Bankruptcy exemptions play an important role in Chapter 13 bankruptcy. A Chapter 13 reorganization bankruptcy is designed to let you keep all of your property and pay back a portion of your debts through your future earnings. In Chapter 7 bankruptcy, exemptions help determine what property you get to keep. In Chapter 13, exemptions determine, in part, how much you will have to pay to your unsecured creditors.
(To learn more about the role that exemptions play in Chapter 7 bankruptcy, see Exemptions in Chapter 7 Bankruptcy.)
The Chapter 13 Repayment Plan
In a Chapter 13 bankruptcy, you propose a plan to repay some of your debts through monthly payments you make to a bankruptcy trustee. The amount of your monthly payment depends on your income, expenses, and how much property and debt you have. Certain debts must be paid in full through your plan. These include your priority debts (such as alimony, child support, and certain taxes) as well as your mortgage arrearages. Your general nonpriority unsecured debts like credits cards, personal loans, and medical bills do not have to be paid back in full. The amount you pay back to these creditors depends on how much disposable income you have and whether you are able to exempt all of your assets.
Exemptions and Chapter 13 Bankruptcy
In a Chapter 7 bankruptcy, if you cannot fully exempt an asset, the bankruptcy trustee may sell it to pay your creditors. In contrast, the trustee in a Chapter 13 bankruptcy will not sell your nonexempt assets. Instead, the you must pay the portion or property you are not able to exempt to your nonpriority unsecured creditors. This is the minimum amount that you must pay to your unsecured creditors in order for the court to confirm your plan.
Here's the public policy behind this rule: Congress does not want creditors to be worse off if you file for Chapter 13 rather than Chapter 7. If you file for Chapter 7 bankruptcy, your unsecured, nonpriority creditors get a portion of the proceeds from the sale of your nonexempt assets. So, says bankruptcy law, these same creditors must get at least that much if you file for Chapter 13 bankruptcy.
How Can Exemptions Affect My Chapter 13 Plan?
Chapter 13 repayment plans have to be completed in three to five years. For the most part, you must contribute all of your "disposable income" to plan payments. However, the amount you must pay to your nonpriority unsecured creditors through your plan is determined not only by your disposable income but also your nonexempt assets. So if your income is not enough to cover the minimum payment to your unsecured creditors, you won't be able to propose a workable plan. (Learn more about the Chapter 13 repayment plan).
Here's an example. Let's say your income allows you to pay $500 per month for five years. Your priority debts, arrearages, and the like eat up $300 of that amount each month, which means you have $200 to pay to your unsecured creditors based on your income. If the value of your nonexempt assets equals $6,000, you'll have to pay at least this amount to your unsecured creditors. You can easily do this with your disposable income ($200 per month times 60 months would pay off $12,000).
However, in the same example, let's say you have $24,000 in nonexempt assets. This would mean you have to pay at least $400 a month for five years to your unsecured creditors regardless of your income (making your total payment $700). So your disposable income would not be enough to pay this amount to unsecured creditors over five years. As a result, you may not be able to afford a Chapter 13 bankruptcy.