Kentucky Bankruptcy Law

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Tax Refunds: A “hidden” bit of disposable income

In a Chapter 13, the debtor puts together a budget they present to the court. This budget encompasses Schedule I (income) and Schedule J (expenses). In order to get a Chapter 13 plan confirmed, it has to be feasible. Part of showing that a plan is feasible involves demonstrating that the debtor can actually make the payments proposed by the plan. If the money left over (the disposable income) when expenses are subtracted from income is substantially less than the proposed plan payment, then the plan is not feasible.

Sometimes the plan calls for payments that are just a bit of a stretch for debtors. This happens when the debtor is using the Chapter 13 to pay off arrears on a house facing foreclosure or when there is priority, non-discharged income tax debts that have to be paid in full during the plan. In these instances, the debtor and their attorney will likely engage in “belt-tightening” by shaving off amounts from expense items that they believe they can realistically accomplish.

However, there is a source of disposable income that may be lying hidden in all the paperwork. Many people over-withhold on their taxes. Some do this to avoid owing a tax debt at the end of the year and others like to have a self-created bonus. This latter practice is essentially loaning the United States government money for several months at zero percent interest. So, while it is a nice little psychological trick to force one to save money up, it is definitely not maximizing use of one’s resources.

Worst of all, if you have engaged in the belt-tightening on your budget as I mention above then you have created a set-point in the eyes of a trustee. They assume that is your actual budget. So, when they see tax refunds exceeding $1,200.00 per year (state and federal combined), then you belt-tightening budget may backfire.

Let me unpack that a little. In my hypothetical scenario, the debtor gets back an average of $3,600.00 per year in tax refunds. That comes to $2,400.00 more than the threshold that many trustees look too for reasonable withholding levels. This is $200.00 per month. The trustee would argue, and rightly so, that if the debtor used the proper withholding levels, they would have $200.00 more in pocket each month.

Now, in order to achieve the $200.00 plan payment needed to pay off the arrears on the house during the five-year bankruptcy, the debtor “shaved” expenses down by $200.00 each month less than actual expenses. This makes the budget really tight and barely sustainable, but the debtor thinks they can manage it. However, at the meeting of creditors, the trustee challenges the tax refunds and insists on a $400.00 per month plan payment reflecting what the debtor proposed plus the $200.00 per month that has been withheld in excess of taxes actually owed.

A quandary develops. The only way to preserve the $200.00 plan payment is to go back and amend Schedule J to show actual expenses. Ah, but that set-point I mentioned is already established. Now, the debtor will have to produce documentation to support higher expenses than they originally claimed (under oath I might add). Most people do not keep records accurate enough to document all their expenses.

So, if your attorney suggests that you plan to change your withholding on taxes so that less is taken out of your paycheck, trust them. This will allow you to set expenses at reasonable, sustainable levels from the very beginning and yet meet the needs of the plan. Honestly, $200.00 more in hand each month is exactly the same as $2,400.00 once a year. Actually, it is more because when you let that money build up with the Internal Revenue Service, you are losing a tiny bit of the “time value” of those dollars.

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July 25, 2013 Posted by | Bankruptcy, Chapter 13, Discharge, Foreclosure, Plan payments, Planning, Pre-filing planning, Priority debt, Secured loan arrears, Tax refund, The estate | , , , , , , , , , , | Leave a comment

Another intersection of divorce law and bankruptcy: Bifurcation

Bifurcation sounds like a painful surgical procedure, but it merely means splitting a joint bankruptcy into two separate ones. Marriage takes tremendous effort (I should know – I have been married to the same woman for 23 plus years) and when a couple is also stretched and stressed by financial tribulations, the marital relationship can take hit after hit. Often, bankruptcy can provide the relief needed on the financial front that allows the husband and wife to redirect their emotional resources to restoring the marriage.

I have encountered a few couples, though, where the relief of bankruptcy was insufficient for them to turn back towards each other. I am sad for these times when one or both decide that they have gone too far and divorce must happen. When this happens after a joint Chapter 7 has been filed, then there is no impact on the bankruptcy. However, in a Chapter 13 the couple will probably opt to split the case. At the point of divorce, the parties financial interest and desire for maximum separation makes the case split, or bifurcation, necessary. After all, who wants to keep pooling resources with an ex-spouse.

The process to bifurcate is simple enough. An entirely new filing fee is assessed by the court for the new case. A motion to split the cases must be filed and served on all creditors and the trustee in the case. Typically, the motion provides for a 14 day notice and opportunity to object to the case split, but each district is likely to have variations on this. After that period has run and the fee paid, then clerks create two identical cases.

Once the split occurs, though, each party must file new Schedules I & J showing their individual budgets. They also must create separate payment plans, modifying the confirmed plan or amending a pending plan. If there is real estate, at least one party is likely surrendering the house in their plan. If either party could have filed a Chapter 7 to begin with  or their new income would qualify them for a Chapter 7, then that party may opt to convert to a Chapter 7.

June 24, 2013 Posted by | Bankruptcy, Chapter 13, Chapter 7, Conversion, Disposable Income, Divorce, Plan, Plan payments, Planning | , , , , , , , , , , , | 1 Comment

Chapter 13 plan percentages

If you consult with a bankruptcy lawyer about a possible Chapter 13, then you will likely hear them tossing around phrases such as, “100% plan” or “7% plan”. This sounds foreign, but I want to give you a quick explanation. When one files a Chapter 13, they propose a plan. This is very much like the reorganization of debt plans that businesses (and sometimes individuals) use to restructure in a Chapter 11. On a miniature scale, the individual debtor in a Chapter 13 is restructuring their debt via their plan.

One aspect of a plan that can be confirmed (approved by the court) is that it divides debts and creditors into different classes. The common classes are priority debts, such as recent income tax debt; secured debt, such as a car loan or mortgaged loan on your house; and unsecured debts, such as most credit cards. There are different rules for each class. For example, priority debts get paid in full in a plan. The rule for unsecured creditors is that each gets treated the same and will receive a pro-rata share of the payments made over an above what is required to pay priority and secured debts.

So, unsecured creditors are the last on the list of who gets paid and they only receive the leftovers. They must get as much in leftovers as they would have gotten in a Chapter 7, but this bottom number is usually zero. That is, most individual Chapter 7 bankruptcies have no non-exempt assets to be liquidated, divided and distributed. But, if your assets in the Chapter 13 are not entirely exempt, then you may have a higher dollar amount that must go to unsecured creditors. For example, if you can exempt all but $10,000.00 of the equity in the home you are keeping, then your unsecured creditors will have to collectively receive $10,000.00 over the course of your Chapter 13.

Now, the percentages I referred to above speaks to the pro-rata share each unsecured creditor will receive through the plan. Ordinarily, trustees will give higher scrutiny to expenses listed in your budget (Schedule J) when your plan only pays a very low percentage. Despite this, there are plans that get approved for debtors who are barely getting by where unsecured creditors get zero percent payment. From my experience, though, the average Chapter 13 debtor is going to repay 3 to 7% of their unsecured debts.

I have seen a number of 100% plans for debtors with relatively high income who fell behind because of a temporary job loss or some snowball effect of debt. In these plans, the trustees are typically less concerned about relatively high expenses and lifestyles.

June 19, 2013 Posted by | Bankruptcy, Chapter 11, Chapter 13, Chapter 7, Disposable Income, Plan, Plan payments, Tax Debts | , , , , , , , , , , | Leave a comment

Objecting to Claims in a Chapter 13

I spoke previously about objecting to a claim filed in a Chapter 13 bankruptcy as it relates to “cramming down” or “stripping off” secured debt. In that article I explained the role of creditors’ claims, so I will not elaborate on that here. A more pressing reason to object to a claim filed is if your Chapter 13 plan calls for unsecured creditors to be paid in full. This is referred to as a 100% plan.

I suppose the first thing to explain is why anyone would bother filing bankruptcy if they can pay their creditors in full. Essentially, Chapter 13 bankruptcy forces all creditors to play ball by the same rules. It puts each creditor on the same footing within their class. If you have one creditor who is pursuing a lawsuit or post-judgment collection activities, such as wage garnishment, the debtor may not have the resources to work things out with other less aggressive creditors. The debtor essentially enters into a “debt” spiral because they can only deal with one or a few creditors at a time instead of a global resolution of debt with all creditors. Chapter 13 stops the debt spiral and makes that one or few aggressive creditors operate under the same plan as all the other creditors. So, a 100% plan can allow a global resolution of debt in an orderly fashion rather than a rush to the courthouse by aggressive creditors.

Another benefit to the 100% Chapter 13 plan ties in with the one just discussed: payments can be spread over five (5) years. A debtor who could not afford to make large payments to a creditor that demands being paid in full in just one year very well be able to afford to pay in full over the five-year period of a Chapter 13 plan. An additional benefit is that people are facing interest rates that of 29% (usurious in my opinion), but under a Chapter 13 payment plan unsecured creditors cannot demand payment of the post-petition interest. Along these same lines, the debtor may have fallen behind on secured debt payments, such as their house payment. Their mortgage company may demand payment in full immediately or they will foreclose on the property. Under the Chapter 13 plan, the arrears can be spread over the plan period.

So, a 100% Chapter 13 plan can provide for the orderly resolution of debt, halt exceedingly high interest rates, and avoid the spiral of debt. This brings up to the reason for objecting to claims in a 100% plan: you can also pay off a 100% plan early! Simply put, if you have $50,000.00 in unsecured debt, but only $30,000.00 worth of claims are filed, the Chapter 13 payment that would resolve the debt in full over five years may allow you to be finished in only three years. This gives impetus to examining creditor claims closely in a 100% plan, because if some of the amounts owed are inflated or unsupported, an objection could allow you to be done early with your bankruptcy.

June 17, 2013 Posted by | Bankruptcy, Chapter 13, Discharge, Plan, Plan payments, Planning, Proof of Claim, Secured loan arrears | , , , , , , , , | Leave a comment

Name It, Claim It

Claims play a major role in Chapter 13 bankruptcies. They are essentially superfluous in a “no asset” Chapter 7 so they are often not filed in such cases except for secured creditors. If there are non-exempt assets that will be liquidated in a Chapter 7, then it is an “asset” Chapter 7 and claims serve a similar function as I’ll describe for the Chapter 13.

In a Chapter 13, a plan is proposed by the Debtor that spells out what the Debtor will pay in over time. The plan also describes how various creditors will be treated. Some districts, such as the Eastern District of Kentucky, treat provisions of the plan as motions that become orders of the court once the plan is confirmed (blessed by the court). In such districts the plan provisions can “cram down” or “strip off” liens by secured creditors based on the value of the asset they have a lien against pursuant to 11 U.S.C. Section 506. However, I am venturing a bit off of the topic of claims.

For a creditor to actually receive what is owed to them per the plan, they must file a claim. There is a form available just for this purpose and the creditor can either send it in to the court clerk to be electronically filed or, if they have set up an account, they can electronically file it themselves. The claims for most creditors (other than governmental agencies) must be filed by a deadline specified in the Notice that is sent out to all creditors when a bankruptcy is filed. If they miss the deadline, their claim will likely be denied and the full debt discharged as to the Debtor.

The claim also puts the Debtor on notice of any additional fees and penalties that the creditor may be entitled to receive under the loan contract or by law. It is up to the Debtor to review the claims and object to anything that is erroneous or to excessive fees. It is also good practice to object to secured claims if the plan calls for them to be crammed down or stripped off. The reason to object to claims is because they are presumed to be sufficient proof, on their face, to establish the existence and amount of a debt. This is because there are hefty penalties to filing false claims. In the next post I will give a little more detail as to when it is beneficial to object to a claim.

June 14, 2013 Posted by | Bankruptcy, Chapter 13, Chapter 7, Plan payments, Proof of Claim, Secured loan arrears | , , , , , , , , | Leave a comment

Balloon or Bust!

A number of people took out balloon payment loans (interest only loans) prior to the whole mortgage mess and economic downturn. They seemed like a great idea at the time because it allowed folks to buy more of a house than they could actually afford at the time with the notion that they would either have turned around and sold the home for a profit in a few years or they anticipated greater incomes. Of course, the economic crevasse we fell into precluded sales for profit and kept salaries from rising.

So now, many people are either facing that final payment in a few months or that balloon has already popped leaving them with massive arrears. There is a remedy IF your income can sustain it: Chapter 13. Let’s say you have $50,000.00 in arrears on one of these loans and your income would support a plan payment of $900 or $1,000 per month (about what you would pay in rent anyway), then you could save your home.

In the Eastern District of Kentucky, the entire arrears can be paid through the plan at 0% interest. Obviously there are other factors that can be considered, but if you have a balloon house payment that has already come due or about to come due, then it would be worth consulting with a bankruptcy attorney to see if saving the house can work.

As a side note, even if a judgment has been issued in a foreclosure action, you can still filed a Chapter 13 and turn things around. So long as the house has not sold at auction, then a Chapter 13 can stop the litigation and give you a chance to work out a plan to save your home. Frankly, this works best for lenders as well, because they will get 100% principal rather than the 2/3 that would come through a Master Commissioner sale.

May 17, 2013 Posted by | Bankruptcy, Chapter 13, Discharge, Foreclosure, Plan, Plan payments, Planning, Pre-filing planning | , , , , , , , | Leave a comment

Another way to keep your car in Chapter 7 bankruptcy

A common question when looking at filing for Chapter 7 bankruptcy is whether a debtor can keep their car. If the car has equity, then to keep the car it must be covered by an exemption. There is a specific exemption for a vehicle under Federal law, but one may also use any excess “wild card” exemption. The Federal exemption is at least $3,675.00 in equity (it goes up most years).

If the car has a secured loan against it then to keep it in a Chapter 7 one typically will have to reaffirm the debt. This means that the debtor will have to agree to remain personally liable on the loan as it existed when the bankruptcy was filed. Sometimes creditors will not insist on the reaffirmation so long as the loan is not past due and the debtor keeps making payments on time. However, many of these loans are for much more than the car is worth and have exceedingly high interest rates.

Another way to keep your car in the Chapter 7 is to file a Motion to Redeem Personal Property under 11 USC Sect. 722 of the bankruptcy code. Essentially, the debtor is moving to court to let them pay fair market value of the car in one lump sum as opposed to the full amount of the loan. If granted, then the creditor must release the lien on the car for the lump sum payment.

You may have enough exempted funds in a bank account to pay the lump sum, or you may have to seek a “722 loan” from another source.  Either way, this is a good option for a vehicle that is upside down on its loan or has a high interest rate.

May 13, 2013 Posted by | Bankruptcy, Chapter 7, Redeem / Redemption, Secured loan arrears, Security interests | , , , , , , , , | 1 Comment

Chapter 13 Plan: Take care with income and expenses

A couple of days ago I wrote about ways income and expenses influence your Chapter 13 plan payments. Today I want to encourage people preparing for bankruptcy to invest time into a careful look at your income and expenses. Because your plan payment in a Chapter 13 must be at least the amount of your disposable income, then accuracy matters in figuring out what that is. Once you have put the amounts in your Schedules (Schedule I is income an Schedule J for expenses), you are locked into them unless you can verify changes with documentation.

It is incredibly common, though, that people really do not know what they spend on expenses. Sometimes, people do not have an accurate idea of income either. This is less of an issue if all your income show up on pay advices (pay stubs) from wages. It is a bigger challenge for independent contractors and business owners. Almost no one, though, accurately tracks all personal expenses.

Despite the challenge presented by the lack of tracking, it is crucial to be as accurate as possible with expenses. If you underestimate your expenses, your plan payment may end up being too high to maintain resulting ultimately in dismissal of your case. Over-estimating your expenses may keep you from being able to show a plan payment of a certain amount (an amount required to pay arrears on a house, priority tax debt, or other mandatory items) to be feasible.

So, it is worth spending a few hours going back over bank statements or other documents that can help show average monthly expenses. If you have time before filing, it would be helpful to do a detailed tracking of expenses for a month. This can be very revealing and may also help you figure where things can be cut.

This accuracy, though, in determining income and expenses can mean the difference between a successful Chapter 13 bankruptcy and one that is dismissed or converted to a Chapter 7.

May 10, 2013 Posted by | Bankruptcy, Chapter 13, Chapter 7, Conversion, Disposable Income, Documentation, Means test, Plan payments, Planning | , , , , , , , , , , , , , | 1 Comment

Quick Note: Income, expenses and; Chapter 13 plan

The major driving force in determining what your Chapter 13 bankruptcy plan payment will be are your household income minus reasonable and necessary expenses, at least in the Eastern District of Kentucky. I encounter two general situations when looking at household income and expenses to determine what a debtor’s plan payment will likely be in a Chapter 13: 1) people who have constrained their expenses to an unsustainable point in order to try to stave off bankruptcy, and 2) people who find it very challenging to tighten their belt.

The first scenario can show up different ways. They may have stopped paying into voluntary retirement plans in hopes to make things work. Or, perhaps they went against personal convictions and stopped tithing to their church believing it would be a short-term constraint. With these two approaches, they are essentially locking themselves in to being unable to go back to tithing or retirement funding for the three to five-year duration of their Chapter 13. This is because the Chapter 13 trustee will expect documentation of consistent and ongoing tithing or payments into retirement. This is to preclude people who suddenly decide to do these things just to help their own bottom line as opposed to a conviction or long-held practice. The remedy for this requires very early bankruptcy planning and is not easily fixed; it often must be lived with for the term of the bankruptcy.

The second scenario is easier to fix, but tougher for debtor’s to swallow. Those who most often find themselves in this situation have had a healthy income for a long time and unforeseen circumstances, like job loss, drop them into a very constrained income. Most people expand their spending to fill up their income. This is not wise, but it is terribly common. Once certain “luxuries” become routine expenses, it is incredibly hard to reverse them. I see this with higher food expenses for top-of the line organics and fresh food, health supplements, or personal training expenses. Other ways it manifests are in high-end clothing or nice (“dependable”) cars. The remedy is simple: cut expenses. However, it is tough to swallow the idea of trading in the expensive SUV for an old economy car. It is hard to cut food costs without buying processed food. Hard won fitness is hard through personal training is hard to exchange for a modest gym membership and self-training.

However, to get the discharge of debt and relief from foreclosure that Chapter 13 offers, tough decisions and sacrifices must be made.

May 8, 2013 Posted by | Bankruptcy, Chapter 13, Discharge, Documentation, Plan, Plan payments, Planning, Pre-filing planning, Secured loan arrears | , , , , , , , , , , , , | Leave a comment

No need to fear 13 (Chapter 13 that is)

Many people in debt feel overwhelmed when looking a filing a chapter 13. As much as five years of plan payments seem daunting and having to seek approval of incurring new debt seems intrusive. However, a Chapter 13 bankruptcy can often accomplish goals for people who a Chapter 7 cannot. One of the most frequent of these goals is for the debtor to keep their home even though they are behind on payments. To take some of the mystery and fear out of Chapter 13 plans, let’s look at what it takes for a Chapter 13 plan to be confirmed (approved) by the court.

There are four tests that a Chapter 13 plan has to pass in order to be confirmed. First, since debtors often turn to a 13 to save a house with past due payments, the Chapter 13 plan has to account for full repayment on these arrears. In the Eastern District of Kentucky, past due amounts of any secured debt, such as house payment arrears, must be paid through the plan. Your ongoing house payment can usually continue to be paid directly (outside the plan) to the creditor so that you are not also paying the trustee commission on top of the interest. So, if your regular house payment is $1000.00 per month and your loan won’t be paid off for five (5) plus years, you keep paying the creditor directly. But, if you owe $12,000.00 in past due payments on that same house, you will have to pay $12,000.00 into the plan over the course of those sixty (60) months (or $200.00 per month plus trustee’s commission).

Now, lets say you own a car and only have twenty-four (24) months left on the debt. Since this will be paid in full during the duration of the plan, you will either have to pay the entire amount through the plan or make a step up in your plan payment when it is paid off outside the plan. Since you will have to make that step up in payment anyway, you might as well look at paying the entire thing through the plan UNLESS your current interest rate is less than around 6%. So, the first test is that all secured debt is accounted for by the plan with all arrears paid through the plan. I am calling this the “first” test not because there is any particular order, but because most people’s highest priority is keeping their house.

The second test is the “disposable income” (a.k.a. “projected disposable income”) test. Basically, the debtor accounts for their average income (current monthly income) each month and subtracts out their reasonable living expenses. This takes the debtor looking back in time and seeing what they spend on food, clothing, recreation, and various other items. Determining reasonable expenses is probably the place where there are the most challenges by trustees to the plan. If you report expenses that are substantially over the norm for most people living in your region with the same household size and similar income, then your plan will draw challenges. However, if your expenses are in the realm of reasonable, whatever is left over after you subtract these expenses from your income is the disposable income.

The debtor is expected to pay their disposable income into the plan. If your proposed plan payment is substantially less than your disposable income, your plan will not get confirmed. If it is higher than your income minus expenses, then it might also be challenged because the plan has to be feasible that you can actually pay it.

The third test is very straightforward: If you owe priority income tax debt (some tax debt cannot be discharged – this is priority tax debt), then the plan payment must be sufficient to pay all the priority taxes in full through the plan. Federal income tax debt can still accrue 4% interest through the plan and Kentucky tax debt 5%. However, penalties are halted.

Fourth, unsecured creditors in the Chapter 13 must get paid at least as much through the plan as they would have gotten had you filed a Chapter 7. If in a hypothetical Chapter 7 all of your assets were covered by exemptions creating a “no asset” bankruptcy, then your Chapter 13 does not have to pay anything to unsecured creditors (some districts expect at least a small percentage of unsecured debt to be paid, but zero (0%) percent plans have been approved occasionally in Kentucky). Alternatively, if your home (or other asset) that you are wanting to keep has equity that could not be covered by exemptions, then the amount of equity left “exposed” has to be paid to unsecured creditors over the life of the plan.

Let us use the same example as above where a $12,000.00 arrears existed and add that $6,000.00 of equity in the home was left exposed (not covered by exemptions). In this scenario the debtor would have to pay $100.00 more than the $200.00 per month. The $200.00 covers the arrears and the $100.00 takes care of the “liquidation test” and pays the exposed $6,000.00 equity. Now, we have a $300.00 per month payment plus the trustee’s commission.

One has to look at all four tests in concert because if the disposable income is only $150.00 per month but the plan demands $300.00 per month, the Debtor needs to come up with a way to make that $300 payment feasible or make a tough choice of surrendering the home. If, though, the disposable income is actually $400.00 per month but the other tests demand only a $300.00 plan payment, then $400.00 will be the plan payment.

One of the good things about Chapter 13 is that through looking at these tests, the debtor is often faced with making decisions about what expenses can be reduced in order to come up with a plan that can be confirmed. The result of that process is that they sometimes realize there is no way to hang on to an asset, such as a home, with their income. Sometimes, though, they learn how to live within a budget which is feasible and which lets them keep important assets. Either way, Chapter 13 pushes debtors to live within their means far better than a Chapter 7.

April 17, 2013 Posted by | Bankruptcy, Chapter 13, Foreclosure, Plan, Plan payments, Planning, Pre-filing planning, Secured loan arrears | , , , , , , , , , , , , , | Leave a comment