Supreme Court Clarifies "Applicable" Car Ownership Expenses

March 20, 2011

The Supreme Court recently issued an important ruling for those individuals who are filing a Chapter 13 bankruptcy. With over 1.5 million Americans having filed for bankruptcy protection in 2010, this ruling will have a significant impact on a number of cases.

Through bankruptcy, a person with overwhelming debts is protected from creditors and collection actions, and given a fresh financial start. In exchange, the person filing bankruptcy may be required to surrender some personal assets to make partial payment on the outstanding debts.

Some property (known as exempt property) is excluded from the bankruptcy estate. It is not taken from the debtor. For example, the homestead exemption allows a person filing for bankruptcy to keep a certain amount of home equity. In California, the homestead exemption allows debtors to keep up to $175,000 of equity in their home provided that they stay current on mortgage payments. Also, money in retirement plans is usually 100% exempt. The equity in an automobile can be exempt up to $3,525.

Protecting Assets in Chapter 13 Bankruptcy

In a Chapter 13 bankruptcy, an individual with a steady income can enter into a structured repayment plan to pay, in full or in part, amounts still owing the unsecured creditors. Provided that the debtor makes the payments as required over the three- to five-year plan period, any remaining debts will then be discharged. More importantly, the Debtor will not be required to pay any interest, late fees or penalties to unsecured creditors during the repayment plan. Some debts such as tax liens, child support arrears and student loans are generally not dischargeable in bankruptcy.

To arrive at a feasible payment plan, the court must determine the debtor's projected disposable income, i.e. the income that is available to pay creditors. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCA) instituted the means test to make this determination. Although commonly thought of only in terms of debtor qualification to file under Chapter 7, the means test is also used to determine available resources in a Chapter 13 bankruptcy. The means test allows a debtor to deduct certain essential expenses from the debtor's income. One such expense is vehicle ownership cost.

Not explicitly defined in the Bankruptcy Code, the Supreme Court recently clarified, in the case of Ransom v. FIA Card Services, that a debtor who owns a vehicle free and clear cannot claim any standard monthly ownership costs for that vehicle.

Jason M. Ransom claimed the applicable $471 ownership allowance on his unencumbered vehicle, which would have allowed him to shield over $28,000 from creditors. One of his creditors objected, arguing that only people making loan or lease payments on a vehicle should qualify for the deduction. The Supreme Court agreed.

Writing for the majority, Justice Elena Kagan opined that "applicable monthly expense amounts" for vehicles does not contemplate debtors who own their vehicles outright, and the car-ownership expense amount is not applicable to these people.

Justice Kagan said to allow otherwise would permit a potential debtor entering bankruptcy to "purchase for a song a junkyard car" solely to take advantage of the deduction. In a solo dissent, Justice Antonin Scalia wrote that the Court's "job, it seems to me, is not to eliminate or reduce these oddities but to give the formula Congress adopted its fairest meaning." Citing error on the part of the majority, he said, "[t]he point of the statutory language is to entitle debtors who own cars to an ownership deduction."

Justice Scalia went on to offer a hypothetical of his own, that a "debtor entering bankruptcy might purchase a junkyard car for a song plus a $10 promissory note payable over several years" and therefore qualify for the full ownership expense deduction.

Strategic Purchasing

As Justice Scalia noted, the Ransom decision leaves room for debtors to make strategic purchases. It may be advisable for some debtors contemplating filing for bankruptcy, who own an older vehicle or one in disrepair, to buy or lease a new car, even at a high interest rate.

Additionally, a purchase of this size, resulting in a payment on a secured asset (the vehicle) may also affect whether a debtor would qualify under the means test to file for Chapter 7 liquidation rather than Chapter 13 repayment a choice preferred by most debtors.

The upshot of the Ransom decision is that now, more than ever before, anyone considering filing for bankruptcy protection should contact a bankruptcy attorney about their available options and how to protect their assets. There are important considerations such as the timing of a purchase or new lease and potential interest rates before and after filing. You need the services of an expert to guide you through the process.

Article provided by Law Offices of Robert L Firth
Visit us at www.firthlaw.com