What Is a Bankruptcy Audit?
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The majority of bankruptcy filers provide the most accurate financial information they can to the court and bankruptcy trustee. But incorrect information can still find its way to the bankruptcy proceeding. Most of the time, these mistakes are accidental, but sometimes they’re deliberate. To help find these mistakes, the U.S. Trustee Program hires outside auditing companies to conduct a detailed review of select bankruptcy petitions.
Written by Attorney Paige Hooper.
Updated July 27, 2023
INTRODUCTION
To file bankruptcy, you must complete a set of bankruptcy forms, which require you to disclose a lot of personal and financial information. Finding this information isn’t always easy, and it can be tempting to just guess — after all, who’s checking? The answer is a lot of people, from the bankruptcy court to your case trustee. One of the most in-depth checks, though, comes from the United States Trustee Program (USTP) audit process.
This article covers what a bankruptcy audit is, why they exist, and how the USTP chooses cases to audit. The article also covers what to expect if your case is selected for audit and what could happen if the audit procedures uncover inaccurate information in your bankruptcy forms.
Why Are Bankruptcy Cases Audited?
Every bankruptcy case is assigned to a case trustee, who reviews the filed documents and oversees the administration of the bankruptcy estate. Every bankruptcy case (except for filers in Alabama or North Carolina) is also assigned to a U.S. Trustee’s office.
The USTP is part of the Department of Justice, a branch of federal law enforcement. Like all law enforcement programs, the USTP’s job is preventing, detecting, and reporting crimes — specifically bankruptcy fraud and related crimes. One way they do this is through debtor audits.
The USTP reviews all bankruptcy cases, but it doesn’t conduct an in-depth review of each one. The USTP checks for red flags that indicate the debtor could be committing fraud or abusing the bankruptcy laws (more about those red flags later). In addition to this review, a select few cases will be reviewed in closer detail. This detailed review is called an audit.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is a federal law that requires the USTP, with the help of third-party auditing firms, to conduct audits on a small percentage of bankruptcy cases each year. These audits check for material, or significant, misstatements in a debtor’s bankruptcy forms. If the audit uncovers intentional misstatements, the debtor could face criminal prosecution.
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Which Bankruptcy Cases Get Audited?
The USTP only audits consumer (non-business) cases that are filed under Chapter 7 or Chapter 13 of the Bankruptcy Code. Some cases are designated for audit because the information in the bankruptcy paperwork raised “red flags” for potential fraud or abuse. For example, your case could be red-flagged for audit if your income or expenses are significantly higher or lower than the average figures for most debtors in your district.
The majority of cases chosen for USTP audits, though, are chosen at random. Like random airport security searches, random audits encourage everyone to follow the rules because anyone could be selected.
In March 2020, due to the COVID-19 pandemic, the USTP suspended its audit selection process indefinitely. As of the date of this article, this suspension is still in place. In other words, the USTP is not currently designating any new cases for audit.
What Does a Bankruptcy Audit Entail?
The USTP usually designates cases for audit within 10 days after the case is filed with the bankruptcy court. When a case is chosen for an audit, it’s immediately assigned to a private audit firm, which is often a public accountant or similar firm. The audit firm, not the USTP, conducts the actual audit.
If your bankruptcy case is selected for audit, the audit firm will notify you (or your bankruptcy attorney) of the audit right away. This notice will contain a list of documents and other information the audit firm needs. This list usually includes the following:
Tax returns for the past two or more years
Pay stubs or other documentation of your income for at least six months before the case was filed
Bank statements for all your bank accounts going back six months or more before the bankruptcy filing date
Documents related to any property you sold, gave away, or otherwise transferred within the two years before filing bankruptcy, such as contracts, agreements, or bills of sale
You (or your attorney) typically must send all requested information to the audit firm within 21 days after receiving notice of the audit. In addition, the audit firm will usually do its own search of the public records in your county of residence. This is to check for any additional assets or transfers listed in your name.
The audit firm uses the search results and the information you provide to verify that the information in your bankruptcy forms is accurate. If the audit firm concludes that your paperwork is substantially correct, then you don’t need to do anything further. If the audit firm has questions or needs additional information, it will contact you and give you a chance to provide the necessary answers or documents.
The Audit Firm’s Report
When the audit is complete, the audit firm files an audit report with the bankruptcy court and sends a copy to the UST. The report says whether the audit firm found any material misstatements — about your income, expenses, or assets — in your bankruptcy forms. If the firm didn’t find any material misstatements, then your bankruptcy case will proceed like any other bankruptcy. If the audit firm’s report contains findings of material misstatements, you must explain those findings to the court (more on that below).
If you (or your attorney) don’t provide all the information the audit firm requests, the audit firm will file a Report of No Audit with the court and the UST. In this situation, the UST may ask the bankruptcy court to deny or revoke your bankruptcy discharge or take other action against you. The audit firm will also file a Report of No Audit if your bankruptcy case gets dismissed for some other reason while the audit is pending.
What Happens if the Bankruptcy Auditor Finds Something?
If the audit firm reports that it found one or more material misstatements in your bankruptcy petition, you usually still have a chance to fix the situation. If the misstatement was just an honest mistake or miscalculation, you may just need to amend your bankruptcy forms to reflect the correct information. Sometimes, correcting your paperwork alone isn’t enough. In those cases, the UST may ask you to explain to the court how the misstatement happened.
Based on your explanation, if the court determines the misstatement was unintentional, you can amend your petition and proceed with your bankruptcy case. If the court determines that you made an intentional misstatement — that is, you lied on your bankruptcy forms or intentionally left out income, assets, or transfers — you’ll likely face some consequences. Depending on the nature and severity of the misstatement, the court could:
Dismiss your bankruptcy case
Deny or revoke your right to a bankruptcy discharge
Refer your case to the U.S. Attorney for criminal prosecution
Do all of the above
What Are the Chances My Bankruptcy Case Will Get Audited?
Historically, your chances of being selected for a bankruptcy audit are fairly low — around 2 in 1,000, based on the figures from fiscal year 2020, the most recent year UST audits took place. (Note: the UST’s fiscal year runs from Oct. 1 to Sept. 30.)
In fiscal year 2020, 396,424 people filed Chapter 7 bankruptcy cases, and 193,095 people filed Chapter 13 bankruptcy cases. That means a total of 589,519 cases were eligible for audit. According to the UST’s annual audit report for fiscal year 2020, the USTP designated 1,396 of those cases for audit. That’s less than 1% of cases.
Your case is more likely to be selected for audit if your income or expense information is much higher or lower than the typical income and expenditure figures for bankruptcies in your district. These audits are called “exception” audits because they contain numbers that are exceptionally high or low for the filing district. Of the 1,396 cases selected for audit in fiscal year 2020, 347 were exception audits, while 1,049 were randomly selected.
Let’s Summarize…
The USTP’s bankruptcy audit program oversees federally mandated audits in a small percentage of consumer bankruptcy cases each year. These audits are aimed at detecting bankruptcy fraud and abuse. Some cases are selected for an audit because they have exceptional income or expense figures for their district. Other cases are chosen at random.
The audits are conducted by third-party audit firms. The firms use documents provided by the debtor as well as independent searches to verify the accuracy of the debtor’s petition. At the end of the investigation, the firm files a report indicating whether it found material misstatements. If so, the debtor may face criminal or other penalties unless they can show the misstatement was unintentional.
