What Is Projected Disposable Income In Chapter 13?

In a Chapter 13 bankruptcy a debtors is required to commit all projected disposal income to payment of creditors under the payment plan under the bankruptcy reform act adopted in 2005. How is projected disposable income calculated?

This is the question before the U.S. Supreme Court in Hamilton v. Lanning (08-998) in which it heard oral arguments on Monday.

Normally, disposable income under the revised bankruptcy code means average monthly income based on the six months prior to bankruptcy reduced by certain statutorily allowed expenses. But, what if everyone knows when a Chapter 13 plan is presented that the previous six months income is going to produce a result that is more than the debtor can pay?

In Hamilton, the six month figure was inflated by a severance bonus. The bankruptcy trustee argued that income should nonetheless be projected based on average income for the six month period times duration of the plan in months.

Attorneys for the debtor argued (with the concurrence, more or less, of the solicitor general), that it makes more sense to read "projected disposable income" as something different than ordinary disposable income times the number of months in the plan. The debtor's attorneys argued that projected disposable income for the purpose of determining what should be paid under a Chapter 13 plan should include changes in income that the parties know will happen going forward (in the case in question, that there will be no more severance payments and that the debtor will cease to receive income from the job from which she was fired).

The questioning at oral arguments made clear that the court is likely to side with the debtor on this issue. Whether the know changes favor or disadvantage the debtor, it simply makes more sense to figure in changes in income that the parties know will happen, when projecting the amount of disposable income available for creditors in a Chapter 13 plan.

Background: Implications of the Projected Disposable Income Rule

The calculation of projected disposable income has a potentially great income on who files for bankruptcy. People who have less than the median state income or have no significant disposable income can file under Chapter 7 (the test is, of course, more complicated than that), but most high income debtors do not qualify for Chapter 7 and must instead file for bankruptcy under Chapter 13, usually with a five year payment plan.

In the case of debtors with high incomes, payments of "all projected disposable income" under Chapter 13, if reasonably calculated, will often exceed what creditors would have received outside of bankruptcy over a five year period, because there are limitations on the amount of wages that a creditor may garnish.

Before the 2005 reforms, in contrast, it was frequently possible to do a three year Chapter 13 plan which paid creditors only slightly more than they would have received in a Chapter 7 liquidation bankruptcy with no payment plan, even if the debtor had far more disposable income. As long as the payments under the plan made up for the exclusion from the bankruptcy estate of assets that would be otherwise available to creditors (e.g. home equity), the plan would usually pass muster.

To only modestly oversimplify, taken together, the means test for Chapter 7 and the new rules for Chapter 13 plans under the 2005 bankruptcy reforms mean that high income debtors deal with their creditors outside the bankruptcy process unless forced into bankruptcy involuntarily, that middle income debtors must enter into tough five year payment plans to have their debts discharged (but may get to keep key assets like a home), and that low income debtors can have their debts immediately discharged with no payment plan.

The cutoff between low income debtors and middle income debtors is slightly over the state median income (most people who exceed the state median income are also barred from filing under Chapter 7 by the means test). The effective cutoff between middle income debtors and high income debtors is in the ballpark of $100,000 a year for a head of a four person household.