December 2010 Archives

December 15, 2010

Chapter 7 Bankruptcy: Beware of Preferences and Pre-Bankruptcy Transfers

Many issues that arise in Chapter 7 bankruptcy relate to the means test. (For more on these, see my previous blog post Common Chapter 7 Bankruptcy Means Test Issues.) However, there are several issues that commonly arise in Chapter 7 bankruptcy that do not relate to the means test. These include preferences and pre-bankruptcy transfers.

Preferences

Preferences are payments made to some but not all creditors prior to your bankruptcy filing. Basically (with some exceptions), you can't make more than $600 total in payments to an arms-length creditor within a three-month period prior to your bankruptcy filing date -- and you can't make payments to creditors who are relatives or business associates within the year prior to you bankruptcy filing.

If you do engage in a preference, the bankruptcy trustee can demand that the recipient of the money turn it over to be distributed to your creditors. Where I have most-often encountered this rule is when a client has borrowed money from mom or dad or sis and then repaid them out of a tax refund. Believe me, it's not easy trying to explain that you can prefer mom over Citibank when it comes to repaying your creditors.

Pre-Bankruptcy Transfers

A related rule concerns pre-bankruptcy transfers. More than a few people who contemplate bankruptcy decide to give some of their valuable property to a friend or relative. Big mistake.

The basic rule is that while you are insolvent you can't make any transfers of real or personal property within the two year period prior to your bankruptcy filing unless you receive fair value in exchange and, if asked, are able to account for what you did with what you got. Most often, a violation of this rule occurs because of a lack of understanding about how bankruptcy works. Simply put, most property that people try to unload could have been kept under their state's exemption system - so there was no need to unload it in order to keep it. But, once you have done the deed it's often hard (but not impossible) to undo it.

To learn more about bankruptcy, check out Nolo's Bankruptcy Center.

December 10, 2010

Common Chapter 7 Bankrutpcy Means Test Issues

Chapter 7 bankruptcy is a marvelous remedy allowing the vast majority of people who use it the luxury of canceling many thousands of dollars worth of debt simply by disclosing their property, debts, and income on a set of official forms, making one personal appearance in court (usually lasting a minute or two), and waiting 60 days after the appearance to receive a final discharge from the court. In these types of cases, self-representation works beautifully.

But sometimes Murphy's Law strikes and a successful outcome requires a lawyer's help. The most common outlier issues in Chapter 7 bankruptcy deal with the means test itself. (To learn more about the means test, see my previous blog post, Why the Means Test Separates the 80% From the 20%.)

Ownership Expenses for Cars

For instance, a successful result in the means test may depend on whether you can claim the "ownership" expense for one or more of your cars. Most but not all courts have ruled that you can't claim the ownership expense unless you are making purchase or lease payments on the vehicle. For people with two cars who aren't making payments on them, this judicial interpretation could deprive them of close to $800 worth of expense deductions and easily be the difference between passing and failing the means test. Fortunately the U.S. Supreme Court will finally decide this issue sometime in 2011.

Mortgage Deduction

Another means test issue is whether you can claim a deduction for your mortgage if you have stopped making payments or you plan on moving out of the house. Although it is counterintuitive to count mortgage payments as expenses when you won't be making them, the courts have mostly decided that you can deduct them -- based on how the statute is written. The Supreme Court's future decision on the car ownership case may also clear up this mortgage deduction issue.

Number of People in Your Household

A third common means test issue has been how to count the number of people in your household. The bankruptcy law doesn't define this term and courts are all over the place about whether members of your household must be dependents or whether people living under the same roof also count. Of course the number of people in your household will often determine whether you pass or fail the means test.

There are many more issues about the means test have shown up in Chapter 13 cases. See www.legalconsumer.com for a database of Chapter 13 court decisions about these and other issues.

December 8, 2010

Why the Means Test Separates the 80% From the 20%

In previous blogs, I've said that for 80% of Chapter 7 bankruptcy filers, the 2005 bankruptcy law changes won't alter much in their bankruptcy. (See The New Bankruptcy Law: Little Change for Most Debtors (Other Than Pricier Lawyers).) But that leaves 20% of bankruptcy filers, for whom the new laws will make a difference.

So what separates the 80% from the 20%? Simply stated, with a few rare exceptions, about 20% of people who want to file Chapter 7 bankruptcy have made enough money over the previous six months so as to be required to take what's known under the new law as the means test. To learn more about the Chapter 7 means test, see Nolo's article The Bankruptcy Means Test: Are You Eligible for Chapter 7 Bankruptcy?.

The Means Test: Three Steps

The means test has three steps. The first step is to compute your average gross monthly income from all sources (taxable or not) for the six-month period prior to the month in which you plan to file for bankruptcy.

The second step is to compare that average monthly gross income figure with the median gross income for a similarly sized household in your state. If your income is under the median income figure you've passed the means test (in only two steps).

If your income is over the median income figure you must take a test to determine if you would have enough income left over after your allowable expenses to pay down some of your debt in a Chapter 13 plan. If so, you can be forced in a Chapter 13 bankruptcy (or alternatively, have your case dismissed). If not, you are eligible for Chapter 7 bankruptcy (again, with rare exceptions).

Use a Handy Means Test Calculater

Because of the means test, many people believed it would be harder to file for Chapter 7 bankruptcy -- and if they are in the 20% category they would be right. Still, as it turns out, a majority of people who are forced into taking the means test pass it and are eligible for Chapter 7 bankruptcy. And thanks to Albin Reneauer (my co-author on my bankruptcy books, How to File for Chapter 7 Bankruptcy and Chapter 13 Bankruptcy), an easy to use (dare I say fun) free online calculator helps you determine whether you pass or fail the means test. If you want to find out whether you are in the 80% or 20% category on account of the means test, visit www.legalconsumer.com, punch in your zip code, enter the average gross monthly income figure for your household, and follow the instructions to complete the test.

Oh, one last word on this topic. Nothing in law is as tidy as I've made it here. Even for people who pass the means test, there may be complications in individual cases that make it difficult to do your own bankruptcy, and that might add a percent or two to the group that needs a lawyer. I'll write more about this in future blogs. Stay posted.