Filing for Chapter 13 offers debtors a chance to regain control of their finances by paying back most, if not all, of their debts over a three or five-year period. However, due to the time frame for these plans, a lot can happen in life, including cash gifts and even inheritances.
In general, changes to your income need to be reported to the bankruptcy court. Whether or not an income change affects your monthly payments will depend on the type of income and if it is a one-time addition or if it is regularly recurring.
Here is what you need to know about how bankruptcy courts handle these windfalls and income changes during bankruptcy proceedings.
How a typical Chapter 13 bankruptcy plan works
Under Chapter 13 bankruptcy, you will prepare a three or five-year repayment plan. This plan will include your total income as well as your reasonable monthly household expenses. These include:
- Housing costs
- Utility
fees - Food and clothing
- Childcare costs
- Transportation expenses, and
- Medical or dental bills
The remainder of your income is your disposable income, which is then used by the bankruptcy trustee to pay your creditors. This often requires tightening belts and learning to live within a strict budget because much of your actual income will go to the trustee
- Priority claims, such as taxes, child and spousal support, and costs to administer the bankruptcy are paid first.
- Secured claims, which are any debts secured by
property are paid second. These include the mortgage on your home, your car loan, and secured credit cards. If you want to keep the property secured by the loan, you will need to pay the creditor at least the value of the property. - Unsecured claims, which are any debts not backed by a security interest in property are paid last. These include unsecured credit cards, medical bills, and personal loans.
Priority claims are paid in full, while secured claims must be paid at least the value of the property. Unsecured claims will receive the remainder of your disposable income, meaning that they may, or may not be paid during the bankruptcy plan, depending on how much disposable income is left over each month.
When you file for bankruptcy, most of the property you own will become part of the bankruptcy estate. Under Chapter 7 filings, nonexempt property in the estate can be liquidated, and the proceeds go to paying your creditors. On the other unhand, in Chapter 13 filings, the portion of your estate that debtors care about is your income during the repayment plan.
Receiving a cash gift while in Chapter 13
How the bankruptcy trustee will treat your cash gift while you are in Chapter 13 will entirely depend on whether or not you receive it before or after your Chapter 13 repayment plan is confirmed by the court.
See related article: How Long Does It Take To File Chapter 13 Bankruptcy?
Before plan confirmation
If the funds are received after filing for bankruptcy, but before your Chapter 13 plan is confirmed, the gift may or may not be considered part of your bankruptcy estate as disposable income. As a result, you might be required to use the gift to pay your creditors.
After plan confirmation
After your Chapter 13 plan is confirmed by the court, your trustee may still try to have the money go to your creditors by increasing your monthly payments. However, in this situation, the bankruptcy court may be more likely to allow you to keep some or all of the gift.
Before accepting a cash gift, you should speak with your bankruptcy attorney to understand the effect the gift may have on your bankruptcy filings.
Other types of income changes during your Chapter 13 plan
Due to the length of a Chapter 13 plan, many life changes can occur that change the amount of disposable income you may have to put towards your bankruptcy estate. Here are some common financial situations my clients face during their plan, and how your trustee may handle them.
Inheritance
Your bankruptcy trustee will treat a cash inheritance differently than a cash gift, but the distribution will still depend on when you receive the inheritance. The timeline will depend on when you become entitled to the inheritance, not when you actually receive it.
Within 180 days of filing for bankruptcy
If the inheritance is received within 180 days of filing for bankruptcy, you will be required to pay your unsecured creditors at least the amount of nonexempt funds you receive as part of the inheritance.
After 180 days of filing for bankruptcy
If the inheritance is received after 180 days of filing for bankruptcy, the trustee may or may not require you to put the funds towards your Chapter 13 plan. The typical reasoning behind this requirement is that the funds are a windfall and as such, they should be put towards the bankruptcy estate. This requirement will depend on the rules from the local bankruptcy court. Speaking with your attorney will give you a better idea of how your court will handle this inheritance.
Tax returns
If you receive a tax return, you will need to disclose this to the bankruptcy court. Your bankruptcy trustee may or may not require you to put these funds towards paying your creditors. This will depend on your final situation. If you are able to meet all your monthly expenses without the funds, it can be considered surplus, and therefore disposable, income.
On the other hand, you may be able to have the tax return excused if you can show that you rely on those funds in order to make it through the year. For example, you may use your tax return to cover an annual medical or dental appointment for yourself or your children. In this situation, your plan may be drafted to exclude all your tax returns from disposable income.
It’s also possible to petition the bankruptcy court to exclude a single tax return if an unexpected but necessary expense appeared and you have no other means to handle the expense. This could include a car breaking down, or needing to purchase a new refrigerator.
Increase in salary
If you receive a raise at your job during the Chapter 13 bankruptcy plan, you must report it to your bankruptcy court, no matter how small the raise is. If you fail to report, this could be considered a bad faith action that could jeopardize your case.
You may be required to increase your monthly payments due to the increase in disposable income. This will be dependent on the amount of the raise. A significant increase in income will likely result in higher monthly payments, but a smaller raise may not be considered large enough to merit a change.
One-time commission or unexpected bonuses at work
Your repayment plan may cover your responsibilities towards repaying your creditors if you receive bonuses or commissions at work, especially if you are in a line of work where you experience this type of regular bump to your paycheck. Even if your Christmas bonus is only given once a year, your repayment plan should account for this paycheck bump if it is expected additional income.
If your plan is silent as to your responsibilities here, you should discuss your obligations to the court with your bankruptcy attorney. You may be required to report the additional income and put it towards paying your
Salary decrease or job loss
Unfortunately, things are not always coming up roses during your repayment plan and you may find yourself facing a significant salary decrease, or even waiting in the unemployment line while you are in your repayment period.
Bankruptcy courts recognize these life events do happen and have provisions built in for flexibility. You will need to petition the court to change your plan due to your reduction in disposable income. Priority and secured debts will still be paid, but the amount going to your unsecured nonpriority creditors will decrease.
In certain situations, you may be able to request a Chapter 13 hardship discharge. This type of discharge is granted if:
- You cannot complete the repayment plan for reasons outside your control
- Your unsecured creditors have received the same amount they would have received under a Chapter 7 plan, and
- It is not practical to modify your Chapter 13 repayment plan.
The situation must be truly dire for a court to grant this type of discharge. For example, losing your belongings in a house fire, hurricane, or another natural disaster four years into your five-year plan may qualify you for a hardship discharge. Losing your job nine months into your plan likely would not meet this test.
Changes to your family during your Chapter 13 plan
During your Chapter 13 repayment plan, your family composition may change in ways that affect either your actual income, your disposable income, or both.
If you are welcoming a new child into your life, your household size will increase, which will also increase the number of expenses you must account for. Although your actual income may not change, your disposable income will likely decrease, meaning that you will pay less to your creditors.
If you and your spouse hit a rough patch and decide to separate or divorce, this can also affect your income. You should speak with your bankruptcy attorney to understand how this will affect your case, especially if you and your spouse filed for joint bankruptcy. Your plan may be converted to a Chapter 7 plan, or the court may separate the joint bankruptcy case into two separate cases.
If the debtor or the spouse of a debtor dies during the repayment plan, the surviving spouse should speak with your bankruptcy attorney to understand how this affects the case. The bankruptcy may not end, but monthly payments may decrease or it may be converted to a Chapter 7 filing.
There are a number of other life events that can change the amount of disposable income you have to put towards your creditors. You should discuss your specific scenario with your bankruptcy attorney to understand how changes in your life may affect your Chapter 13 repayment plan.
Giving cash or other gifts during your Chapter 13 plan
One final question people often ask about their Chapter 13 repayment plan is if they can give cash gifts to others before or during their plan.
Bankruptcy law forbids people from giving or selling assets, including cash, to others for less than market value before filing. This helps prevent abuse of the bankruptcy system, which balances creditor rights with debt relief.
Because of this balance, you won’t be able to give gifts to your children, friends, or charitable donations prior to filing for bankruptcy. The trustee will have access to all your financial records from the period before you file, and he or she will carefully review your statements for potential fraud.
During the Chapter 13 plan, your disposable income will go to your creditors, not towards your savings account or your loved ones. Additionally, you won’t be able to take on new debt without good reason and court permission. This can make surviving the holidays difficult, especially if you find joy in giving gifts to your loved ones.
The important thing to remember is that life is long compared to your three or five-year bankruptcy plan. Your Chapter 13 repayment time is for you to get your affairs in order so that you can have a fresh start in your financial life when the plan is complete. Finding ways to celebrate and make meaningful memories while staying in your budget is essential during this time. It is truly the thought that counts.
This article is for informational purposes only and does not provide legal advice, nor does it form an attorney-client relationship. If you have questions about cash gifts received during your Chapter 13 bankruptcy, contact Kelly Can Help today.