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MAKING SENSE OF THE NEW

BANKRUPTCYCODE AND IRA

PROTECTIONS

By: Frank Armstrong, CFP, AIF

www.investorsolutions.com800-508-8500

Making Sense of the New Bankruptcy Code and IRA Protections:

Erasing your debts just got much harder. Two major decisions have recently passed in

Washington that may have a dramatic impact, positive or negative, on the lives of manyAmericans.

On April 20, 2005 President Bush signed into law the Bankruptcy Abuse Prevention and

Consumer Protection Act of 2005. And on April 4th, 2005 the U.S. Supreme court ruled thatunder the bankruptcy code, IRA balances were protected from creditors in a bankruptcy.

Both decisions might radically affect your life and require careful consideration, especially ifyour profession (ie. Medicine) exposes you to potential litigation. This article will expand onsome of the recent changes.

Bankruptcy Act

Backed by powerful credit card industry lobbyists, our "friends" on Capitol Hill have beenbusily at work protecting credit card companies at the expense of the consumer. The Act,

parts of which are effective immediately and other parts which go into effect on October17th, 2005, makes it harder for consumers to erase their unsecured debts and requiresdebtors to seek credit card counseling before being able to file (more on this later). Here

are some of the highlights.

By way of background, individuals may declare one of two forms of bankruptcy---Chapter 7or Chapter 13.

Under Chapter 7, individual is permitted to keep certain assets, but all others arerelinquished to satisfy cost of bankruptcy and creditor claims. Most debts are discharged

completely and debtor is no longer responsible for repayment. Child support, alimony and

education loans cannot be discharged and the debtor cannot file again for eight years(bumped up from six years).

Under Chapter 13 bankruptcy, a plan is created under which the debtor will repayoutstanding debts within specified time. Usually the amount owed is reduced by the judgeso that payments remain manageable and debtor is generally not obligated to relinquish any

assets.

Means Testing

The most important factor of the law has to do with the "means test" that bankruptcy filerswould be subjected to in order to determine if they qualify for Chapter 7 or Chapter 13.There are two facets of the test that are conducted: the median income test and the means

test.

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The (personal income) means test is based largely on median state incomes. So if thecombined gross household income is greater than the median income in your state, the law

prevents you from filing Chapter 7 (completely eliminating your debt) and may force you to

file a Chapter 13 plan. So, for example a Florida physician supporting a family of 4 wouldbe subjected to a state median of only $62,742 (add $7,500 for each individual in excess of4). If the combined income in the physician's household is more than the state's median

income threshold (and, of course it is), then you do have to apply the Mean's Test, and todo so you need to calculate Monthly Expenses. To find out what the state median incomelevels are, click here. (http://www.chapter7.com/state-median-income-tables/)

The second test checks to see if the debtor's current monthly income (reduced by allowedexpenses) exceeds an amount allowed under the Act for a family of the same size. Themeans test is basically an "excess income" test used to determine what money is left over

after deducting reasonable expenses that can be used to pay unsecured creditors.

Included within the calculation of debtor's monthly expenses are: 1) reasonably necessary

expenses incurred to maintain the safety of the debtor and the debtor's family (see link

below); 2) continuation of actual expenses paid by the debtor for the care and support of anelderly, chronically ill, or disabled household or nondependent immediate family member;

and 3) an additional allowance for housing and utilities based upon documented homeenergy expenses.

Individuals may use the 'National Standards for Allowable Living Expenses' charts available

on the IRS website to determine the standards for food, clothing and other items. The chart

is based on the individuals gross monthly income.

If a Debtor's income meets or exceeds the mean's test, then any Ch 13 Plan must haveduration for at least five years unless the plan provides that all allowed unsecured claims

are to be paid in full over a shorter term.

Credit Counseling

The other critical (and controversial) matter is the mandatory requirement that debtors go

through credit counseling in order to qualify for bankruptcy, and counseling must start atleast 180 days before filing for federal bankruptcy protection. This particular portion of the

Act is quite disturbing, given that the credit counseling industry is not only unregulated, but

in fact is beset with unimaginable fraud and abuse by "bad players". There are too manycounseling agencies out there posing as non-profits that get away with grossly overcharging

clients for services, implementing absurd monthly fees, and do little to negotiate with the

credit card companies to reduce rates and/or debt. Credit counseling agencies are supposedto help consumers out of debt; many in fact, make the problems worse. Basically, Congress

just paved the way for unknowing consumers to be thrown into the lion's den in an already

corrupt system. Their mission, I'm sure, was accomplished as soon as they secured sizable

contributions from credit card companies in exchange for this law.

Homestead Protection

The Act also modified some of the protections offered by the previous Homestead Exception(which is already in effect).

The homestead exemption applies to property used as your residence. As of 2011, thefederal homestead exemption is $21,165. State homestead exemptions vary a great deal.

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In some states, like Florida, there's no limit, while in other states, like New York, the limit is$50,000 to $150, 000, depending on where you live.

Before the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (Act) waspassed, it was common for homeowners to move to a state with a generous homesteadexemption and shield assets from creditors by buying an expensive home. The Act tries to

stop this practice by limiting any homestead exemption to $125,000 (inflation adjusted$146,450) if you bought the home within 1215 days (3 years and 4 months) before filing forbankruptcy. This doesnt apply to a debtor already living in the same state who merely

transferred his/her interest from a previous principal residence.

Any addition to the value of a homestead that is funded by nonexempt property, and madewith the intent to hinder, delay, or defraud creditors, is not protected by the state

homestead exemption if it was made during the ten year period before a debtor filed forbankruptcy.

There is a $125,000 cap on the homestead exemption for any debtor convicted of a felony

which demonstrates bankruptcy abuse, or if the debtor owes a debt arising from violation ofFederal or State securities laws, criminal act, intentional tort, or willful or reckless

misconduct that caused serious physical injury or death to another individual during the lastfive years.

Fraudulent Transfers

Fraudulent transfers are asset transfers that are made with the intent to defraud a creditor(or potential creditor). It is not a criminal activity, but the transaction may be reversed by a

judge and therefore make the assets accessible to your creditorThe look back period in which certain transfers are deemed to be fraudulent and recoverable

under the Bankruptcy Code was increased from one to two years. However, state fraudulent

conveyance laws often allow the bankruptcy trustee to go back even further. The two yearperiod applies only to cases filed twelve months or more after enactment of the Act.