Be Prepared for Tougher Bankruptcy Laws

Erasing debts by filing for bankruptcyis about to get muchtougher. The new bankruptcy law,the Bankruptcy Abuse Prevention andConsumer Protection Act of 2005, willsharply reduce the number of people whoare eligible for Chapter 7 bankruptcy.

Bye, Bye Bankruptcy

Currently, individuals who file forbankruptcy file under Chapter 7 orChapter 13. In a Chapter 7 bankruptcy, adebtor must liquidate all nonexemptassets—some of the debtor's assets qualifyas exempt under their state laws. The proceedsare then used to pay off creditors.After all proceeds are paid, any remainingdebts are canceled and the individual isdebt free. The key point about Chapter 7bankruptcy is that many of the debtors donot have assets that can be liquidated;therefore, most of their debts are erased.

On the other hand, when a debtor filesfor Chapter 13 bankruptcy, instead ofbeing forced to liquidate their assets,they're put on a repayment plan.Payments are made in regular installmentsuntil the debts are paid in full or until theend of a 3-to 5-year period.

The new bankruptcy law establishesprovisions that will force more debtors tofile under Chapter 13 and repay theirdebts. It also requires debtors to take anincome-based test, which measures theirability to repay debts. Basically, if thedebtor's income is above their state'smedian income and they can pay $6000over 5 years, they'll be forced into Chapter13 and be put on a repayment plan. Otherchanges made in the law will enhance therestrictions and make it harder for debtorsto abuse the bankruptcy laws.

Prominent Changes

One notable change involves limiting astate's homestead exemption. A fewstates like Florida and Texas have unlimitedhomestead exemptions. So if you filefor bankruptcy, your home is shelteredfrom creditors regardless of its value. Thenew law, however, restricts a state's homesteadexemption to $125,000 for debtorswho bought their residence at least 3years 4 months before filing. This changeis to prevent the transfer of substantialassets into people's homes in anticipationof filing Chapter 7.

A second change in the law gives childsupport payments top priority, which willhelp out single parents. The bill alsoallows for special accommodations forthose in the military who are on activeduty, those who are seriously injured, andlow-income veterans.

Lawmakers didn't make any changes tothe existing laws of debtor-friendly stateslike Delaware and Alaska. These statesallow individuals to shelter their assets inspecial asset protection trusts, which havebuilt-in anticreditor provisions. Because ofthe costs inherent in settig up and maintainingthese special trusts, they're typicallyreserved for the wealthy.

Although Washington gave the newbankruptcy law two thumbs up, someAmericans feel differently. Jim Henderson,a Birmingham, Ala, attorney who specializesin bankruptcy law and a partner withPritchard, McCall & Jones, expressed concernover what people will do when theyfeel they have no way out of their financialproblems. "This law will tend to paintdebtors into a corner for which there is noexit, Henderson explains. He's hopingthat people will be much more careful inhandling their finances.

®, AEP,

is the founder of the Welch

Group, LLC, which specializes in

providing fee-only wealth management

services to affluent retirees

and health care professionals

throughout the United States. He is the

coauthor of J.K. Lasser's New Rules for Estate

and Tax Planning (John Wiley & Sons, Inc;

2001). He welcomes questions or comments at

800-709-7100 or visit www.welchgroup.com.

This article was reprinted with permission from

the Birmingham Post Herald.

Stewart H. Welch III, CFP