Bankruptcy is governed by federal law, (United States Code Title 11 Sections 101 et sequitur (11 US Code 101 et seq)) which at 11 US Code 522 lists exemptions debtors can use to keep property of up to certain values out of their bankruptcy estates. A debtor’s bankruptcy estate is all property and property rights that the bankruptcy court may administer. Property not in the bankruptcy estate is exempt from administration.
The exemptions debtors claim determine what property they can protect in Chapter 7 (11 US Code 701–784) and what property creditors can claim in Chapter 13 (11 US Code 1101–1174) bankruptcies. Exemptions are available under federal and state law, and which set debtors may use depends on their state laws.
Federal bankruptcy law per 11 US Code 522(b) allows debtors to use either state or federal exemptions. It also allows states to opt out of the federal scheme and require debtors to use state exemptions only.
Exemptions under Section 522 do not vary in value from state to state. The federal bankruptcy exemptions protect equity in assets to certain levels. Most common are the homestead exemption for equity in the debtor’s home, the automobile exemption, and the wildcard exemption that can apply to any property. Many other federal exemptions protect assets ranging from retirement accounts to jewelry.
Each state has its own set of exemptions, mostly similar to the federal exemptions but amounts vary. Some are generous, others are not, so it is important to check state exemption laws before filing a bankruptcy petition.
Which Exemption System?
The answer depends on the law of the debtor’s domiciliary state. Most states prohibit use of federal bankruptcy exemptions. Other states* allow use of either state or federal exemptions. Domiciliaries select one or the other with no mixing or matching.
Debtors using state exemptions also may use federal nonbankruptcy exemptions, but debtors using federal exemptions may not, and the nonbankruptcy exemptions usually require the debtor to belong to a certain occupation or specified group to qualify for their use. Examples are retirement, deat and disability, and survivor benefits.
Most of the bankruptcy estate consists of all of the property the debtor owns when filing for bankruptcy. In Chapter 7 bankruptcy, most property acquired after filing remains out of the estate, but under in Chapter 13 all property and income whenever acquired case goes into it with some exceptions for certain educational savings accounts, for example.
Bankruptcy Estate Property Categories:
- Property owned and possessed when filing even with money owed on it.
- Property not possessed but owned when filing. Examples are security deposits or property loaned.
- Property the debtor is entitled to receive. Examples are wages, commissions, tax refunds, and accounts receivable.
- Community property: If spouses file jointly for bankruptcy, all community and separate properties are parts of the bankruptcy estate. If either files alone, all community property and the filer’s separate property is within the estate.
- Marital property in common law states: For spouses filing jointly, the bankruptcy estate includes all property owned together and separately. For those filing alone, it includes the filer’s separate property and half the property jointly owned unless owned as tenants by the entirety.
- Property acquired within 180 days after filing from an inheritance, a marital settlement or divorce decree, or life insurance death benefits or policy proceeds.
- Income generated by property in the estate. Example: royalties from sales of published writings.
- Property fraudulently transferred within two years before filing.
Bankruptcy courts appoint trustees to administer bankruptcy estates by selling property to raise money to pay the creditors off. Exempt property generally relates to necessities of modern life, property necessary for earning a living. Bankruptcy law aims to pay creditors what debtors owe them but also to get debtors back on their financial feet. Nonexempt property is not essential to earning a living.
Examples of nonexempt Chapter 7 property:
- Expensive musical instruments unless the debtor is a professional musician
- Collections of stamps, coins, and other valuable items
- Family heirlooms
- Cash, bank accounts, stocks, bonds, and other investments
- A second motor vehicle
- A second home
Examples of exempt Chapter 7 Property:
- Motor vehicles up to a certain value
- Reasonably necessary household goods and furnishings
- Household appliances
- Jewelry up to a certain value
- A portion of debtor home equity
- Tools of the debtor’s trade or profession up to a certain value
- A portion of unpaid earned wages
- Public assistance, social security benefits, and unemployment compensation payments
- Damages awarded for personal injury
Bankruptcy exemptions have different purposes in Chapter 7 and Chapter 13 bankruptcies, but the common objective is for the bankruptcy estate to allow the debtor enough money and property for economic survival. The bankruptcy trustee job is to make sure that any nonexempt property in the estate goes to the creditors. If the debtor owns property worth $40,000 but can exempt only $30,000, the creditors must receive the $10,000 difference.
State versus Federal Exemptions
Chapter 7 Exemptions
Chapter 7 bankruptcy is for liquidation of the debtor’s nonexempt assets to repay creditors. Most Chapter 7s are no-asset cases because most debtors can use exemptions to protect their property. If unable to exempt all property, the debtor can pay the trustee the nonexempt value or the trustee will sell the property and distribute the nonexempt proceeds to the creditors. If, for example, a debtor’s car is worth $5,000 with $3,000 of exempt value, the debtor can pay the trustee $2,000 to keep the vehicle, or the trustee can sell it, pay the debtor $3,000 for the exemption, and distribute the $2,000 nonexempt remainder to the creditors.
Chapter 13 Exemptions
In Chapter 13 cases, the debtor proposes a repayment plan to pay back over time, normally three years, some or all debts to a Chapter 13 trustee, who distributes the payback to creditors. Section 1322 requires full repayment to all creditors with priority claims under Section 507. Debtor with nonexempt assets must put enough into the proposed plan to pay off those unsecured creditors. The debtor with $2,000 of nonexempt equity in a car worth $5,000 must put enough into the repayment plan to pay $2,000 to the creditors over the term of the plan.
Consult an Attorney
Bankruptcy is complicated and frequently breeds additional litigation. A smart debtor consults aa attorney skilled and experienced in bankruptcy practice before filing a petition.