All of these choices, by the way, create unintended consequences – if you are reaching that point of desperation where you are thinking about selling things, cashing out retirement plans, etc., I would rather that you call me  before taking any action because of the risk that you might unknowingly lose some of the benefit from your bankruptcy filing, or possibly disqualify yourself altogether.

Retirement plan loans such as 401(k) loans create a variety of issues and are almost always a bad idea in a bankruptcy context.   Presumably you borrow against your 401(k) because you need cash now, you expect to repay that loan in the near term, you want to preserve your 401(k) account for the future, and because you do not want the tax consequences associated with cashing out your 401(k).

Bankruptcy trustees, however, look at 401(k) loans in a different light.   They see any allocation to repay a 401(k) loan (and sometimes any ongoing contribution to a 401(k) plan) as an unnecessary reduction of disposable income that would otherwise be available to pay creditors.    401(k) loan payments cannot be counted as allowable deductions in your means test calculations.   And both Chapter 7 and Chapter 13 trustees and/or creditors will often object if you include a 401(k) loan repayment allocation in your Schedule I and J budget in either a Chapter 7 or Chapter 13.

Since 401(k) plan funds are generally considered “exempt” or sheltered property in a Georgia Chapter 7 or Chapter 13, your best choice often means not using your 401(k) as a last gasp source of cash.

401(k) loans and on-going 401(k) contributions do not make bankruptcy impossible, but they do complicate matters.  If you are in financial trouble and are thinking about raiding your 401(k) or retirement plan but have not done so, you should not take any action until you have spoken to a bankruptcy lawyer.   If you have already cashed out or borrowed against your 401(k), make sure that your attorney is aware of this fact.

The issue in Lanning is one that has troubled bankruptcy lawyers since 2005, when the “means test” was added to the Bankruptcy Code.   The means test functions as a test – do you have the “means” or disposable income to fund a Chapter 13 repayment plan?  If the means test shows that you do not have sufficient disposable income to make a Chapter 13 work, then you qualify for Chapter 7.

As one of the assistant United States trustees once told me – the purpose of the means test is to disqualify as many people as possible from Chapter 7, and to force them into Chapter 13.

In practice, the means test does not work very well in predicting who can make a Chapter 13 work.  One of the biggest complaints has to do with the mechanical nature of means testing.   To run a means test, I have to gather pay stubs from the past 6 months.  I then create a monthly average, which represents available income.  Next I prepare a means test budget, but I do not use actual expense amounts.  Instead, the means test tells me how much my clients are allowed to spend for food, medicine, utilities, etc.  And where do these budget numbers come from?  Means test numbers are based on IRS budgets used in delinquent tax repayment plans.  In other words, the means test budget allocations are not especially generous.

This explanation of the means test is somewhat oversimplified, but you get the main idea – every bankruptcy debtor’s income and expense numbers have to be run through the means test, and not surprisingly this somewhat mechanical test produces some absurd results.

The classic example of absurd results occurs when a debtor has received a Christmas bonus or a one time payment.  That bonus/one time payment has to be included in the monthly income numbers even if it is not guaranteed or likely to happen again.  In other situations a debtor may have earned a comfortable income but has now lost his job – under a strict reading of the means test, he earns too much money to file Chapter 7.  And he can’t afford to file a Chapter 13 because he now has no income.

The Supreme Court has injected some common sense into this situation.  In the Lemming case, which was filed in Topeka, Kansas, the debtor’s 6 month average was skewed by a one time payment arising from a buyout from her former employer.  The debtor filed a Chapter 13 plan that called for a payment that the debtor could afford based on her actual, current income.  The trustee objected on the grounds that the means test dictated a higher number (that the debtor clearly could not afford based on his actual income).

The Topeka bankruptcy judge agreed with the debtor and approved a plan that Ms. Lemming could afford.  The trustee appealed and lost in the 10th Circuit Court of Appeals.  The trustee appealed again and the Supreme Court granted certiorari.

The Supreme Court affirmed the decision of the 10th Circuit Court of Appeals and held that bankruptcy judges need not apply a “mechanical approach” to means testing in Chapter 13 cases.  Instead, judges should “take into account other known or virtually known certain information about the debtor’s future income or expenses.”  Rather than looking backwards, judges can take a forward looking approach and consider the realities of a debtor’s income.   This forward looking approach should be considered in cases with unusual facts and the Lemming decision should not be construed as an invalidation of the means testing formula.

Despite the Supreme Court’s warning that a “forward looking” approach should only be used in limited situations, I suspect that bankruptcy judges will use “Lemming arguments” mitigate some of the harsh results of Chapter 13 in general.   Bankruptcy judges recognize that Chapter 13 cases often do not work because means testing and aggressive trustee arguments force debtors to agree to plans that commit debtors to pay every last dime to the trustee.  Unfortunately, family emergencies and unexpected things happen over the course of a five year bankruptcy plan and many plans will fail – not because the debtor did anything wrong, but because there is no “give” in the plan.

I predict that judges will use the rationale of Lemming to reduce some of the harsh results of the means test and help debtors improve their chances at success in Chapter 13.

If you want to read the Lemming decision, click on the link.  I also found a nice summary of Lemming in attorney Jordan Bublick’s fine South Florida bankruptcy blog.

Sorry – can’t do it.  As North Carolina bankruptcy lawyer Adrian Lapas writes in his recent post in the Bankruptcy Law Network blog:

When you sign your bankruptcy petition, you are certifying to the United States Bankruptcy Court, under penalty of perjury, that the petition and schedules attached to it lists all of your assets and all of your debts.  All means all!  You do not get to pick and choose which debts you list in your bankruptcy case.

Not only must you include all of your creditors but you may also have to include other “interested parties.”  In the Northern District of Georgia, for example, the Chapter 13 trustee requires all debtors who are subject to child support orders to include the custodial parent as a priority creditor in their Chapter 13 petitions.  Notice must be provided the custodial parent/child support recipient even if there is no arrearage.

Needless to say this requirement does not make child support paying debtors very happy because it means that their ex-spouse will know that the debtor has filed bankruptcy and will have ready access to the debtor’s financial picture.

The big picture here:  you lose a certain degree of control when you file bankruptcy, and you have to play by the rules.  Details of your financial life become part of the public record and people like ex-spouses, parents, bosses and friends may very well get notice of your filing and you can assume that some of these “nosy neighbors” will review your filing.

Although I explain the implications this provision, many of my clients express shock and outrage when their expected refund of $3,000, $4,000 or more does not show up in their mailboxes, but instead ends up in the hands of the Chapter 13 trustee.  These clients, quite naturally, expect that the tax refund payment will reduce their Chapter 13 obligation and either reduce the term of their plans or possibly allow for a reduction in the regular monthly payment.

More recently one of my clients fell behind on his Chapter 13 plan and had to enter into a consent order with the Chapter 13 trustee to pay extra each month to cure the delinquency.   Shortly after the consent order was filed, this client saw a  $2,200 tax refund to to the trustee and he wanted to see that money applied to his delinquency and thus reduce the burden of his delinquency cure.

Unfortunately in both of these situations, my clients will not get the desired benefit from the “seizure” of their tax refunds.  The funds will go into the plan, but instead of reducing the balance or the term of the plan, they will increase the dividend payable to unsecured creditors

Why?  The trustee’s position is that a debtor who is eligible for a tax refund has had too much withheld from his paycheck.  In other words, by having too much withheld, the debtor/taxpayer is essentially putting money into a savings account (a savings account that amounts to an interest free loan to the government, but that is another story).  Presumably, if the debtor had the correct amount withheld, there would be more disposable money available for the debtor’s Chapter 13 plan.   Unsecured creditors should not bear the burden of a lower plan dividend so that the debtor can have a savings account.

Given that this is the trustee’s position, I advise my clients to adjust their withholding numbers so that there will be little or no refund payable at the end of the tax year.   Assuming that there is some flexibility in the debtor’s budget, the “extra” money can be allocated to approved expenses and what I call expected emergency categories, such as medical costs, transportation costs, even food.   If “extra” money is needed down the road, my client can tighten his belt some, but still have enough to survive.   This approach, in my view, clearly beats giving up one’s expected emergency funds to the Chapter 13 trustee.

I might need to file chapter 13 in the future.  I filed a Chapter 7 in 2003 and now have a lot of credit card debt.  I have a house but I do not want to keep it. When the house goes into foreclosure the only property I will have in my name is 3 cars valued from $6000 to $8000 each.  I only own one of them.  The other two belong to my parents.  I got loans in my name for the cars because I got the best rates, but when they were paid off I never signed the titles over to my parents.  In a ch. 13 will all the cars be considered mine, or is there a way to prove that they belong to my parents?  My name is the only name on the titles.

It appears to me that Lou and his parents made a common sense decision at a time when bankruptcy was not a consideration.  Lou most likely qualified for better rates because he was working so he made a decision to help out his parents by applying for car loans in his name.   His parents have made all the payments so as far as they and Lou are concerned the cars belong to the parents.

Unfortunately this is not how the bankruptcy court will look at things.   If the title to the vehicle shows Lou’s name only, all three cars belong to him.   If he files a Chapter 13 in Georgia, he can exempt up to $3,500 in vehicle equity but that is it.   Lou’s Chapter 13 will have to account for any non-exempt equity, as follows:

Let’s assume that all three vehicles are paid for and that each are worth $7,000.  That would be $21,000 of equity in vehicles.   In Georgia, Lou could exempt $3,500 of equity, leaving $17,500 of non-exempt equity.  Lou can also use half of his real estate exemption to shelter the vehicles.   In Georgia, the real estate exemption is $10,000, which means that Lou can use $5,000 of exemption and apply to the vehicles.  $17,500 – $5,000 = $12,500.  Georgia law also provides for a wild card exemption of $400 that applies to any property – I typically use that for cash and checking accounts so let’s leave that out of the mix.  For our example, Lou has $12,500 of “non-exempt” equity.

If Lou was able to qualify for Chapter 7, the trustee would have the right to sell the vehicles to liquidate $12,500, which would be used to pay claims of the Chapter 7 estate.   $12,500 is 25% of $50,000.  In a Chapter 13, therefore, Lou would have to pay back at least 25% of his unsecured debt.

Note that for purposes of this analysis, I did not address any means test problems which might arise from Lou’s household income.  Additionally, I think that Lou could face an objection from the Chapter 13 trustee regarding his need for three vehicles.  If Lou’s parents are not dependent upon him, the trustee might take the position that three vehicles are not essential for Lou’s financial rehabilitation.   As far as the trustee is concerned, the rights of Lou’s creditors may trump the needs of Lou’s parents.   In other words, should Lou’s creditors have to deal with the risk inherent in Lou being on the hook for two vehicles he does not drive?   In my experience, the Chapter 13 trustee would object to Lou keeping all three vehicles – his solution would be to pay a higher dividend (i.e. more than 25%) to the unsecured creditors.

As you can see, a simple question arising from a non-bankruptcy decision can have all kinds of bankruptcy implications.

Recently, I have had to deal with problems arising from "estimated liability claims" filed by either the IRS or Georgia in Chapter 13 cases.

The problem arises in the case of a debtor who did not file a tax return in a prior year because of very low or non-existent income.  I have had a number of clients tell me that their accountants or tax preparers advise them that the debtor did not need to file a tax return for years in which the debtor earned little or no income.

I do not know if this advice about not filing returns is correct or not as I am not a CPA or a tax preparer.  What I do know, however, is that if you did not file a return in a prior year, there is a good chance that the IRS or Georgia will file an estimated liability claim for those tax years in your Chapter 13 case.

This estimated liability claim will often be calculated based on your earnings for recent years.  In other words if you earned zero in 2003, but earned $50,000 in 2004, 2005 and 2006, then the IRS will assume that you earned around $50,000 in 2003 and they will estimate your liability for that period as well.  Their estimated liability claim will include tax liability, interest and penalties.

If the IRS files an estimated liabilty claim based on unfiled returns, your Chapter 13 case will include unanticipated priority tax debt and there is a good chance that the Chapter 13 trustee will not agree to recommend confirmation of your case because your tax debt is actually unknown.

I am currently working on several cases where we have had to ask for reset after reset to give the debtor time to file a return showing zero earnings and for the IRS to amend its claim.

If there are any years in which you did not file tax returns, I think it would be wise for you to consult with your tax preparer prior to filing Chapter 13.  I am now recommending to my clients that they advise their tax preparers about this estimated liability problem and file a return showing zero income so that their Chapter 13 plans will not be in jeopardy.

Technorati Tags: chapter 13 and taxes, estimated tax liability claims in bankruptcy, proof of claim, Georgia Department of Revenue, IRS claims

Because Chapter 13 cases must pay out in five years, unknown tax debt is a big problem.  If your tax debt is unknown, it is impossible to create a repayment plan that pays out in five years since we don’t know exactly how much debt is involved in the case.

My client intake questionnaire specifically asks if there are any years where tax returns have not been filed.  In each of these cases, my clients (three cases total) did not reveal any information about unfiled tax returns.,

If you have not filed tax returns, your Chapter 13 case can never be confirmed.  Rather than misleading your lawyer, a better option is to acknowledge this issue and get working immediately on solving the problem.   The IRS will provide you with W-2′s and 1099′s that you can use to prepare tax returns from previous years.  IRS and Georgia DOR forms for previous years are widely available on the Interent and most tax preparers can prepare tax returns for previous years.

Technorati Tags: unfiled tax returns, tax returns and bankruptcy, tax returns and Chapter 13

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• food
• charitable contributions
• non-reimbursed medical expenses
• gasoline and automobile related expenses
• child care
• after school program costs
• child education related expenses

The best evidence to prove that you actually spend what is set out in your budget are payment receipts of vendor invoices.  If those are not available, I have had some success using a debtor’s affidavit swearing that you actually spend what you say you do.

About a year ago, I wrote a blog post identifying the information I need to start a bankruptcy representation.  Add "receipts and documentation"  to that list.  Your best guess is no longer good enough for the Chapter 13 trustee.  You can save yourself a lot of time and aggrevation by saving receipts and invoices.

Technorati Tags: schedule I & J, bankruptcy budget, chapter 13, proof of what I spend, proof of expenses

Of course, I did not want the person to go to jail and did not obtain any promissory note or security agreement at the time the funds were wired to the bank’s fraud recovery department.

I have not yet obtained a promissory note and mortgage as I assume it could now be disallowed by the trustee because the money was disbursed in mid-February and I’ll bet there’s a "consideration" issue now.

What do you recommend?  Is it too late to get a note and/or secure the debt.  The friend has yet to file Chapter XIII yet.

Would there be any priority in my payment becuase I kept the person out of jail?

–Michael

Jonathan Ginsberg responds:  Michael, as you said in your email – "no good deed goes unpunished."   I do not represent creditors so I would advise you to find a lawyer who regularly represents creditors in Chapter 13 claims.  Typically lawyers who represent used car dealers or high risk vehicle finance companies would have a lot of experience regarding possible objections to Chapter 13 cases since they file objections all the time .

I have no doubt that creditor lawyers and Chapter 13 trustee attorneys read this blog – perhaps one of my colleagues at the bar could post a comment or email me with more insight.

Your predicament serves as an important lesson to anyone who ever considers loaning money to friends or family.  If you make these loans, especially in an emergency situation, be prepared to lose the money, your friends or both.

Technorati Tags: treatment of personal loans in bankruptcy, objections to chapter 13 confirmation