Halverson, 401 B.R. 378 (D. Minn. 2009).]

Application. This court’s interpretation of the key term “gross annual income” is both broad and reasonable. Any court that follows this interpretation will reduce the authority of bankruptcy trustees to recover charitable contributions made by donors to their church or other charity in the year preceding the filing of a bankruptcy petition. In re Lewis 401 B.R. 431 (C.D. Cal. 2009).

This Recent Development first appeared in Church Law & Tax Report, November/December 2009.

Legal Developments

Bankruptcy

A bankruptcy court in Arkansas ruled that a bankruptcy trustee could not object to a couple’s bankruptcy plan on the ground that they proposed to continue making contributions to their church.

Richard R. Hammar, Attorney, CPA

Bio

State: Arkansas
Categories: Bankruptcy

• Key point 9-09. Bankruptcy trustees are prohibited by the federal Religious Liberty and Charitable Donation Protection Act from recovering contributions made by bankrupt debtors to a church or other charity prior to declaring bankruptcy, unless the contributions were made with an intent to defraud creditors. This protection extends to any contribution amounting to less than 15 percent of a debtor's gross annual income, or more if the debtor can establish a regular pattern of giving more. In addition, the Act bars bankruptcy courts from rejecting a bankruptcy plan because it allows the debtor to continue making contributions to a church or charity.

* A bankruptcy court in Arkansas ruled that a bankruptcy trustee could not object to a couple's bankruptcy plan on the ground that they proposed to continue making contributions to their church. A married couple filed a bankruptcy petition under Chapter 13 of the Bankruptcy Code. The couple's bankruptcy plan called for the payment of $879 per month for 36 months to secured and unsecured creditors, which would satisfy less than 1% of unsecured creditors' claims. Their plan also called for the payment of monthly contributions to their church of $416, representing 9.8% of their monthly gross income. The bankruptcy trustee opposed the plan on the basis of the charitable contributions. The trustee insisted that the contributions should be redirected to the creditors.

Section 1325 of the Bankruptcy Code specifies that if a bankruptcy trustee objects to the confirmation of the plan, then the court may not approve the plan 'unless, as of the effective date of the plan … the plan provides that all of the debtor's projected disposable income to be received in the three year period beginning on the date that the first payment is due under the plan will be applied to made payments under the plan.' Disposable income is defined as income which is received by the debtor and which is not reasonably necessary for the maintenance or support of the debtor or a dependent of the debtor.

The Religious Liberty and Charitable Donation Protection Act of 1998 amended the Bankruptcy Code to define disposable income to exclude charitable contributions 'in an amount not to exceed 15 percent of the gross income of the debtor for the year in which the contributions are made.' While the couple's charitable contributions amounted to less than 15 percent of their gross income, the trustee insisted that this did not automatically require their plan to be accepted. Rather, the trustee insisted that the plan as a whole must still be 'reasonable,' and he concluded that it was not.

The bankruptcy court noted that the Code recognizes that 'charitable contributions that do not exceed 15 percent of a debtor's gross income may be excluded from the debtor's disposable income,' and that 'the Code makes clear that a court is not supposed to engage in a separate analysis to determine whether charitable contributions up to 15 percent are reasonably necessary for the debtor's maintenance and support.'

The court acknowledged that 'despite the plain meaning of the statute, some courts have interpreted the Code to subject charitable contributions to two limitations. First, that the amount of the contribution cannot exceed 15 percent of the debtor's gross income, and, second, that the amount of the contribution itself is reasonable.' The court concluded that such an interpretation of the Bankruptcy Code

obviates the goal of the Code, namely to protect certain charitable contributions from the consideration-based, cost/benefit oriented disposable income test. Allowing a court to apply a 'reasonably necessary" qualification to the charitable contributions provision would thwart that stated purpose of [the Code]. Courts would be compelled by precedent and common sense to conclude that a religious gift could never be reasonably necessary for support in the same economic sense as food expenditures or the cost of transport to a place of employment. The only lasting effect of [the Code] would be to deprive courts of the power to find all such contributions unnecessary as a matter of law and thus provide a debtor with a futile evidentiary hearing at which to defend his contributions as reasonably necessary. Surely Congress did not intend [the Code] to serve such a limited purpose ….The debtors' proposed charitable contributions fall within the amount allowed by [the Code] and will not be included in the debtors' disposable income for the purpose of plan confirmation.

The bankruptcy trustee also argued that the plan must be rejected on the ground that it was not made in 'good faith.' The Bankruptcy Code specifies that for a court to confirm a plan, it must find that the plan 'has been proposed in good faith and not by any means forbidden by law." In rejecting this argument, the court noted that the couple had regularly tithed to their church.

Application
. The Religious Liberty and Charitable Donation Protection Act of 1998 provides important protections to churches and church members. This historic legislation is addressed fully in a feature article in the May-June 1999 issue of this newsletter. One of the key protections of the Act prevents bankruptcy trustees from objecting to bankruptcy plans on the ground that the debtor proposes to continue making charitable contributions so long as the amount of the contributions does not exceed (1) 15 percent of the debtor's income or (2) more than 15 percent of the debtor's income if the contributions were 'consistent with the practices of the debtor in making charitable contributions.' In re Petty, 338 B.R. 805 (E.D. Ark. 2006).

Copyright © 1994 – 2006 Christianity Today International.All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, A publication of Christianity Today International, 465 Gundersen Drive, Carol Stream, IL 60188.

Legal Developments

Bankruptcy

Church Law and Tax 1990-05-01 Recent Developments Bankruptcy Richard R. Hammar, J.D., LL.M., CPA •

Richard R. Hammar, Attorney, CPA

Bio

State: New Mexico
Categories: Bankruptcy, Charitable Contributions

Church Law and Tax 1990-05-01 Recent Developments

Bankruptcy

Richard R. Hammar, J.D., LL.M., CPA

• Can a bankruptcy court reject a debtor’s bankruptcy petition on the ground that it calls for monthly contributions of $100 to the debtor’s church? Yes, concluded a bankruptcy court in New Mexico. The debtor filed a “Chapter 13” (wage-earner’s) bankruptcy petition that listed $22,000 in debts. The plan called for only 2% of unsecured debts to be satisfied over the next four years. The largest unsecured creditor (a local bank) objected to the petition on the ground that the plan did not provide for the payment of all of the debtor’s disposable income to the bankruptcy trustee. Among other things, the bank pointed out that the debtor’s plan called for monthly contributions of $100 to the debtor’s church. The court noted that the right of a bankruptcy debtor to make charitable contributions has been addressed in several decisions. Nearly all courts have concluded that debtors can make no contributions whatever, or very minimal ones (i.e., $1.50 per week in one case). The court agreed with these prior rulings. It observed: “By allowing a debtor to deduct contributions to any organization, the court necessarily is forcing the debtor’s creditors to contribute to the debtor’s church or favorite charity. Congress could have intended no such result.” Accordingly, the court rejected the debtor’s bankruptcy petition. In re Tucker, 102 B.R. 219 (D.N.M. 1989).

© Copyright 1990, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m05 m08 c0390

Legal Developments

Bankruptcy

Is it appropriate for a creditor to persuade church elders to excommunicate a church member

Richard R. Hammar, Attorney, CPA

Bio

State: Federal
Categories: Bankruptcy, Church Members

Is it appropriate for a creditor to persuade church elders to excommunicate a church member who declared bankruptcy?

No, ruled a federal appeals court. A church member filed a bankruptcy petition, resulting in a court order prohibiting any attempts by any creditors to collect their debts against him. One creditor contacted the member's church elders and attempted to persuade them to excommunicate the member for filing the bankruptcy petition (which the creditor claimed to be unscriptural conduct).

The debtor sued the creditor for violating the court's prohibition of any effort to collect the debt, and the court awarded punitive damages to the church member. Federal law permits a bankrupt debtor to sue creditors who violate such court orders, and punitive damages may be awarded in appropriate circumstances. The court had "no trouble" in awarding punitive damages against the creditor in this case.

"In particular, we point to the efforts by the creditor … to have the debtor excommunicated from his church. Thus, the creditor not only willfully failed to fulfill its obligations under the [bankruptcy] code, it brazenly attempted to punish the debtor for pursuing his rights given by the code. Such reprehensible conduct more than adequately proves the 'appropriate circumstances' necessary for punitive damages." This case illustrates the danger that creditors face when they attempt to collect a debt from a bankrupt debtor by seeking the help of church leaders. In re Knaus, 889 F.2d 772 (8th Cir. 1989).

Legal Developments

Bankruptcy

Church Law and Tax 1989-11-01 Recent Developments Bankruptcy Richard R. Hammar, J.D., LL.M., CPA •

Richard R. Hammar, Attorney, CPA

Bio

State: Florida
Categories: Bankruptcy, Charitable Contributions

Church Law and Tax 1989-11-01 Recent Developments

Bankruptcy

Richard R. Hammar, J.D., LL.M., CPA

• Can a debtor who files a “Chapter 13” bankruptcy plan continue to make monthly contributions to his church? No, concluded a federal district court in Florida. The debtor filed a plan under which he proposed to pay only $50 per month for three years (a total of $1,800) against $90,000 in unsecured debts. The plan reflected monthly take-home pay of $1,150 out of which the debtor donated $160 to his church. Under federal law, a bankruptcy court need not confirm a Chapter 13 plan over the objection of the bankruptcy trustee unless the plan provides that all of the debtor’s “projected disposable income” over the next three years “will be applied to make payments under the plan.” The bankruptcy trustee objected to the debtor’s plan, arguing that by making the monthly contributions of $160 to his church the debtor was not applying all of his “disposable income” toward the payment of his debts. The issue, as stated by the court, was whether “the court, over the objection of the trustee, can confirm a plan which pays only a minimal dividend to unsecured creditors while the debtor continues to devote substantial amounts of his income to the support of his church.” The court concluded that the trustee was correct in objecting to the plan, and accordingly it denied the debtor’s bankruptcy petition. The court observed: “[We] reject the proposition … that the constitutional separation of church and state protects debtors who with the ability to make payments to their creditors choose instead to donate those funds to their church. While church donations may be a source of inner strength and comfort to those who feel compelled to make them, they are not necessary for the maintenance or support of the debtor or a dependent of the debtor” and accordingly the debtor failed to meet the “disposable income test required for confirmation of the plan.” In re Miles, 20 Collier Bankruptcy Cases 912 (N.D. Fl. 1989).

© Copyright 1989, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m05 m08 c0689