One of the most persistent and wholly incorrect myths about bankruptcy is that when a person files for bankruptcy protection, all of their property is taken from them and sold for the benefit of their creditors. They lose their house, their car, their personal belongings, everything. Nothing could be farther from the from truth. Bankruptcy is designed to help people recover from a bad financial situation and provide them with a fresh start, not strip them of all of their possessions. A key element in protecting a bankrupt debtor’s property comes from bankruptcy exemptions.
An exemption in bankruptcy at its most basic level is a law that protects specific assets of an individual and keeps them out of reach of their creditors. They are adopted in order to protect basic necessities of an individual, such as housing, transportation, clothing, reasonable personal property and retirement savings. Without these laws, bankruptcy would leave people homeless, jobless and without the tools they need to earn a living. By protecting essential assets, exemptions help to provide the honest but unfortunate debtor with a legitimate fresh start.
While the Bankruptcy Code is part of federal law, found in Title 11 of the U.S. Code, exemptions can be found in both federal and state law. Federal exemptions can be found in Section 522 of the Bankruptcy Code. Each state, however, has the right to allow their citizens to use the federal exemptions, use the state’s own exemptions or, in some states, choose which they elect to use.
The way this works is that when you file for bankruptcy protection, either under Chapter 7 or Chapter 13, you are required to disclose every asset that you own along with the current value of each asset. You then have the ability to claim exemptions against many of your assets, protecting all or at least some of the value of the asset from your creditors.
In Chapter 7 bankruptcy cases, proper exemption claiming is essential because any assets that have value that are not claimed as exempt can be sold by the trustee, with the proceeds of the sale being paid to creditors. Exemptions allow you to keep your property.
In Chapter 13 bankruptcy cases, proper exemption claiming is equally important because one of the requirements of a Chapter 13 plan of reorganization is that it meets the liquidation test. The liquidation test simply states that creditors have to receive as much money through the Chapter 13 plan as they would if the debtor filed for Chapter 7 and the non-exempt assets were sold. Exemptions reduce the amount that you are required to pay creditors through the plan.
This is yet another reason to hire an experienced bankruptcy attorney to represent you in your case. Bankruptcy attorneys have in depth knowledge as to which exemptions are available to you and how to best claim them in order to maximize the amount of property protected and, in Chapter 13 cases, minimize the amount that you need to pay to your creditors.
There are several types of exemptions that are common, though not absolutely uniform, under all statutory structures, federal and state alike. These include:
Homestead Exemption – This protects equity in your primary residence, usually up to a certain dollar amount. There are certain states, such as Florida and Texas, that have unlimited homestead exemptions, but most cap the exemption.
Motor Vehicle Exemption – This protects equity in one motor vehicle up to a certain dollar amount. This usually cannot be split to protect multiple vehicles.
Household Goods Exemption – This protects ordinary household essentials such as furniture, appliances, electronics and other household goods up to a certain dollar amount. Clothing is sometimes included in household goods and sometimes has its own exemption.
Tools of Trade Exemption – This protects tools and equipment that are necessary for your occupation up to a certain dollar amount. This exemption is broader than it sounds, ranging from protecting a carpenter’s tools to a law enforcement officer’s sidearm.
Retirement Accounts Exemption – This protects qualified retirement accounts such as pensions, 401(k) accounts, 403(b) accounts and many IRAs. In most states and under federal exemptions, this is an unlimited value exemption, protecting the entire balance of these savings.
Wild Card Exemption – This can be used to protect any asset that you choose to protect up to a specific dollar amount. May jurisdictions allow you to use an unused portion of your homestead exemption as an additional wild card exemption up to a certain dollar amount.
States that elect to use their own exemptions will often have adopted specific exemptions to reflect their citizen’s values. Some states exempt 529 educations savings accounts, others have a specific exemption for firearms, while still others exempt balances held in standard checking and savings accounts up to a dollar limit. There are countless more state-specific exemptions out there.
In some situations, you have the ability to “stack” exemptions to protect property more effectively. A skilled tradesman’s tools may have more value than the tools of trade exemption allows, but the state’s exemption scheme may allow that person to use their wild card exemption on top of the tools of trade exemption in order to fully protect them.
These variations highlight why professional legal advice is vital in bankruptcy.
Federal exemptions are reviewed, and values updated, every three years to account for inflation. States can update their exemptions at will, and some do so frequently. A relatively recent trend adopted by some states is to tie their homestead exemption to the median sales price of a single-family home in the prior year at the county level, adjusting it annually and providing a cap on the value. This ensures that the exemption keeps up with appreciation in the housing market. Many changes in exemptions are the result of heavy lobbying by consumer advocate groups. Illinois recently dramatically increased their homestead exemption, at least partially because of the advocacy of consumer bankruptcy attorneys arguing that the existing exemption was too low.
Exemptions exist in bankruptcy to ensure that when the honest but unfortunate debtors receives their discharge and exits the bankruptcy cases, they do so with the property that they need to effectively move forward in life. Knowing what exemptions are available to you and applying them in the most strategic manner possible will maximize the property that you are allowed to keep in a Chapter 7 bankruptcy and minimize the amount that you have to pay in a Chapter 13 bankruptcy. Few areas of bankruptcy law are as complicated yet as important as exemptions.
