Erasing your debts just got much harder. Two major decisions have recently passed in Washington that may have a dramatic impact, positive or negative, on the lives of many Americans. On April 20, 2005 President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. And on April 4th, 2005 the U.S. Supreme court ruled that under the bankruptcy code, IRA balances were protected from creditors in a bankruptcy. Both decisions might radically affect your life and require careful consideration, especially if your profession (ie. Medicine) exposes you to potential litigation. This article will expand on some of the recent changes.
Bankruptcy Act
Backed by powerful credit card industry lobbyists, our "friends" on Capitol Hill have been busily at work protecting credit card companies at the expense of the consumer. The Act, parts of which are effective immediately and other parts which go into effect on October 17th, 2005, makes it harder for consumers to erase their unsecured debts and requires debtors to seek credit card counseling before being able to file (more on this later). Here are some of the highlights.
By way of background, individuals may declare one of two forms of bankruptcy---Chapter 7 or Chapter 13.
Under Chapter 7, individual is permitted to keep certain assets, but all others are relinquished to satisfy cost of bankruptcy and creditor claims. Most debts are discharged completely and debtor is no longer responsible for repayment. Child support, alimony and education loans cannot be discharged and the debtor cannot file again for eight years (bumped up from six years).
Under Chapter 13 bankruptcy, a plan is created under which the debtor will repay outstanding debts within specified time. Usually the amount owed is reduced by the judge so that payments remain manageable and debtor is generally not obligated to relinquish any assets.
Means Testing
The most important factor of the law has to do with the "means test" that bankruptcy filers would be subjected to in order to determine if they qualify for Chapter 7 or Chapter 13. There are two facets of the test that are conducted: the median income test and the means test.
The (personal income) means test is based largely on median state incomes. So if the combined gross household income is greater than the median income in your state, the law prevents you from filing Chapter 7 (completely eliminating your debt) and may force you to file a Chapter 13 plan. So, for example a Florida physician supporting a family of 4 would be subjected to a state median of only $62,742 (add $7,500 for each individual in excess of 4). If the combined income in the physician's household is more than the state's median income threshold (and, of course it is), then you do have to apply the Mean's Test, and to do so you need to calculate Monthly Expenses. To find out what the state median income levels are you can visit the Census Bureau's website.
The second test checks to see if the debtor's current monthly income (reduced by allowed expenses) exceeds an amount allowed under the Act for a family of the same size. The means test is basically an "excess income" test used to determine what money is left over after deducting reasonable expenses that can be used to pay unsecured creditors.
Included within the calculation of debtor's monthly expenses are: 1) reasonably necessary expenses incurred to maintain the safety of the debtor and the debtor's family (see link below); 2) continuation of actual expenses paid by the debtor for the care and support of an elderly, chronically ill, or disabled household or nondependent immediate family member; and 3) an additional allowance for housing and utilities based upon documented home energy expenses.
Individuals may use the 'National Standards for Allowable Living Expenses' charts available on the IRS website to determine the standards for food, clothing and other items. The chart is based on the individual's gross monthly income.
If a Debtor's income meets or exceeds the mean's test, then any Ch 13 Plan must have duration for at least five years unless the plan provides that all allowed unsecured claims are to be paid in full over a shorter term.
Credit Counseling
The other critical (and controversial) matter is the mandatory requirement that debtors go through credit counseling in order to qualify for bankruptcy, and counseling must start at least 180 days before filing for federal bankruptcy protection. This particular portion of the Act is quite disturbing, given that the credit counseling industry is not only unregulated, but in fact is beset with unimaginable fraud and abuse by "bad players". There are too many counseling agencies out there posing as non-profits that get away with grossly overcharging clients for services, implementing absurd monthly fees, and do little to negotiate with the credit card companies to reduce rates and/or debt. Credit counseling agencies are supposed to help consumers out of debt; many in fact, make the problems worse. Basically, Congress just paved the way for unknowing consumers to be thrown into the lion's den in an already corrupt system. Their mission, I'm sure, was accomplished as soon as they secured sizable contributions from credit card companies in exchange for this law.
Homestead Protection
The Act also modified some of the protections offered by the previous Homestead Exception (which is already in effect).
The homestead exemption applies to property used as your residence. As of 2011, the federal homestead exemption is $21,165. State homestead exemptions vary a great deal. In some states, like Florida, there's no limit, while in other states, like New York, the limit is $50,000 to $150, 000, depending on where you live.
Before the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (Act) was passed, it was common for homeowners to move to a state with a generous homestead exemption and shield assets from creditors by buying an expensive home.
The Act tries to stop this practice by limiting any homestead exemption to $125,000 (inflation adjusted $146,450) if you bought the home within 1215 days (3 years and 4 months) before filing for bankruptcy. This doesn't apply to a debtor already living in the same state who merely transferred his/her interest from a previous principal residence.
Any addition to the value of a homestead that is funded by nonexempt property, and made with the intent to hinder, delay, or defraud creditors, is not protected by the state homestead exemption if it was made during the ten year period before a debtor filed for bankruptcy.
There is a $125,000 cap on the homestead exemption for any debtor convicted of a felony which demonstrates bankruptcy abuse, or if the debtor owes a debt arising from violation of Federal or State securities laws, criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual during the last five years.
Fraudulent Transfers
Fraudulent transfers are asset transfers that are made with the intent to defraud a creditor (or potential creditor). It is not a criminal activity, but the transaction may be reversed by a judge and therefore make the assets accessible to your creditor.
The look back period in which certain transfers are deemed to be fraudulent and recoverable under the Bankruptcy Code was increased from one to two years. However, state fraudulent conveyance laws often allow the bankruptcy trustee to go back even further. The two year period applies only to cases filed twelve months or more after enactment of the Act.
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