The myth of the “pay it all back” bankruptcy.

I’ve lost count of the number of times I have recommended a Chapter 13 Bankruptcy to a client only to have them stare back at me with their eyes bulging, and usually with one of the following responses:
“Isn’t that the one where I have to pay everything back?”

“Why should I bother filing for bankruptcy if I have to pay everything back?”

“#@!$ you.”
Or some combination of all three.
One of the major problems with getting legal advice from your friends at the bar is that an entire new field of “faux law” develops.  Assumptions are made, facts are distorted, and words are used carelessly.  Before you know it, a new bankruptcy myth emerges that bears little or no resemblance to reality.
I spoke about this once before.  The notion of “filing against debts” gave rise to a mistaken notion shared by many of my clients that whether a debt would be discharged or not had to do with whether or not it was listed on their bankruptcy schedules.  I’m not going to go down that road again.  Suffice to say, listing creditors on bankruptcy schedules is a due process requirement, and has very little to do with the discharge.  You can read more about that here.
Filing Chapter 13 Bankruptcy does not [necessarily] mean you are paying everything back.  So, how does this myth get started?
Well, for one thing, if you are in Chapter 13 – you are indeed making monthly payments to the Trustee.  The way I explain it to my clients (at the beginning of our consultations, before I have specific facts of their case) is that…  Chapter 13 is a 3 to 5 year debt consolidation and repayment program.  We take all of your debts, pool them together, and break them up into categories.  Then, based on the types of debts you have and the circumstances of your case – certain debts will be paid in full and other debts will be paid a percentage – based primarily on income but sometimes other factors.
Let’s take a simple example…  Unmarried individual makes $20k per year, he has a car loan and three credit cards.  He qualifies for Chapter 7 based on in his income, but he has a prior bankruptcy case that makes him ineligible to refile a Chapter 7 at this time.  In his case, he will make monthly payments to the trustee – he will pay off the secured balance on his car during the life of the plan, and he will likely pay nothing to his unsecured creditors based on his income.  In this particular example, he may very well be paying the exact same thing he would have been paying if he filed Chapter 7, except instead of paying his auto creditor directly, he pays the trustee.  And, with up to 60 months to do the Chapter 13, and the possibility of lower interest rates and a possible reduction of the principal balance – he is actually paying LESS in Chapter 13 than he would have been paying if he filed Chapter 7.  So, while it is true he is making monthly payments, he is certainly not paying “everything” back, and in this case, he’s actually better off than he was in Chapter 7.
Does everyone come out of Chapter 13 faring so well?  No.  Often, people in Chapter 13 will pay back something to their unsecured creditors, but seldom do they pay it all back.  People file Chapter 13 either because they make too much money (in which case they’re paying unsecured creditors a percentage based on income) or they’re filing Chapter 13 for a non-income reason, and most of those reasons require a percentage to unsecured creditors.
And of course, many priority (taxes, domestic support, etc.) and secured debts (auto loans, mortgage arrears, etc.) do have to be paid in full.  Though, not always, so don’t let the general rule frighten you.  Talk to a bankruptcy attorney to find out exactly what does and what doesn’t have to be paid if you choose to file Chapter 13 Bankruptcy.
Are there cases where debtors have to pay back all of their debts?  Yes, there are.  These are relatively rare, but there are several different ways this could happen.  Someone could make so much money relative to their debt (remember that bankruptcy is less concerned about income and more concerned with your debt-to-income ratio) that the formula set forth by Congress determines that you have to pay back all of your debt.  Or, if you’re filing for a non-income reason, that reason may also force you to “pay it all back” – though these scenarios are far less common.
So, let’s say you’re that rare debtor – the one unfortunate enough to find out from your attorney that you have to file Chapter 13 and “pay it all back”.  Why bother filing?
Well, maybe you don’t want to file.  But don’t rule it out just yet.
For starters, you’re still probably not paying it all back.  Interest rates on debts in Chapter 13 vary by district, but they are almost always better than what you would be paying contractually.  For example, in the Eastern District of Wisconsin, priority debts and general unsecured debts are all paid with 0% interest.  Mortgage and lease arrears are also paid at 0% interest.  The only real interest that gets charged are for other secured loans (such as vehicle loans), and those receive “Till interest” which is prime rate plus 1-3%.  Prime rate has been stuck at 3.25% for several years now, so unless you have ridiculously low rates on your vehicles and interest free credit cards, you’re still getting relief on interest rates.
You will still benefit from the automatic stay – which means any adverse collection actions (ranging from wage garnishments and bank levies to repossessions and foreclosures – and including annoying creditor phone calls) all stop.  Apart from any long-term debts, you can walk out of Chapter 13 debt free, with a reorganization plan that will put you in much more control than you are perhaps feeling right now.
The lesson of today’s story is that you shouldn’t get your legal advice from a bar stool.  What happened in your friend’s bankruptcy case is unlikely to be what happened in your bankruptcy case (for better or for worse).  Results vary by the circumstances of each case.  Get the facts from an experienced bankruptcy attorney.

Value of Season Tickets

Most of my clients are surprised to learn that season tickets are an asset.  But yes indeed, they are a thing of value that can be sold for money (admittedly, with restrictions) for the benefit of creditors, so yes, they are an asset.  In fact, individual game tickets are technically an asset as well, but considerably less valuable, so the trustees never bother to inquire about them.
Does that mean the trustee is going to take your tickets?  Not necessarily.  Nor you should lie to your attorney about their existence.
Here in Green Bay, people who own season tickets for the Green Bay Packers is fairly common.  Elsewhere in the state, you might find season ticket holders for the Milwaukee Brewers, Milwaukee Admirals, or Milwaukee Bucks.
They are not a common asset of people filing for bankruptcy.  However, I have had about a half dozen cases over the years where my clients held season tickets.  In each case, there was plenty of exemption to cover them.
But it does beg the question – how to value the ticket.
The value of any asset is the price that some third party would pay at an arm’s length transaction.  But that is often hard to pin down.
Presently, the consensus for valuation of season tickets is the license fee (last I checked – $1,400) plus the actual ticket value itself, if it has already been issued.

Title 11? I thought I filed Chapter 7!

This is a very common misconception that I want to dispel quickly.  On the bankruptcy forms, in formal court pleadings, and perhaps even in an attorney’s retainer agremeent or other forms and letters – there will be several references to “Title 11 of the U.S. Code” or “11 U.S.C.” or “Title 11 – Bankruptcy Code” or some other variation.
People reading this will mistakenly believe that this refers to Chapter 11 Bankruptcy.  It does not.
The United States Code – the body of federal statutes – is divided into 51 “titles” which are broad-area topics.  For example – Title 18 covers federal crimes.  Title 26 is the Internal Revenue Code.  Title 12 is about banks.  And Title 11 is all bankruptcy.  Each title is further broken down into parts, chapters, sections, and subsections.
When we refer to “chapters of bankruptcy” such as Chapter 7 or Chapter 13, we are referring to a subdivision of Title 11.  There just so happens to also be a Chapter 11 bankruptcy, which is what fuels the confusion.  For the record, certain entitles can also file for bankruptcy under Chapters 9 and 12 (and 15, but that’s not exactly a separate filing).
There are other chapters in Title 11, too, which contain general provisions that apply to the other “chapters of bankruptcy”.  Chapter 1 is “General Provisions”, Chapter 3 is “Case Administration”, and Chapter 5 is “Creditors, the Debtor, and the Estate”.  There are no even-numbered chapters, except for Chapter 12.  That’s just the way Congress chose to structure it.
So, when you hear or read something from your attorney or the court talking about “Title 11”, that doesn’t mean that your attorney filed (or is going to file) a Chapter 11 Bankruptcy for you.  All chapters of bankruptcy, such as Chapter 7 and Chapter 13, fall within Title 11 of the United States Code.

Tax Refund Strategies in Chapter 13

In Chapter 13 Bankruptcy – debtors who are below-median (or above-median debtors who amend their plan after confirmation) are required to submit 1/2 of their federal and state income tax returns to the trustee each year that they remain in the plan.  (Different districts have different rules concerning tax refunds – the rule I’m describing pertains to the Eastern District of Wisconsin.)  I have explained in the past why this is so, but to reiterate, it’s because people can have too much in tax withholding, which artificially decreases their disposable income while rewarding them each year with a large lump sum payout from the government.  Above-median debtors are initially exempt from this requirement since they are subject to the formulaic means test which measures actual tax liability.  If an above-median debtor over-withholds, in theory, they are only making it more difficult for themselves to make the plan payments.

Regardless of the equitable nature of this rule, the fact of the matter is that most people are none too pleased about having to fork over half of their tax refunds.  And as your attorney, it is my responsibility to ensure that you are educated enough about your options to proceed through bankruptcy as wisely as possible.

First of all – let’s clear up two extremely common misperceptions.

ONE – Regardless of whether you are required to submit one half of your tax refunds to the trustee, all Chapter 13 debtors must submit copies of their tax returns to the trustee each year that they remain in the plan.  This is for reasons separate from the tax refund issue (though the tax returns also help the trustee verify that you have paid in the correct half amount – without the tax returns, he must assume that you did not).

TWO – Tax refunds do not help pay off your bankruptcy faster (unless all debts are being paid in full).  Tax refunds are earmarked for unsecured creditors – as an ADDITIONAL dividend to be paid to unsecured creditors above and beyond what you are required to pay them under other factors.

Because of distribution rules, tax refunds will be used to pay priority and secured creditors first.  So, let’s say we have a plan paying $100/mo for 60 months to pay back $6k in secured debt.  After two years, the debtor has paid in $2,400 and also paid in $3,600 in tax refunds.  Now the secured creditor is paid off in full.  The regular monthly payments ($100/mo) that the debtor will continue to pay out for the remainder of his 60 month plan (36 months) will replenish the tax refund money ($3,600) that was earmarked for unsecured creditors, but paid instead to the secured creditor.  The tax refunds paid in for the remaining three years will also go to unsecured creditors, but since the secured and priority creditors have been paid in full, that money will go straight to the unsecured creditors and not part of the “replenishment”.

So, the title of this blog promised a strategy, so a strategy I shall give.  And that strategy is actually really simple…

The best way to avoid your obligation to fork over half of your tax refund to the trustee is to not have a tax refund.

Does this mean you shouldn’t file your taxes?  Absolutely not.  Your case will either be dismissed by the trustee for failure to do so, or the IRS and state will file section 1305 claims against you in the bankruptcy, making your plan unfeasible.

What you do is adjust your tax withholding such that you get little or no refund at the end of the year.  In other words, more money on your paycheck to live off of, and no large lump sum at the end of the year.

Now, how to do this is a whole different question, and that I leave to other professionals, such as tax attorneys, CPAs, or perhaps even qualified people on your employer’s HR staff.

Technically, if you have more money on your paycheck, you will have more disposable income, and therefore your plan payments would be higher.  That being said – if you are below median, your budget controls feasibility, not the Means Test.  Whether anyone (such as a trustee) wants to admit this or not, the budget is an art form.  If there is an extra $100/mo on your paychecks, that money can often be negated by a reasonable expense with great ease.

Before I close out this post, I want to leave you with a paraphrased, but otherwise actual conversation I recently had with a client.  She had come to me because she was struggling with her plan payments.  I was reviewing her case to determine if there was any wiggle room.  Unfortunately, there wasn’t, but I also happened to notice that she was paying in a LOT of money each year to the trustee for tax refunds – close to $10k each year.

Me:  You’re paying in an awful lot of money to the trustee for tax refunds each year.  Why don’t you adjust your tax withholding?  That will give you more money on your paychecks, and you should be able to manage the plan payments just fine, then.

Client:  I can’t.  I depend on that tax refund to pay my property taxes.

Me:  I understand that.  But you can set that money aside – into a savings account – and pay it later.

Client:  I’m not disciplined enough to save money like that.

Me:  Yeah, but if you do it the way you’ve been doing it, you’re struggling with plan payments and you only get $10k to pay for property taxes.  Do it the way I’m suggesting, and you get $20k each year.  You’re giving up $10k to unsecured creditors each year and you don’t have to be.

Once I made the contrast clear to her, I believe my client summoned the strength to discipline herself into setting aside some of that extra money on her own.  Yeah, you can look at the IRS as a savings account.  But they’re holding on to your money, interest-free.  And when you’re below-median and in Chapter 13 Bankruptcy, you only get to keep half.  It’s better to manage the money more carefully on your own.

The Importance of Following Directions

Chalk this one up under the category of “Mistakes to Learn From”.  About 6 weeks ago, I filed a case for a person who did not follow directions at all.  Prior to our meeting, I had explicitly instructed him to obtain updated and accurate numbers for about a half dozen secured and priority debts.  He apparently didn’t think that was very important, and he showed up to the meeting with nothing but some rough estimates, very old statements, and other numbers that were nothing more than guesstimates.
I don’t ask my clients to do anything just for kicks.  If I ask for something, there’s a very important reason I have asked for it – even if that isn’t apparent to my client.  In this case, having accurate numbers for secured and priority debts is important because in Chapter 13, most of these debts have to be paid in full (as opposed to unsecured debts, which are often paid mere pennies on the dollar), and the claims will [ultimately] control how much has to be paid.  When I ask for these updated numbers, it’s so we can predict what the claims will be with a high degree of accuracy.
Unfortunately, with foreclosure imminent, we didn’t have time to take another crack at it.  The case had to be filed with the estimated numbers.
I prepped the case today.  The debtor had estimated about $7,600 in mortgage arrears.  The actual number came in at almost $26,000.  If this guy wants to keep his house, his plan payment will have to increase by approximately $333/mo to make up the difference.  That would have been a handy tidbit of information to have before the bankruptcy case was filed.  It’s hard for a client to make informed decisions when they don’t bother to arm themselves with accurate information.

November 2013 Median Income Levels

About twice a year, we get new median income levels.  For bankruptcy purposes, being below the median income level presumptively means you qualify for Chapter 7 (though it is possible to be below median and still have to file Chapter 13 for income reasons – read here).   Being above the median income level presumptively means you have to file under Chapter 13 (though it is possible to beat the Means Test or rebut the presumption).
Median income levels vary by state and by household size.
The next change goes into effect November 15, 2013.  In Wisconsin, it will be slightly easier for households of 1 and 3 to get into Chapter 7, and slightly tougher for households of 2, or 4+.
Old Numbers:
HH1 – $43,661
HH2 – $58,668
HH3 – $65,775
HH4 – $81,296
New Numbers:
HH1 – $43,958
HH2 – $57,903
HH3 – $67,808
HH4 – $80,198
(For household sizes larger than 4, add $8,100 per additional member of the household.)