Exemptions in Chapter 13 Bankruptcy

Bankruptcy exemptions help give filers a fresh start by allowing them to keep property they'll need to maintain a home and job. Exemptions also help determine the amount a debtor must pay in a Chapter 13 repayment plan.

Even though a filer can keep all property in Chapter 13, it comes at a cost. The debtor must pay creditors the value of any nonexempt property—things that aren't covered by an exemption—in the three- to five-year repayment plan. In this article, you'll learn more about the role exemptions play in Chapter 13 bankruptcy.

If you're not sure which bankruptcy chapter is right for you, start by reading What Are the Differences Between Chapter 7 and Chapter 13 Bankruptcy?

Protecting Property With Exemptions in Chapter 13 Bankruptcy

Bankruptcy exemptions allow you to protect property such as household goods, some equity in a house and car, and a qualified retirement account. Exemptions don't cover non-essential luxury items, like boats or vacation cabins (nonexempt property).

Not only do exemptions protect essential property in both Chapter 7 and 13, but they also ensure that creditors get paid what's owed them. The way each chapter achieves this is slightly different, however. Here's how it works:

• Chapter 7 bankruptcy—a "liquidation" chapter. If you cannot exempt an asset in this chapter, the bankruptcy trustee appointed to the case will sell it, return any exemption amount you're owed, and pay your creditors with the amount that remains after deducting sales costs.
• Chapter 13 bankruptcy—a "repayment" chapter. By contrast, the Chapter 13 trustee won't sell your nonexempt assets. Instead, you'll pay the nonexempt portion to your unsecured creditors through your repayment plan.

In both chapters, the creditors receive the value of the nonexempt property. This system ensures that creditors don't get less in Chapter 13 than they would have received in a Chapter 7 case.

Calculating a Chapter 13 Repayment Plan Payment

In a Chapter 13 bankruptcy, you propose a plan to repay some or all of your debts through monthly payments that you'll make to a bankruptcy trustee. There are a lot of complicated rules that go into a repayment plan, but in general, the amount you'll pay will depend on your:

• income
• monthly living expenses
• the amount and type of debt that you owe, and
• the property you own.

The first step is to determine your disposable income by deducting allowable expenses from your monthly income. Then you'll multiply your disposable income by the number of months in your repayment plan.

The second step is to determine the value of your nonexempt assets. Each state allows filers to keep some property using the state's bankruptcy exemptions. Nonexempt assets are those things that you can't protect with a bankruptcy exemption. In Chapter 13, you must pay your creditors the value of your nonexempt assets in your repayment plan.

The third step is determining which debts you must pay in full in a Chapter 13 plan. These debts include mortgage and car payment arrearages (if you plan to keep the house or car), recently incurred income tax debt, and support arrearages.

Once complete, you'll have three numbers in front of you. Over the course of your plan, you'll be required to pay the greater of:

• your disposable income, or
• the value of your nonexempt property plus the total of the debts you must pay in full.

By complying with this formula, you'll satisfy what's known as the "best-effort" rule in Chapter 13 bankruptcy.

Keep in mind that calculating a repayment plan is complicated. This simplified explanation shouldn't be used as an instructional guide but rather to aid understanding only. You'll find more details in The Chapter 13 Repayment Plan.

Property and Debts That Increase Your Chapter 13 Repayment Plan Payment

People who don't own much nonexempt property and don't have any debts that they must pay in full will have an easier time drafting a confirmable plan (a plan that the judge will approve at the Chapter 13 confirmation hearing). Because the good faith rule requires you to contribute all of your "disposable income" to your plan, pay off certain debts, and pay at least the value of your nonexempt property over your three- to five-year repayment plan, low-income filers often can't meet the good faith requirement.

Example 1. Emma recently graduated from college and landed a position as a high-powered executive working in the tech industry in San Francisco. She makes too much money to qualify for a Chapter 7 discharge; however, because of the high cost of living, she struggles to pay the $24,000 in credit card debt that she amassed while in school. The only property she owns is an old futon and an old car—both of which she can protect with bankruptcy exemptions.

After meeting with a bankruptcy attorney, she learns that she'll pay her discretionary income of $75 per month in a 60-month repayment plan for a total of $4,500. Any remaining credit card balance will get wiped out when she completes the plan. She decides to move forward with Chapter 13 bankruptcy because she'll save a significant amount even after paying the trustee and her attorney fees.

Example 2. Brayden makes minimum wage working as a coffee barista; however, he struggles to pay his bills after a divorce. Because he was awarded spousal support in the divorce settlement, he doesn't qualify for a Chapter 7 discharge. He's also unable to protect $50,000 in home equity and a recreational vehicle worth $20,000 with bankruptcy exemptions, so, hoping to keep the house and RV, he's considering filing for Chapter 13 bankruptcy.

Brayden met with a bankruptcy attorney and learned that his discretionary income is $200 per month. However, because he has $70,000 in nonexempt property, Brayden must pay a minimum of $1,167 per month in a 60-month repayment plan. Brayden isn't a candidate for Chapter 13 bankruptcy because his barista wage isn't sufficient to support the required repayment plan payment.