Kentucky Bankruptcy Law

Counsel with Care

Disability Income and the Means Test

To file a Chapter 7 one must qualify under the means test. Well, that is the layman’s explanation. What is actually going on is that one must go through a formula of looking at their currently monthly income as derived from the last six months preceding the month in which the bankruptcy is filed to see if there is a presumption that filing Chapter 7 is an abuse of the bankruptcy system. Okay, let’s stick with the layman’s version.

Anyway, what matters to those of you who receive disability benefits is whether or not they have to be included in the calculation of your current monthly income in the means test. This matters because it could knock some folks out of the Chapter 7 range. Current monthly income is actually a term in statute and can be found at 11 U.S.C. Sect. 101(10A). This basically says it is all money coming in except for a couple of narrow exceptions. The exception that is most commonly found are funds one receives as a result of the Social Security Act.

The Social Security Act can be found in Title 42 of the United States Code. It covers a number of things, including Social Security retirement funds and Social Security disability. Some jurisdictions also recognize unemployment benefits as falling under this exception, while others do not.

Since Social Security Disability is excluded as “current monthly income” for purposes of the means test, one would logically assume that all disability benefits are excluded. Wrong! For example, disability income that military veterans receive from the Veteran’s Administration arise out of Title 38 of the United States Code rather than Title 42, so they are included as income for the purposes of completing the means test. It just is. Please do not ask me to explain it – just accept it.

November 25, 2014 Posted by | Bankruptcy, Chapter 7, Means test | , , , , , , , , | Leave a comment

Overcoming a “Presumption of Abuse” in Chapter 7 Bankruptcy

Overcoming the “presumption of abuse” in Chapter 7 bankruptcy is not always as daunting as it may sound. In order to qualify for an individual Chapter 7 one either must have predominantly business debts or qualify for it under a “means test”. The means test essentially looks at your household income for the six month preceding the month in which the bankruptcy is filed. Certain things can be deducted out of that income as well as certain standardized costs of living. Once the information has been run through the formula, a potential debtor either falls under the median income for their household size and state of residence, thus qualifying for a Chapter 7, or it does not.

One might be tempted to think that failing to fall under the median income is the end of the story and they cannot file a Chapter 7 (they almost always can still do a Chapter 13). This is true for the majority of persons where the presumption arises. However, it is not automatically the end of the analysis that your bankruptcy attorney should engage in. They need to also explore any changes in circumstances that would justify going into the Chapter 7 anyway.

So, having an income above the median only creates a “presumption” that doing a Chapter 7 would be abusive of the bankruptcy process. This presumption can be overcome by a showing of a change of circumstances. For example, a sudden change in one’s health could decrease the current income or increase health costs that can be deducted from that income. Such a sudden event may not show up in the means test results for months since one is looking at a six month snapshot but, one may not be able to wait that long to file.

The way to overcome that presumption of abuse requires your attorney to prepare two extra documents. First, they should prepare a sworn statement for you to sign (an affidavit) that explains the change in circumstance that justifies overcoming the presumption. Second, they should prepare a mock means test showing what that change in circumstances would look like over time. These can be filed  concurrently with the petition.

The United States Trustee would look at these extra documents and make their own determination whether to pursue dismissal of the Chapter 7 or decline to pursue it. Even if the US Trustee declines to pursue the presumption of abuse dismissal, individual creditors could still pursue it, though they are unlikely to do so.

November 19, 2014 Posted by | Bankruptcy, Chapter 13, Chapter 7 | , , , , , , , , , , , , , | Leave a comment

Trending in Chapter 13 in the Eastern District of Kentucky

The trustee’s office appears to be taking a closer look at expenses in Schedule J of Chapter 13 cases. Specifically, they appear to be pushing for decreasing recreational/entertainment expenses and miscellaneous expenses. Previously, this trustee’s office tended to utilize the standardized amounts provided for in the means test as a gauge. As a result, if a debtor reported a particular expense in excess of those amounts, I would encourage them to engage in “belt-tightening” in that area.

The interesting thing about those standardized expenses is people who make less money have lower expenses while people who make more money have higher expenses even when the family size is the same. In the prior approach, the trustee’s made some allowance for this dynamic. The trustee’s current approach seems to be to cram those relatively higher income families into the expense structure of the lower-income Chapter 13 families. Now, even if expenses fall within the standard allowance of the means test, the trustee is looking for deeper cuts.

On the surface, this seems fair – after all, why should richer people get to have higher expenses and still discharge their debts at the end? The problem comes down to human nature. Once people develop a set point of expenses, then it is extremely hard for them to do substantial cuts in those expenses. When one is talking about the extended timeframe of five years in a bankruptcy, well the likelihood of successfully maintaining extensive cuts drops dramatically.

So, what is the goal of Chapter 13? I suggest that we are best served when people successfully complete Chapter 13 plans. This will not happen when budgets are made so tight as to be unwieldy over time. Debtors will get into a tight spot with unexpected expenses and be unable to make their payments. This is not to suggest that people should get to engage in lavish lifestyles in a Chapter 13; rather, I suggest a balance between belt-tightening and sustainable budgets. Clothing makes for a good analogy: a really tight dress may look really trim and neat, but no one can wear it day in and day out. Rather, one needs slightly roomy clothes to go about their day-to-day business. Such an approach will increase Chapter 13 successful outcomes and, thus, increase the overall return to unsecured creditors.

May 28, 2014 Posted by | Bankruptcy, Chapter 13, Disposable Income / Budget, Plan, Plan payments | , , , , , , , , , , , , , | Leave a comment

What happens to my tax refund in a Chapter 7?

A couple of days ago I talked about the tax refund issue that is involved in both a Chapter 7 or a Chapter 13 bankruptcy. Today I will talk about the issue that arises only in a Chapter 7 (sort of). To qualify for a Chapter 7, your household income must be lower that the median income for your family size in the area where you live. This information can be found at the Trustee’s website on means testing. If your gross income is too high, you can go through a second time and deduct certain expenses. These include taxes taken from your paycheck.

If you pass the means test on the second round, the U.S. Trustee still can look at your income and expenses and see if you could actually pay a significant amount into a Chapter 13 plan. If you actually have over $160 in disposable income despite passing the means test, then the trustee may object and move to kick you out of the Chapter 7 (either as a dismissal or conversion to a Chapter 13).

Part of the trustee’s analysis is looking at your tax refund. If you received a substantial refund (I heard one trustee say $1,200.00 was the range they began looking), then they may demand that the excess taxes paid be attributed to your income. So, if you receive a $6,000.00 refund, you arguably could have $500.00 more per month to pay creditors. In practice, I have not seen this kind of challenge happen often, but it is a potential issue.

April 10, 2013 Posted by | Bankruptcy, Chapter 7, Tax refund, The estate | , , , , , , , | Leave a comment

What options do small businesses have to deal with debt?

This economy has been tough on the small business owner. Many of the people I talk with are sole owners of a Limited Liability Company, S Corporation, or sole proprietorship. Invariably, the owner has invested a great deal of his or her own resources into the business to fuel their dream. Because small business ventures, especially start-ups, lack assets and reliable revenue streams, banks always insist that the company and the owner individually AND the owner’s spouse all co-sign any loans. They typically also insist on a lien against personal property, such as the family residence.

So, when a small business start-up becomes insolvent (which statistically accounts for the majority of new businesses) there is far more at stake than just the business assets. The home and other personal property are at stake as well. Because of what is at stake, many folks understandably push on past the point of wise investing and empty out retirement accounts and cash in other exempt assets to keep the business going just a little longer.

When the economy first began faltering, this strategy had some wisdom to it because everyone expected a rebound in a few months. Now, though, the new reality of our economy is setting in and fewer people are expecting a big turn around. Because of this, the small business owner is compelled to a new level of shrewd thinking.

However, what happens when one’s best laid plans simply are no match for sluggish sales? It basically boils down to two possibilities: 1) an out of court work-out, or 2) bankruptcy. The way to determine which route to go involves an analysis of debt, income and assets. One business owner I consulted with was being pressed very hard by creditors and wanted to do a bankruptcy, but when I reviewed the assets he had that were not encumbered (were not collateral on a debt) he realized how much he stood to lose in a bankruptcy. The analysis allowed him to explore an out of court restructuring of debt because he had a dollar number where it made sense to incur additional debt and a cut off point. In other words, the analysis gave him a make it or break it line. I’m happy to say he avoided bankruptcy and his business is still going.

Out of court work-outs are generally a good thing to attempt, but you have to be careful. I’ll visit that more in-depth soon. The other option is bankruptcy. If most of your total debt is from business debt (your home loan debt is non-business in nearly every instance, so that is often a stumbling point for this) then you can file a personal Chapter 7 bankruptcy without having to pass the means test (the test that sets a threshold of income for taking Chapter 7 bankruptcy). I say a personal bankruptcy because a business cannot receive a discharge from debt; only an individual, and as I said earlier, small business owners are on the hook individually 99 and 44/100s percent of the time. Whether or not the business also takes bankruptcy is a case by case analysis. Often, the company can be dissolved prior to filing bankruptcy and then a new business can be created afterwards. Sometimes the value of the business is so low that one can exempt their ownership interest.

Many small business owners have heard about Chapter 11 bankruptcy. This is an option to consider if you have too much at stake in terms of non-exempt assets (assets you stand to lose in a bankruptcy) to file a Chapter 7 but your creditors are unwilling to cooperate in a work-out. However, Chapter 11s are not a viable option for the overwhelming majority of small businesses because they are incredibly expensive. And, if any secured creditor has a perfected security interest against your cash collateral (including revenue coming in), then you are going to have to have a new source of funding on-line whether that is a new creditor who gets a super-priority position for the new value they bring or if it is an investor who will inject unencumbered cash.

January 3, 2012 Posted by | Bankruptcy, Planning, Pre-filing planning, Property (exempt | , , , , , , , , , , , , , , , , | 2 Comments

New median incomes for means test available

In order to qualify for a consumer Chapter 7 bankruptcy, your household income has to be below the median income for your state or territory. If your gross income falls below it, you pass the means test on the first pass. If not, then there are a number of deductions that can be made on the second pass of the means test where you still might qualify for a Chapter 7. To get a rough idea of where you fall in terms of your household income versus the median income for your state, click on this link to go the the Department of Justice’s website for Trustees.

November 11, 2010 Posted by | Bankruptcy, Chapter 7 | , , , , , | Leave a comment

Chapter 13’s “projected disposable income”

One of the controversies that resulted from the major changes in bankruptcy law from Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) was answered by the Supreme Court of the United States on June 7th, 2010. The issue decided was whether a Chapter 13 Debtor had to use the mechanical calculation of their income in the means test to determine “projected disposable income” or could they use a more fluid forward looking number. SCOTUS held that the forward looking approach was the correct one with one dissenting opinion by Justice Scalia. The case is Hamilton v. Lanning, No. 08-998 (2010) and will be published soon.

This decision will help some Chapter 13 filers and harm others. If your income over the six month period prior to filing is higher than what it currently is or known to be in the future, then this decision will be helpful because using means test numbers would inflate your projected disposable income. That would lead to a higher plan payment than you could actually afford to make. Instead, your plan payment will be based on what your actual or reasonably certain income will be. This is consistent with the approach that the bankruptcy courts in Kentucky already take; they look at Schedule I income and Schedule J expenses to determine disposable income.

The opinion itself is more complicated and nuanced that what I have summarized above. In fact, there is a lost of controversy among lawyers as to what several statements in the opinion means and how they will play out in reality. However, I am confident that time will show this to be a narrow holding consistent with the simple summary above. In practice, lawyers should start with the average income from the six whole months preceding the date you file as a starting point for what your projected disposable income will be. Then, they should account for events that are certain to occurr or foreseable with a high level of certainty to adjust that income. All of this should be transparent in the petition.

There is another case expected to be decided by SCOTUS in the coming months that will begin to answer a similar controversy over expenses. That is the Ransom case. That is, can a debtor use actual expenses or are they to use averaged expenses promulgated by the government. The Ransom case may be too narrow to fully answer the controversy, but it will be a step in that direction. Again, some debtors would be better off with government expenses because they actually spend less, while others would be better off using actual expenses. The Lanning decision indicates to me that the court will go with actual expenses and expeneses that are foreseeable with a high level of certainty.

June 12, 2010 Posted by | Bankruptcy, Chapter 13, Plan payments | , , , , | 3 Comments