Having Your Cake and Eating it Too: Why Voluntary Post-petition 401(k) Contributions Are Disposable Income

• Publication year: 2022

Having Your Cake and Eating It Too: Why Voluntary Post-Petition 401(k) Contributions Are Disposable Income

Austin S. Howell

HAVING YOUR CAKE AND EATING IT TOO: WHY VOLUNTARY POST-PETITION 401(k) CONTRIBUTIONS ARE DISPOSABLE INCOME

Abstract

Following the 2005 amendments to the Bankruptcy Code, the majority of chapter 13 debtors have been successful in minimizing their repayment obligations to creditors while bolstering their financial stability during retirement. The Bankruptcy Code allows chapter 13 debtors to retain their assets and repay their debts to creditors using their earned income. Alternatively, debtors may simply avoid some of the liability by dedicating a portion of their earned income for reasonably necessary expenses. Judicial inconsistencies have emerged concerning whether voluntary post-petition 401(k) retirement contributions for chapter 13 debtors constitute disposable income in accordance with Sections 541(b)(7) and 1325(b) of the Bankruptcy Code.

A majority of courts follow the Johnson approach, whereby all post-petition 40l(k) contributions are excluded from a debtor's disposable income, and therefore out of reach for creditors. Other bankruptcy courts follow the Prigge approach, whereby post-petition 401(k) contributions are included as disposable income available to creditors. Still other courts follow the Seafort approach, whereby post-petition 401(k) contributions are excluded from disposable income only if such contributions were made pre-petition.

This Comment argues that excluding post-petition 401(k) contributions from the debtor's disposable income available to creditors—the approach followed by most courts—undermines the "fresh start" goal of consumer bankruptcy. After highlighting the shortcomings of the current post-petition 401(k) contribution analysis, this Comment suggests that there lies a strong argument for including post-petition 401(k) contributions in a debtor's disposable income, thereby curbing the opportunity for abuse and restoring the balance between debtors and creditors.

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Table of Contents

Introduction.............................................................................................147

I. Disposable Income Defined—An Overview of §§ 1325(B) and 542(B)(7)....................................................................................150

A. The Language of 11 U.S.C. Section 1325(B)(2)........................ 151
B. BAPCA: Its Legislative History and the Means Test under § 707(B)(2)................................................................................ 153
C. The "Hanging Paragraph" of § 541(B)(7) Applied to § 1325(B)(2).............................................................................. 155
D. 401(k) Employer Contribution Plans........................................ 156
E. The IRS Standards .................................................................... 157

II. Judicial Interpretation and the Evolving Classification of Voluntary Post-Petition 401(K) Contributions in Chapter 13 Cases...........................................................................159

A. Patterson, Hebbring, and Other Pre-BAPCPA Decisions ........ 159

1. Patterson and Pre-Petition 401(k) Contributions ............... 160
2. The Second Circuit Case-By-Case Test .............................. 162
3. The Hebbring Test .............................................................. 164

B. Johnson, Prigge, and seafort: Post-BAPCPA Decisions .......... 165

1. Johnson Approach .............................................................. 165
2. Prigge Approach ................................................................. 167
3. seafort Approach ................................................................ 169

a. In re Arm-Thai Thi Vu Approach ................................. 171

III. Analysis: Shortcomings of the Johnson Approach.................173

A. Excluding Voluntary 401(k) Contributions from Disposable Income Gives Debtors a "Head Start" Instead of Merely a "Fresh Start" ........................................................................... 173
B. The Majority's Interpretation of the "Hanging Paragraph" of § 541(B)(7) Contradicts Other Areas Within the Bankruptcy Code.......................................................................................... 175
C. Treating Voluntary 401(k) Contributions as "Reasonably Necessary" for a Debtor's Maintenance Conflicts with the IRS Standards Referenced in the Bankruptcy Code.................. 179

Conclusion.................................................................................................182

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Introduction

Allowing a debtor to deduct her voluntary post-petition 401(k) contributions from the disposable income available to her creditors under her chapter 13 repayment plan creates an opportunity for abuse. The facts in Davis v. Helbling (In re Davis) illustrate this point:

In 2017, Camille Davis filed a chapter 13 bankruptcy petition in Ohio after accumulating over $200,000 in debt.¹ Davis' chapter 13 petition allowed her to satisfy her unsecured debts—totaling around $189,000—by agreeing to pay all of her disposable income to her unsecured creditors over a five-year period.² Davis committed to a plan that would pay her creditors $19,380, approximately ten percent of the $189,000 of her accrued debt.³ Of Davis's $5,627 in gross monthly income, she designated $323 as disposable income available to her creditors.⁴ In making her calculation, Davis set aside $220 of her gross monthly income to contribute to her 401(k) plan.⁵

Under the view of most courts,⁶ allowing Davis to shield an additional forty percent of the amount she could have paid her creditors, is acceptable.⁷ While Davis gets quite the windfall, her creditors are left with only ten cents for every dollar they are owed.⁸ Considering the stakes, this windfall is exactly the kind of abuse that the Bankruptcy Code ought to prevent. Yet the treatment of post-

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petition 401(k) contributions in chapter 13 bankruptcy remains unpredictable and confusing.⁹

This Comment argues that the majority approach which permits the exclusion of voluntary post-petition 401(k) contributions from disposable income in chapter 13 cases unfairly incentivizes debtors to prioritize their retirement needs and benefit their own future financial standing, rather than repaying the creditors of their accrued debts. In 2017, the number of individuals who filed a chapter 13 petition almost reached the number of civil and criminal cases filed in federal district courts that same year.¹⁰ The Internal Revenue Code provides some clarity as to whether voluntary post-petition 401(k) contributions constitute disposable income.¹¹ Despite intersecting with the Internal Revenue Code at times, the Bankruptcy Code's language regarding the issue remains unclear.¹²

Individual debtors seeking relief may file under chapter 7 or chapter 13, depending on their financial circumstances. Because chapter 7 and chapter 13 differ in their processes, implications, and obligations, debtors must weigh the advantages and disadvantages of these two avenues before filing for bankruptcy relief. For example, the chapter 7 process liquidates the debtor's property to repay creditors. On the other hand, when filing under chapter 13, the debtor retains their assets and proposes a plan to the court to repay their creditors using her future earned income.¹³

For the court to approve a debtor's chapter 13 plan proposal, "all of the debtor's projected disposable income" must be applied toward payments to creditors.¹⁴ Section 1325(b)(2) excludes "amounts reasonably necessary . . . for the maintenance or support of the debtor" from the debtor's projected amount of disposable income.¹⁵ Before Congress passed the Bankruptcy Abuse Prevention

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and Consumer Protection Act of 2005 ("BAPCPA"),¹⁶ bankruptcy courts held that post-petition contributions were part of a debtor's disposable income and were not eligible for exemption as a reasonably necessary expense for a debtor's maintenance.¹⁷

However, the addition of Section 541(b)(7) caused confusion among bankruptcy courts and resulted in inconsistent treatment of post-petition contributions.¹⁸ Section 541(b)(7) excludes amounts "withheld by an employer from the wages of employees for payment as contributions" to a 401(k) retirement plan from the property of the estate.¹⁹ The confusion is caused by a provision included under Section 541(b)(7)(A)(i)(III), which reads "except that such amount under this subparagraph shall not constitute disposable income as defined in [S]ection 1325(b)(2)."²⁰ Addressed in Davis v. Helbling (In re Davis), this uncertainty concerns whether debtors like Davis should be permitted to exclude 401(k) contributions from the disposable income available to creditors based on the language of Sections 541(b)(7) and 1325(b)(2) of the Bankruptcy Code.²¹ In attempting to resolve this issue, courts disagree on matters such as statutory interpretation, policy objectives, and whether debtors should be allowed to ease their repayment commitments while securing their future retirement plans.

Part I of this Comment introduces the relevant provisions of the Bankruptcy Code and shows that Congress used BAPCPA to further its intent to curb abuse of the Bankruptcy Code. Part II illustrates the effect of BAPCPA on the treatment of post-petition 401(k) contributions and describes the different judicial analytical frameworks that have emerged as a result. Part III explains how shielding 401(k) contributions from creditors invites abuse and gives Code

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support the conclusion that post-petition 401(k) contributions should be included in a debtor's disposable income.

I. Disposable Income Defined—An Overview of §§ 1325(B) and 541(B)(7)

The crux of the issue of whether a debtor may deduct voluntary post-petition 401(k) contributions from a chapter 13 plan lies in the language of Section 541(b)(7)²²...