Tax Article -Bankruptcy Abuse, Prevention and Consumer Protection Act of 2005

Impact on Estate and Asset Protection Planning

On April 20, 2005 President Bush signed into law the Bankruptcy Abuse, Prevention and Consumer Protection Act of 2005. This act was originally introduced in the Clinton administration and has died many times and now has been enacted and contains sweeping bankruptcy reform. Most of the changes brought about by the act will take affect six months from the date of signing. 

Only a few provisions of the new act will impact ordinary estate or assets protection planning. However, where it does affect planning, the effect is quite dramatic.

Homestead Exclusions

The new act amends the bankruptcy code so as to restrict the value of estate residential homestead restrictions regardless of contrary State law as well as introducing minimum residency requirements.

1. A debtor may only protect the interest in a residential homestead if the interest is exempted by local State law.
2. A debtor may only protect the interest in excess of $125,000 (if allowed by local State law) if the interest was acquired 1,215 days (3 years 4 months) prior to the bankruptcy filing. Interest in excess of $125,000 that are acquired within the 1,215-day period are simply not protected. A debtor can no longer pay down his home mortgage at the last second and expect the new home equity to be exempted from the bankruptcy estate if the equity in the homestead exceeds $125,000.
3. Regardless of when the property interest was acquired, within or without the 1,215 day period, the value of the interest in excess of the $125,000 will not be exempt if the court determines the bankruptcy filing was abusive or if the debtor owed debts resulting from securities fraud, civil RICO fines or liabilities from a violent crime causing serious injury or death to another. 

The new act allows a rollover of the equity in a former residence into a new home without triggering the restart of the 1,215 day period, but only if the former and new residence are in the same State. The obvious implication is that a North Carolina resident, whose homestead protection is limited to $10,000 cannot sell the home, move to Florida and use the non-exempt cash to buy a posh residence and expect Florida's unlimited homestead law to apply in bankruptcy shortly there after.

However, going the other way, the new law has the odd effect of eradicating the unlimited exemption for a debtor moving from one state with an unlimited exemption such as Texas to another state with unlimited exemptions such as Florida. The use of the move to Florida plan to take advantage of Florida's debtor friendly state exemption is likely to decline. Debtors can no longer wait until a case is filed against them before they try to move to Florida, Texas or another state with generous homestead exemptions.

Retirement and Benefit Funds

The new act makes significant changes to the protection of the debtor's interest in pension plans, benefit plans, and retirement accounts.

The new act excludes from bankruptcy estate amounts withheld from wages by an employer or received from an employee for payment of a contribution to:

• Government sponsored employee plan,
• Section 457 deferred compensation plan,
• Section 403(b) tax deferred annuities, or
• Health insurance plans regulated by State law

Finally, the new act provides exemption for debtor's interest in qualified retirement plans whether State or Federal exemptions are elected:

• IRAs and Roth IRAs up to $1.0M in aggregate and unlimited exemptions for qualified rollover IRAs, SEP IRAs, and Simple IRAs.

Keep in mind that these changes to retirement plans only apply in bankruptcy. This may make is tricky for a debtor living in a State with an unlimited homestead exemption. If they do not file for bankruptcy, their retirement funds may not be protected but if they do file for bankruptcy then his homestead may be limited to $125,000 if they have not passed the 1,215-day period.

Life Insurance and Annuities

The new act makes no changes to the highly favorable State law exemptions for life insurance and annuities except to the extent that the new domicile requirements are imposed with regard to the length of time that the debtor must reside in a State in order to claim the State bankruptcy exemptions in general.

Asset Protection Trust

The new act added provisions that are specifically aimed at asset protection trusts. Bankruptcy trustees have now broad power to avoid transfers made to such trusts. The ordinary fraudulent transfer rules are mostly unchanged except that the limitations period is increased to two years from one year. The transfer is allowed when the transfer was made for value. A new section of the law, 548(e)(1) attacks transfers made to asset protection trusts. The trustee may avoid any transfer of interest of a debtor if the transfer is made 10 years before the filing of the petition, made to a self settled trust, made by the debtor, the debtor is a beneficiary of such trust and the debtor made such transfer with the actual intent to hinder, delay or defraud any entity to which the debtor was or became indebted to after the date of the transfer.

This transfer also includes any transfer made in anticipation of civil or criminal liability under securities laws. Thus, to the extent that asset protection trusts are used at all, other planning must protect assets until the 10 years have passed.

The act changes the debtor / creditor relationship. Until now, a debtor could threaten to file a bankruptcy petition to wipe out all the creditors' claims. Asset protection plans were thus created in anticipation of possible bankruptcy filing to protect certain core assets. Now, creditors will likely threaten to force a debtor into bankruptcy so that the debtor's assets can be picked clean. A new asset protection plan should be designed to avoid bankruptcy altogether and to distance the assets from the debtor's estate in case the debtor is forced into an involuntary bankruptcy.

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