Can Social Security Be Excluded From Calculating “Projected Disposable Income”?

by Gary on November 23, 2012

The Fifth and Tenth Circuits join the Sixth and Eighth Circuits in concluding that Chapter 13 debtors are not required to include social security benefits in the calculation of their “projected disposable income” for plan purposes.

The two cases, released within days of each other, considered similar facts.  Each had a debtor that disclosed but failed to include social security benefits to fund his Chapter 13 plan.  Each had a Chapter 13 trustee that objected to the plan and argued that the debtor failed to devote all “projected disposable income” to the plan as contemplated by 11 U.S.C. § 1325(b)(1), and therefore failed to offer the plan in good faith.  The appellate court decisions considered similar arguments made by the trustees and concluded that neither plan was offered in bad faith and that a debtor is not required to include social security benefits in “projected disposable income”.

Even though a debtor’s plan passes every test of § 1325(a), Chapter 13 trustees have often challenged Chapter 13 plans under §§ 1322(a)(4) or 1325(b)(1)(B) when a comparison of the debtor’s Schedules I and J show that he has positive disposable income that he isn’t using to fund his plan and pay unsecured claims.  Section 1325(b)(1)(B) would allow a plan to be confirmed over a trustee’s objection if the debtor proposes to pay all allowed unsecured claims or fund the plan with “projected disposable income” during the commitment period.

A disconnect often occurs when the debtor’s Schedule I (listing income) discloses social security benefits, his Schedule J expenses are less than his income, and he chooses to exclude the social security benefits from funding his plan payments.  The trustee will argue that social security must be devoted to plan payments.  The debtor will argue that social security can be excluded.  In the cases cited above, the Fifth and Tenth Circuits agreed with the debtors.

The term “projected disposable income” is not defined in the Bankruptcy Code, although the more basic term, “disposable income” is defined at 11 U.S.C. § 1325(b)(2) by reference to yet another term “current monthly income.”  “Current monthly income” is defined in the Bankruptcy Code.  [In addition to calculating disposable income, “current monthly income” is also used to determine the debtor’s eligibility to file a Chapter 7 case (see § 707(b)).]  It specifically excludes “benefits received under the Social Security Act.”  11 U.S.C. § 101(10A).

Because “current monthly income” excludes social security benefits, the appellate panels reasoned that “disposable income” must, therefore, exclude social security benefits, and that adding the adjective “projected” does not modify the meaning of the phrase so as to require that benefits be included.

The courts also relied on § 407(a) of the Social Security Act of 1935, which instructs that social security payments are not subject to “the operation of any bankruptcy or insolvency law,” and § 407(b), which specifically prohibits interpretation of any other provision of law as limiting § 407(a) without expressly referencing it.  The legislative history of § 407(b) indicates that Congress enacted the follow-up provision in 1983 to protect social security benefits after some number of bankruptcy courts had apparently ignored § 407(a).

Both trustees argued that the Supreme Court’s recent case, Hamilton v. Lanning (In re Lanning), 130 S. Ct. 2464 (2010), would allow them to take into account their debtors’ social security benefits.  In an “unusual” case, the Lanning Court held, a court “may account for changes in the debtor’s income or expenses that are known or virtually certain at the time of confirmation.”  Id. at 2475.  Both the Fifth Circuit and Tenth Circuit rejected the Lanning argument because the social security benefits the debtors were receiving at confirmation were not a change in income.

As to whether the debtors lacked good faith in proposing plans that failed to include social security benefits, the appellate panels reasoned that a debtor cannot be in bad faith for doing exactly what the Bankruptcy Code allows him to do.

In re Ragos, — F.3d —-, 2012 WL 5292949 (5th Cir., Oct. 29, 2012)
In re Cranmer, — F.3d —, 2012 WL 5235365 (10th Cir., Oct. 24, 2012)

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