Updated: May 3, 2013 12:14PM
Originally published: April 25, 2005
Odds are you know someone who has declared bankruptcy. One in 73 American households filed for bankruptcy in just the year ended March, 2004, and about 1.5 million personal bankruptcy filings are posted every year.
That’s why so much attention has been given to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 signed recently by President Bush.
Here’s what has changed:
Chapter 7 or 13? Chapter 7 is the provision of the bankruptcy code that has been used by most individual filers. It literally “wipes the slate clean” of debts, except for most back taxes, alimony, child support and student loans. But under the new law, the courts will give more scrutiny to a debtor’s ability to repay at least a portion of the debt owed.
There will now be a “means test” to determine whether the filer will be allowed to void payment of all debt. If the amount of his or her income -- net of expenses -- is less than $100 a month (or $6,000 over the next five years), then Chapter 7 may still be used.
Above that level, you’ll probably be required to file a Chapter 13 partial repayment plan, especially if your income is sufficient to pay at least 25 percent of your outstanding debts.
New duties for lawyers
Don’t worry about figuring this all out yourself. The new law requires attorneys to be responsible for determining which of their clients qualify for Chapter 7 or 13. In fact, if an attorney violates the regulations, he or she can be subject to costs, fees and civil penalties. Lawyers will have to spend more time determining which monthly expenses their clients can reasonably claim as “necessary for living” based on standards set by the IRS.
That means attorneys will spend more time on the bankruptcy process -- and charge higher fees!
There’s another reason consumers have less to fear from the process but face more work to get through it. Credit counseling will be mandatory, and each debtor will be required to provide a certificate of credit counseling and a repayment plan from an approved agency within 180 days of filing.
There are exceptions for debtors who are incapacitated, disabled or on active military duty in a war zone.
Proof of completion of a financial management course is required for discharge of a bankruptcy petition.
The new Bankruptcy Act also makes clear which assets are exempt from a bankruptcy and which debts survive.
For example, Individual Retirement Accounts and company 40l(k) or 403(b) plans are now clearly defined as protected assets. Similarly, college education savings plans such as 529 plans, education IRAs and prepaid tuition plans are exempt if the money was placed in the account(s) at least two years before the filing. Money placed in this type of account at least one year, but less than two years, before filing is limited to a $5,000 exemption per beneficiary. And legitimate borrowings from retirement plans cannot be considered as income.
The debtor will still be required to pay domestic support obligations, and certain back taxes.
The law clarifies those domestic obligations. And it provides that domestic actions such as paternity, support, custody, visitation and domestic violence actions are not stayed by a bankruptcy filing.
There are new definitions of the homestead exemption. You must have lived in a state for two years to use that state’s generous laws to protect the value of your residence. And regardless of state, you can exempt only $125,000 of interest in a homestead that was acquired within 1,215 days prior to the filing.
There are new laws against “shop and drop.” Any luxury good or service totaling more than $500 to a single creditor made within 60 days of filing must be paid for in full. Cash advances made within 70 days of filing are considered non-dischargeable.
New protections for debtors
Finally, consumers will get more protection from collection activities and from reaffirmation agreements, which often get them right back into debt again. And the act creates an ombudsman to protect personal privacy in bankruptcy proceedings.
Who will benefit from all these changes, and who will be hurt? It will take time to sort out the answers. In the meantime, the new law creates an incentive for consumers to take a closer look at their own financial situation. And that’s The Savage Truth.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate.