The purpose of filing for bankruptcy is to give debtors a chance to start over. It allows them an opportunity to build their lives again after being overwhelmed by too much debt. One common misconception of Chapter 7 bankruptcy is to literally give everything up, even the shirt off your back. However, this is not exactly the case—federal and state law allows for property exemptions that help struggling debtors get back on their feet.
Bankruptcy estate—what goes in, and what goes out
Before going in-depth on the different property exemptions, we need to do a little backtrack on what a bankruptcy estate is. A bankruptcy estate refers to property that an individual owns on the day they decide to file for bankruptcy. Included in a person's bankruptcy estate are items that s/he owns and possesses, like a house, automobiles, clothing, furniture, and the like. These items are part of the estate, whether they owe money on it or not.
Part of a person's bankruptcy estate is property that they are due to receive. Examples of this are earned but unpaid wages, commissions, and royalties; a sum of money or property which serves as an inheritance from someone who has not passed away; and a tax refund that is legally due.
State laws also apply for debtors who are married. If an individual resides in a “community property” state, all the items that either spouse acquires while they are married is considered as joint property. Community property states include Arizona, Idaho, California, Nevada, Louisiana, New Mexico, Washington, Texas, and Wisconsin. If a married couple decides to file jointly, all combined property and the separate property that each spouse owns is automatically part of the bankruptcy estate. However, if only one spouse decides to file, all community and personal property of the filing party is included (assuming the property was acquired during the marriage).
However, if a married individual does not live in any of the above listed states, the only property that is included in their bankruptcy estate is their own personal property and half of the property that they and their spouse co-own.
Items that are not included in an individual's bankruptcy estate are: property purchased after filing for bankruptcy, employee benefit pensions under federal law, and withheld wages. On a basic level, property excluded from the bankruptcy estate will not and cannot be used to pay off a person's creditors. Individuals who have filed for bankruptcy are able to keep certain items in their possession that are not to be confiscated by the court. Nonexempt property, which includes most of an individual's property in their bankruptcy estate, needs to be confiscated by court. These goods are liquidated, and the funds generated from this are, in turn, used to pay off the customer's creditors.
Under the old law, debtors who filed Chapter 7 bankruptcy were still able to keep most, if not all, of their personal possessions. When the new law was established in 2005, the non-exempted items were now placed at a higher value; the risk the debtors had to take would enable them to lose more possessions than they would.
What's the difference?
There are states wherein the debtor with the intention of filing bankruptcy has the option of choosing the federal list of exemptions, or the list of exemptions offered by their current state of residence. Among these states are Arkansas, Connecticut, Hawaii, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin. The states not included in this list only offer the exemptions mandated by their local court.
If a customer is filing in a state listed above, they may choose if they will be filing under the federal exemptions or the state exemptions. Some goods may be part of the federal exemptions and not included in the state exemptions, and vice versa. A debtor is not permitted to take a little bit of everything from both lists—it has to be one or the other.
There also exists an available provision in the state of California that allows debtors to choose between two kinds of state exemptions. In reference to homestead exemptions, for example, System 1 allows the California resident to have up to $50,000 exempted if they are single and not disabled; the exemption value still varies according to the filer's monthly income, marital status, and health status. In contrast, System 2 includes any real or personal property as exemptions for up to $20,725, and the unused portion can be applied to any property.
Homestead exemptions
Federal exemptions allow for up to $20,000 in equity in an individual's homestead. A homestead is basically a house and a piece of land inhabited by an individual and their family. Homesteads have two types, which are called real property and personal property. Real property refers to pieces of land, land improvements such as buildings and machinery, and property rights on the land in question. Personal property, on the other hand, refers to “movable” pieces of property. A mobile home, or a boat, are examples of personal property. In other words, real properties are static, as opposed to personal properties, which can be moved from one place to another.
In a federal exemption, an unused part of the homestead up to an amount of $10,125 can be applied to any property that the debtor possesses. This applies to a case-to-case basis on different states, however. The amount may vary, depending on what the local court has delegated to its citizens.
On a smaller scale, homestead exemptions differ from state to state. The law of one state can be entirely different from another's. For example, the District of Columbia offers an unlimited homestead exemption; on the other hand, a number of states such as Pennsylvania and New Jersey do not offer immunity at all. Some states, like Texas and Oklahoma, base the exemptions on the size of the real property in the debtor's possession. Still others base on equity, or the market value of the property. Lastly, there are states that base their exemptions both on lot size and equity.
Here's a short chart illustrating the concept:
Unlimited Homestead Exemptions District of Columbia
Homestead Exemptions based on Lot Size Arkansas, Florida, Iowa, Kansas, Oklahoma, South Dakota, Texas
Homestead Exemptions based on Lot Size and Equity Alabama, Hawaii, Louisiana, Michigan, Minnesota, Mississippi, Nebraska, Oregon
Homestead Exemptions based on Equity Federal bankruptcy exemptions;
Alaska, Arizona, California, Colorado, Connecticut, Georgia, Idaho, Illinois, Indiana, Kentucky, Maine, Massachusetts, Missouri, Montana, Nevada, New Hampshire, New Mexico, New York, North Carolina, North Dakota, Ohio, Rhode Island, South Carolina, Tennessee, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin, Wyoming
No Homestead Exemption Delaware, Maryland, New Jersey, Pennsylvania
Some states also offer “wildcards” to state exemptions. This allows debtors to apply any dollar amount towards the property that they wish to be exempted. While these wildcards can be placed towards real and personal property, some states do not offer this option. They do, however, permit this amount to be allocated towards other personal property as well.
Exemptions on pensions
A debtor is entitled to receive their pensions and not have these used to pay their creditors. These are called “tax-exempt retirement accounts.” These are called individual retirement accounts (IRA's), and some examples are 401(k)'s, 403(b)'s, and SEP's and SIMPLE IRA's, to name a few. These benefits are exempt in all states.
A 401(k) allows a working individual to have a portion of his monthly salary garnished, in order to save up for their retirement. In addition, a 403(b) works the same way as a 401(k), but this savings plan applies to employees of public schools, a few non-profit employers, and self-employed ministers. The 401(k) is utilized by employees of private institutions. An SEP, or Simplified Employee Pension, functions like the previous two examples, but this is applicable to workers of small institutions. The SIMPLE IRA does not require those under the plan to regularly make payments on this program, and requires a lesser amount to the pensioner than the previous three systems.
Another type of retirement account is the Roth IRA, and the federal court allows a debtor up to a $1,095,000 exemption. Any amounts of money deposited to a Roth IRA aren't tax-deductible, and any individual who decides to withdraw from this account will not be charged any taxes. One other type of pension that is included in some states' bankruptcy exemptions is the Keogh plan, which is applicable to self-employed individuals.
Additional pensions also apply to state exemptions. Some states exclude pensions received by government laborers such as public school employees, firefighters, prison employees and police officers. Some states even offer exemptions for pensions to state, city, and county employees, and Korean War, WWII, and Vietnam veterans.
Exemptions on public benefits
A few public benefits included in the federal exemptions are unemployment compensation, Social Security, and public assistance, among others. Most of the states' exemptions also specify aid for the blind, aged, and disabled. Some areas also include worker's compensation, or funds specifically created for employees who are injured on the job, as part of their state exemptions. The state of Virginia even has an exclusive provision for tobacco farmers.
Exemptions on personal property
Federal bankruptcy exemptions allow up to $1350 on jewelry, $3225 for an automobile, $20,200 on personal injury recoveries, and $525 each for clothing, furniture, appliances, household items, crops, animals, and books. However, if a debtor opts to choose the state's exemptions, the amounts and items will vary. Some states, like Massachusetts, allow debtors to keep up to $125 in personal savings. In Alaska, the total amount that can be exempted for clothing, books, heirlooms, family portraits, household items, and musical instruments is $3750. On the other hand, some states like Alabama and Hawaii offer unlimited amounts to some personal effects. The state of Massachusetts even includes a few specifics in its list of exemptions, such as two cows, 12 sheep, two swine, and four tons of hay, while Oklahomans are entitled to 100 chickens, 20 sheep, 10 hogs, two horses, and five dairy cows. Mississippi residents can keep one radio, one TV set, and one firearm. Other states don't specify any exemption on the personal items at all.
Almost all states also include church pews as exemptions to bankruptcy. In early days, pews were considered personal property by churchgoers. They would pay for the pews that they sat on while attending church service every Sunday, and even had “pew deeds” which served as a title for these items. The payments the churchgoers made towards the pews were applied towards building expenses of the church. This goes to show that even if a churchgoer would file for bankruptcy, they would still be able to claim their seats in church.
Child support, wages, and other miscellaneous exemptions
As a general rule, payments made for child support are included in federal bankruptcy exemptions. After all, debtors are still entitled to receive this court-ordered benefit to be able to support their children. However, the court may decide not to issue exemptions on certain pieces of property in the event that the debtor has fallen behind on child support payments. The same rule applies to alimony. These legal obligations are a must to be met.
Wages are considered non-exempt items if an individual chooses the federal exemptions, while various rates apply in different states. Most, if not all, states allow the debtor to receive his earned but unpaid wages. In most states, seventy-five percent of a person's disposable weekly earnings is acceptable, but a bankruptcy judge may allow a higher ratio if the debtor has a low income. The state of Iowa has a different computation, based on a debtor's annual income. For example, if a debtor earns $16,000-$24,000 a year, the amount that would not be exempt would be $800.
Tools of trade refer to items that an individual uses for employment purposes. These are utilized by a person in order to make a living. Federal exemptions allow up to $2,025 in implements, books, and other tools. The state of Virginia allows a generous portion to their citizens: up to $10,000 worth of books, tools, and instruments of trade, and even an automobile is exempted. Military members of the same state are entitled to an unlimited amount of uniforms, arms, and equipment, while farmers can keep a thousand dollars' worth of fertilizer, a pair of horses, one tractor up to $3000, one wagon or cart, two plows and wedges, and one drag, pitchfork, rake, and harvest cradle each. A practicing professional residing in Rhode Island may keep their personal library. In South Dakota, no tools of trade are included in their state exemptions.
Points to ponder
Rest assured that not all your property will be seized by the court once you file for bankruptcy. The good thing about filing for bankruptcy is that you are able to get back on your feet little by little, with the items that you really need to get by. With hard work, patience, and determination, your persistence will surely go a long way, and everything that you lost will be restored.
Related resources:
Exempt property in bankruptcy
Non-exempt property in bankruptcy
Debt collection laws