If you're seriously considering filing for personal bankruptcy, you should start the process now. Otherwise you'll run up against a tough new bankruptcy law that mostly takes effect on Oct. 17. The Bankruptcy Abuse Prevention & Consumer Protection Act, signed by President George W. Bush on Apr. 20, will make it harder and more expensive for individuals to erase or restructure their debts. While it is especially harsh on lower-income debtors, it's no sweet deal for middle- and upper-income borrowers, either.
Most well-heeled individuals will no longer qualify for Chapter 7, the section of the bankruptcy code that lets people cancel their debts and make a fresh start. Instead, they can opt to work out repayment plans under Chapter 13. But they'll have to pay back more of their debt and keep paying for five years instead of three. Since there's a debt cap on Chapter 13 filings -- unsecured debts can't exceed $307,675, while secured debts are limited to $922,975 -- some people will probably wind up in the complicated and costly Chapter 11 reorganizations more commonly used by businesses. One result: Debtors may simply drop out of the bankruptcy system and let their creditors chase them. "Batten down the hatches -- it's going to get ugly," warns Leslie Cohen, a bankruptcy-law specialist and partner at Liner Yankelevitz Sunshine & Regenstreif in Los Angeles.
The biggest factor driving this change is a new "means test" that generally requires your income to be below your state's median level for your family size to qualify for dismissal of your debts. If your income is higher, you can win Chapter 7 relief only if you will have no more than $166 a month left after living expenses and payments on your secured and priority debts. The expenses will be set by the Internal Revenue Service. Some formerly high-earning but out-of-work debtors could still pass the means test because income will be calculated based on salary and wages for the six months prior to filing. "If you've been laid off for three months, you might consider 'staying on the bench' a while longer even if you have a job prospect," says Norman Pressman, a St. Louis bankruptcy lawyer.
BIGGER LEGAL BILLS
Regardless of which type of bankruptcy you file for, if you live in Florida, Texas, or Kansas -- states that allow unlimited homestead exemptions -- you can still hang on to a multimillion-dollar house. Congress mostly left such state exemptions alone. But it's now much harder to move to Florida from New York to take advantage of the exemption. It's capped at $125,000 unless you've lived in Florida for three years and four months.
No matter where debtors live, they'll face a stream of paperwork requirements, higher legal fees, and additional hurdles, such as mandatory credit counseling. Anyone contemplating bankruptcy should start compiling pay stubs and receipts. If your expenses are above the limit set by the IRS -- because, for example, you want to continue tutoring for your learning-disabled child -- you will have to document the payments.
Stiffer standards will make bankruptcy cases more time-consuming and costly for lawyers, who will undoubtedly jack up fees. An attorney preparing a Chapter 13 filing will have to certify that he or she has double-checked the information. The bill for an uncomplicated Chapter 13 filing, now about $1,700 in Missouri, could rise to $2,500 or more, says Pressman. In pricier markets such as Los Angeles, where a Chapter 13 averages about $2,500 now, fees could rise by $1,000.
The new law does grant a break to debtors with substantial retirement assets. While federal law has long shielded employer-sponsored retirement plans from creditors in bankruptcy, the treatment of individual retirement accounts has varied from state to state. The new law fully protects retirement-plan assets that are rolled over into IRAs and up to $1 million of other IRA contributions and account earnings, says Michael Kitces, director of financial planning for Pinnacle Advisory Group, a Columbia (Md.) wealth-management firm.
You can get around the cap by consolidating IRA accounts into your 401(k) plan if your employer allows it. The catch: You must transfer the money well before creditors start banging on your door. It's illegal to move assets around to put them beyond the reach of creditors once you know of an actual or likely claim."The key to asset protection is taking steps to protect yourself before the problem actually occurs," says Kitces. But since few debtors do, bankruptcy lawyers are bracing for a rush to file this fall before the law's stiff new provisions kick in.
By Amy Borrus, with Anne Tergesen