From the January 2006 Idaho Observer:

The "Creditor Relief" Act of 2005

Congress must be commended. It consistently titles, sends to committee, debates and passes bills that mean exactly the opposite of their legislated intent. Congress is so clever in its use of Orwellian Doublespeak that the members of both houses, the pundits, the media and the public never seem to catch on to the trick even though it’s used over and over and over again. This tactic of fooling everyone by naming a bill something that is the opposite of what one reads in its text works every time because those involved either do not read text or they are party to conspiracies where legislation is lied into law.

What Congress (and the president) did to the American people in passing the Bankruptcy Abuse and Consumer Protection Act of 2005 into law can best be described as committing treason against them.

by Don Markham

The reformation of the nation’s bankruptcy laws has been going on for eight years. Bankruptcy reform was first introduced during the Clinton presidency but failed to pass due to the fact the House and Senate had set September 11, 2001, for a conference hearing to hammer out details from their different versions. As a result of 9/11, Congress decided to withhold passing any reform until this last session.

The new, sweeping bankruptcy reforms were passed by the Senate as the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005," and it was passed without modification by the House, and signed by the president April 20, 2005, and most changes came into effect October 17, 2005.

The Bankruptcy Act has already come under fire by both the media and consumer groups because they consider the act to be bad legislation that will unfairly penalize the people needing and deserving the protection and clean start provided by our nation’s bankruptcy laws for over two hundred years.

Some of these new changes require the bankruptcy filer to undergo credit counseling and forces many debtors into Chapter 13 repayment plans when previously they would have qualified for Chapter 7 proceedings eliminating most debts.

Many bankruptcy attorneys are running ads stating, "only ten per cent" of people are affected by the new bankruptcy law. The real story is what is meant by that ten per cent.

Wanna declare bankruptcy? Go see a financial shrink

People maybe surprised that some people may not qualify for relief under this new law. The poor individual will not be as affected as the middle class family which will feel the brunt of this new law and the very wealthy have a large loop hole to hide their wealth from creditors.

Bankruptcy courts acquired new power allowing the judge to rule on whether or not the debtor has ability to repay at least a portion of debt owed. All new filers must go through mandatory credit counseling; exemptions are allowed for the incapacitated, disabled or military personnel on active duty in a war zone. Proof of completion of a financial management course is required for discharge of a bankruptcy petition.

Petitioners must have proof of credit counseling from a nonprofit agency prior to filing a bankruptcy petition. The court now has the power to outright dismiss or convert a petition from Chapter 7 to Chapter 13 and can impose sanctions on debtors or their attorneys on numerous grounds.

Chapter 7

Chapter 7 is known as "straight" bankruptcy. In Chapter 7, you file a petition asking the court to discharge your debts. The basic idea in a Chapter 7 bankruptcy is to wipe out (discharge) your unsecured debts in exchange for you giving up certain property which exceeds certain limits called "exemptions." "Exempt" property is property which the law allows you to keep when you file bankruptcy. In most cases, all of your property will be exempt. But property which is not exempt may be sold, with the money distributed to creditors. If you want to keep property like a home or a car and are behind on mortgage payments or car loan, a Chapter 7 may not be your best choice. That is because Chapter 7 does not eliminate the right of mortgage holders or car loan creditors to take your property to cover your debt.

Chapter 13

Chapter 13 is called "debt adjustment" or a "reorganized plan." In a Chapter 13 case, you are required to make monthly payments to a Chapter 13 trustee to repay some portion of the debt you have. You file a plan showing how you will pay off some of your past-due and current debts now for a period of five years.

All filers will now be confronted with what is known as the "Means Test" which asks for information that will calculate the average income for the past six months, annually and then figures the median income for households of the same size in the debtors’ states of residence.

If a debtor’s income is less than or equal to the state median income (in Idaho that would be $32,531 for single persons and up to $55,914 for a family of four), the debtor "passes’ the means test and can file a Chapter 7.

The new deal

If the debtor’s income exceeds the median income, a further analysis is performed, looking at the debtor’s disposable income, trying to estimate what the debtor could pay to unsecured creditors in a hypothetical Chapter 13. The disposable income is calculated applying a mix of actual and standardized expenses to the historical average income. If the debtor can pay $10,000 in five years OR as little as $167 a month to creditors, a presumption arises that a Chapter 7 filing is "abusive" and could result in sanctions and allowing you only a Chapter 13 filing.

Once allowed into Chapter 13, you’ll have to prove to the court that you can afford to meet all of your payment obligations. All living standards used are set by the IRS and the court cannot look at actual expenses. To find more information concerning median income tables, by state and family size, go to the website of the U.S. Trustee, www.usdoj.gov/ust, and then click on "means testing information."

In Chapter 13, if your debt is too high (over $900,000 and change) you would be ineligible as well as barred from a Chapter 7. A debtor must submit state and federal returns for four previous years. Certain debts such as child support, alimony, and wages owed to employees and certain tax obligations are "priority debts." Your payment plan must include "regular payment" on all car loans and or mortgage(s) as well as repayment of ANY arrearages on these debts.

Your Chapter 13 plan must show that any disposable income you have left after making these required payments will go towards repaying your unsecured debt such as credit card or medical bills and must pay a minimum of 25 percent of these unsecured debts. In some cases these minimums could be increased—as well as interest being allowed to be added—during bankruptcy.

You will be required to pay all filing fees to be accepted for Chapter 13. Part of the new bankruptcy law are provisions known as "shop and drop" which provide that any luxury good or service totaling more than $500 to a single creditor made within 60 days of filing must be paid in full. All cash advances made within 70 days of filing are considered non-dischargeable.

Want bankruptcy protection? Better have accurate tax returns on file

Another roadblock delays people who had not yet filed a tax return for a recent year.

Anyone filing for Chapter 7 bankruptcy has to provide a federal tax return for the most recent year; those filing for Chapter 13 have to be current on tax returns for the previous four years.

Stricken from the new law are debts tinged with fraud, tax claims for which no claims were filed or an old tax year for which no return was filed. For some people, outstanding taxes, federal, state or local, are a main reason for needing bankruptcy protection. In the past, an individual using Chapter 13 bankruptcy (this was a repayment plan that generally ran for three years) could obtain a partial discharge for taxes related to non filed returns and certain late-filed returns; whatever was paid to the government during the repayment period was all the debtor was required to pay for his debt to be discharged.

There is a loophole for some who are filing for bankruptcy that allows a person who would otherwise be in Chapter 13 to drop to a Chapter 7. It is "tithing," which now allows a person to gift 15 percent of income to recognized charities. That 15 percent, in some cases, would be enough to drop their income to a level that would allow a Chapter 7 filing.

The new law has changed the rules for Chapter 13. The repayment period is now five years. The new law under Chapter 7 still provides opportunity to obtain a discharge of those taxes for which the debtor filed timely returns that arose three years prior to filing bankruptcy petition; the IRS must have assessed the tax 240 days before the petition was filed to avoid being accused of bankruptcy fraud.

Old and new

Under the old bankruptcy law, the personal property that debtors were allowed to keep in bankruptcy was determined by the laws of the state where they lived (as long as they lived there for at least three months).

Under the new law, you must live in a state for at least two years prior to filing in order to use that state’s exemptions laws. Otherwise, you must use the exemptions available in the state where you used to live. Similar rules apply to homestead exemptions, which determine how much equity in a home you can keep when filing for Chapter 7 bankruptcy.

The new law now overrides all state laws concerning homestead exemption. The standard is $125,000 if you have acquired your house within 3.3 years. If prior to 3.3 years and if you live in Texas or Florida, then you have unlimited homestead exemption as before this law was passed. The education saving plans known as "529 plans" are state- operated investment plans that give families a federal tax free way to save for college. Contributions made between one and two years of filing bankruptcy are protected up to $5,000 while older contributions are fully protected.

Trusts—me, you, them, who?

One of the most interesting sections of the new law is "Asset Protection Trusts" which creates "self settled trusts" where the grantor can be both beneficiary and trustee while blocking creditors from any assets held in the trust. These trusts are created under state law in only five states: Alaska, Delaware, Nevada, Rhode Island and Utah.

The new asset bankruptcy protection law limits the protection to transfers of property made within 10 years of filing for bankruptcy only if the transfers were not made with the intention to hinder, delay or defraud creditors. States allow nonresidents to set up these trusts but it should be noted this concept has yet to be tested in court. You should be aware that there will be lots of people advertising to sell you a trust but this special trust is formed under state statutes which will be different from all other types of trusts.

Consult the different state statutes for more information. Not all trusts you hear about are the trusts I am talking about. Beware of those that offer a "silver bullet" trust.

If for some reason you cannot finish a Chapter 13 repayment plan—for example, you lose your job a year into the plan and can’t keep up the payment – the bankruptcy trustee may (key word) modify your plan. The Trustee may: Give you a grace period, if the problem looks temporary; reduce your total payments or; extend the repayment period.

If it’s clear that there is no way you’ll be able to complete the plan because of circumstances beyond your control, the court might let you discharge your debts on the basis of hardship. If the bankruptcy court won’t let you modify your plan or give you the option to convert to a Chapter 7 bankruptcy, unless you received a Chapter 7 bankruptcy discharge within eight years or a Chapter 13 bankruptcy discharge within the last six years or ask the court to dismiss your Chapter 13 bankruptcy case. If you have your case dismissed, you would still owe your debts. However, any payment you made during your plan would be deducted from those debts.

On the flip side, your creditors will be able to add on interest, which on credit cards could be as much as 30 percent, an amount they did not charge while your Chapter 13 case was pending.

Under the old law, the U.S. trustee was allowed to review property transfers done six months or less under federal law and six years under most state laws. Now the trustee can go back on transfers made within 10 years. The bottom line about asset protection: In most cases, you won’t be successful using the usual age old strategies. In the future you will need to use new strategies in preparing for asset protection.

No matter what people say, there are no silver bullets. However, in creating whatever entity, you should not be gifting large assets into any entity without understanding all the rules. Creating your entity and selling assets to your entity for at least the equity of the asset will prevent having a court, bankruptcy trustee or some creditor attempt to overturn this transfer. There are numerous entities available, each with their own advantages and/or disadvantages.

This will be a future article concerning this aspect in which I will show new strategies and show warning signs from those who offer asset protection to protect your hard earned money.

Note: Markham is a paralegal who has been following the development of the new bankruptcy law for eight years. He sees the new law as a carefully-crafted set of complex statutory guidelines that provide relief for the poor, loopholes for the wealthy and a Pandora’s box of horrors for middle-class Americans seeking bankruptcy protection. The creation of "self-settled" trusts, just mentioned here, will be the subject of another article that will explore the implications of this asset protection mechanism—who will benefit and who will not. (DWH)