Monthly Archives: August 2014

Chapter 7 Bankruptcy and the Means Test

Alberts Law, Debt Relief & Bankruptcy, , ,

When the Bankruptcy Code is changed in 2005, the idea that this would force people to file under Chapter 13, which requires a plan to repay as much of your debt as possible, instead of using Chapter 7 to get a “fresh start” by discharging most debts and allowing you to keep most (if not all) of your possessions was a commonly held belief. The new law did have a bias against Chapter 7 bankruptcies, but the reality is that most people still can file under the chapter that gives them their best options.

The means test, which can be used to force you pursue a Chapter 13 bankruptcy, has “safe harbors” that protects the average filer’s choice of which bankruptcy to pursue. For this reason, you need some understanding of this test and when the safe harbor based on income will allow you to consider a range of possibilities, including those under the Bankruptcy Code if necessary, to handle your financial struggles.

Due to the formula involved, we will take a greatly simplified journey through the means test. Its starting point is “current monthly income,” which actually looks at the average income from the previous six months to find a monthly average. Also, the focus is on income from all sources used to pay household expenses of the debtor and the debtor’s dependents on a regular basis during this period. The bankruptcy law provides for various deductions from the total and also excludes some sources of funds from being counted. The most prominent of these would be any benefit received under the Social Security Act. However, not everything paid under this Act is not counted necessarily – for example, the Advisory Committee on Bankruptcy Rules did not include Unemployment Compensation as being excluded. Also, we will see some other sources that are omitted due to the use of data regarding income from the Census Bureau.

“Current monthly income” must be calculated, after which it is multiplied by 12 to turn it into a yearly amount. The new total then can be compared to the median income in your state; the median income is the amount at which half of the households fall below it while the other half will be above it. As mentioned previously, the source of this data is the Census Bureau. For this reason, we have to be aware of various items that it leaves out of its income calculations, including Food Stamps, public-housing benefits, and lump-sum inheritances, so that the comparison is based on the same information. Meanwhile, in addition to income, your household size is important for establishing the median income level, as reported by the Census Bureau, that you would use for the means test. Unfortunately, this is another case in which the bankruptcy law does not provide clear guidance, which has made the definition of the size of any particular household an issue of contention at times.

However, despite the problems with ambiguity with the additions to the bankruptcy law in 2005, the means test eventually does produce an income figure to be compared to the median income borrowed from the Census Bureau. As of May 1, 2014, in Pennsylvania, the median income for a one-person household has been $47,809 while, for a household of two, this rises to $56,690. It continues to increase as the household size increases. The issue now becomes what all of this means to you.

Essentially, it means that the means test will be meaningless to you as long as your household income falls below the median level for a household of the same size in Pennsylvania (or the level for whatever state you live in). You would be in one of the safe harbors that Congress built into the means test. In turn, this means that the “presumption of abuse” (which focuses on a debtor’s ability to repay creditors) does not apply to you so that, if you decide to file for bankruptcy, you should be able to choose the chapter that would be most beneficial in meeting your goals for filing.

Most people who pursue a bankruptcy tend to be under the median income figure that applies to them, which means that the means test that can seem so intimidating due to its complexities actually has no effect on them. For those above the median income, the test will have implications, which can be explored at another time. What matters here is that you generally will not have to worry about the means test with its presumption of abuse preventing you from considering all of your options, including a possible Chapter 7 bankruptcy as a last resort, as you begin rebuilding your financial world.

Protecting Retirement Funds in Bankruptcy

Alberts Law, Debt Relief & Bankruptcy, ,

When you file for bankruptcy for consumer debt, everything that you own generally becomes part of your bankruptcy estate. The bankruptcy trustee in charge of the estate could sell these assets to raise funds to pay debts. However, most debtors will find exemptions under the Bankruptcy Code that will protect all, or at least most, of the property in their estate. Property that could not be exempted may remain in the estate because the trustee will look at the cost of selling it versus the amount that a sale would bring and decide to abandon or sell the property back to the debtor. On the other hand, the status of pensions, retirement funds, and similar accounts still is somewhat ambiguous in bankruptcy law.

Looking at the Bankruptcy Code, Section 541(c)(2) states that restrictions on transferring a debtor’s beneficial interest in a trust which are enforceable under applicable nonbankruptcy law will remain enforceable in a bankruptcy case. If the law shields a beneficiary’s interest in a trust from creditors, then the same protection applies during a bankruptcy.

In 1992, the U.S. Supreme Court decided the language in this  section applied to certain types of pensions. ERISA-qualified pension plans were found to be excluded from the bankruptcy estate because this federal law had an “anti-alienation” provision that protected pensions that are covered by ERISA.

Then, in 2005, the Bankruptcy Code was amended. Section 522 was revised to allow the debtor an exemption, usually without limitation, in most types of retirement funds. With this change, whether or not a pension is part of the bankruptcy estate ceased to be an important issue when attempting to protect such plans after a bankruptcy filing. Congress also added provisions stating that any amount withheld or received by an employee in retirement funds or employee benefit plans are not property of the bankruptcy estate.

This does not protect everything, however. If you file for bankruptcy while you are in the process of rolling over your pension funds into another plan, you leave yourself open to the claim that these funds were not in an ERISA-qualified plan when the bankruptcy was filed. Therefore, as the argument goes, your retirement funds should not be  excluded from your bankruptcy estate. This also shows the importance of timing when you decide to file for bankruptcy. Under this scenario, to avoid a possible problem, you could wait to file your bankruptcy case or undertake the rollover. By doing so, the bankruptcy case will be filed while retirement funds are in a qualified plan.

Non-ERISA plans face other issues. For example, the Supreme Court’s 1992 decision pointed to retirement funds that do not qualify under ERISA, determining that they are not entitled to its protection as a result.

Individual retirement accounts (IRAs) would be an example here. However, IRAs now qualify as exempt under subsections 522(b)(3)(C) and (d)(12) (with a $1,245,475 waivable cap for funds that were never rolled over from another plan) and may also be protected from alienation under state law. In addition, if a debtor cannot reach funds in a plan, the bankruptcy estate has the same limitation – it cannot have greater rights than the debtor. Therefore, with the already existing protections plus the expanded ones for retirement savings, a debtor will rarely lose retirement funds in a bankruptcy case.

Other types of plans may be considered spendthrift trusts, with the beneficiary having no right to access the funds whenever the individual so desires. Under the laws of most states, due to this limitation, the beneficiary’s interest in such a trust is protected from the person’s creditors. These trusts are excluded from the debtor’s estate under Section 541(c)(2). However, it should be noted that not all spendthrift trusts are protected under state laws – an example is the “self-settled” spendthrift trust created by its own beneficiary, which most states do not protect from this person’s creditors.

Finally, when possible, the debtor also must remember to list retirement funds, pensions, and similar trust interests in Schedule B of the bankruptcy schedules, even if they do not come into the estate. Any argument that the interest is outside the estate should be noted on Schedule B with a reference to subsections 541(c)(2) or 541(b)(7) of the Bankruptcy Code. In addition, nothing prevents a debtor from claiming on Schedule B that property is outside the estate but listing an applicable exemption on Schedule C in the alternative as a backup.