Disability and Bankruptcy

How disability affects a bankruptcy case depends on what you mean by "disability." There are three major categories of disability payments: social security disability, veteran's disability, and private disability. Private disability is purchased either by an individual or provided by their employer. Other than to mention that some states’ laws exempt private disability from creditors and the bankruptcy trustee, this article will not cover private disability. This article focuses on government disability in the form of Social Security Disability and Veterans’ Disability. 

Types of Disability

The Social Security Administration provides Social Security Disability benefits. These benefits are either Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI). Your accumulated work credit and your disability determine the amount of your SSDI benefits. SSI isn’t dependent on work history. With SSI, it only matters that you’re too disabled to work and/or your income is insufficient to meet basic standards of survival. There are income restrictions placed on those receiving these Social Security Disability benefits. The reason is that you’re being compensated for your disability which is the reason you’re not able to earn enough income. If you’re able to earn as much income as before, then there is no reason for the disability benefit. The Social Security Administration has an online tool to see if you’re eligible for benefits. Your dependents can also be eligible for Social Security Disability benefits. 

Your income will usually drop after a disabling injury. Using a disability lawyer to replace part of your income often goes hand in hand with hiring a bankruptcy lawyer for debt relief since, with the decreased income, you may no longer be able to pay your debts. No one needs a fresh start more than someone who has been disabled. Some bankruptcy law firms also handle disability cases.

The Veterans Administration (VA) offers VA Disability Compensation to those who are eligible. Those eligible can be a veteran or a qualified dependent of a veteran. This compensation is for debilitating illness or injury. The illness or injury must have occurred or a preexisting condition worsened during active duty, active duty training, or inactive duty training. As a general rule, unlike Social Security Disability benefits, there is no restriction on how much income you can earn with VA Disability. This is because VA Disability not only compensates you for your disability, but also for service to our country.

With SSDI and SSI, you will receive a lump-sum payment upon approval for these programs. For SSDI, this lump sum payment will include all benefits that would have been paid to you had payments as soon as you become eligible to receive them, which is five months after the incident that caused the disability. For SSI, the lump-sum includes all payments back to the date you first applied for SSI. There are situations where the VA makes lump-sum back payments.

When filing bankruptcy, there are two primary issues with disability. The first issue is whether to include disability benefits in your calculation of income. The second issue is whether the disability benefits are exempt from claims by the bankruptcy trustee. When you file bankruptcy you must calculate income twice. The first income determination is for purposes of the means test. The second income calculation is for the determination of your disposable income.

Is Disability Income Included in Bankruptcy? It depends.

You must meet certain requirements to qualify for a Chapter 7 bankruptcy. If your income, including income from disability, is less than the median income in your state, you may file a Chapter 7 bankruptcy case. If your income is greater than the median income in your state, you must pass the full means test to file a Chapter 7 bankruptcy. The means test does not include (or count) social security income. In most cases, this would only matter if you were approved for social security disability within the last six months. That’s because you would receive your first lump-sum payment and this could skew your income over the past month. Outside of receiving a large lump sum amount, this generally isn’t a problem as SSDI or SSI payments and the related income restrictions usually put you below the median income for a household of your size. If your income doesn't exceed the median income, you don't have to complete the full means test.

Until August of 2019, VA Disability Compensation was not exempt from the means test. Unlike SSDI and SSI, this did matter because there is no limitation on earned income for VA Disability Compensation except in some cases of 100% disability. You could earn a high income and still receive VA Disability. Without the exemption on VA Disability in the means test, the receipt of these well-deserved benefits could cause you to fail the means test. As a result, you would have been barred from filing a Chapter 7 bankruptcy. The passage of the “Honoring American Veterans in Extreme Need Act” (HAVEN Act) allowed this important change so that VA Disability Compensation is now exempt from the means test.

The Second Income Calculation 

As mentioned, there is a second income calculation in all bankruptcies. This is the calculation for disposable income. This is most important in Chapter 13 bankruptcies since you must be able to prove to the satisfaction of the bankruptcy court that you can make the necessary Chapter 13 payments. This income calculation can also matter when proving you have sufficient income to reaffirm a debt in a Chapter 7 bankruptcy. For example, you may need to prove you can afford your car payment in a Chapter 7 bankruptcy. You can include any disability benefits for purposes of these calculations.

Are Disability Benefits Exempt from the Bankruptcy Trustee?

The reason very few people ever lose anything to the bankruptcy trustee when they file a Chapter 7 bankruptcy is because they’re able to use exemptions under both federal law and state law. These exemptions prohibit the trustee from taking certain assets. In most states, your exemptions are those allowed by state law with a few special federal nonbankruptcy exemptions that apply in all states. In some states, you can choose between the state exemption scheme or a federal exemption scheme. In these states, if neither your state law nor federal nonbankruptcy exemptions have an exemption you need, it may be better to choose the “federal bankruptcy exemptions.” You will not face this dilemma when deciding how to apply exemptions to federal disability benefits.

VA Disability Compensation may be exempt under the federal exemptions, but not under your state law. While this is a matter to discuss with your bankruptcy attorney, it’s usually best not to use the federal exemptions only because they provide an exemption for VA disability benefits. There is a federal nonbankruptcy exemption that applies to all states. This exemption is not part of the Bankruptcy Code but it does apply to bankruptcies. This exemption protects these benefits from garnishment as the benefits are being paid to you and after the benefits are in your bank account. Social security disability benefits are also exempt from creditors after they become part of your bank account due to a statute contained in the Social Security Act.

The wise use of exemptions avoids wasting valuable “wildcard” exemptions for a bank account. Wildcard exemptions are those that can apply to any type of asset up to a certain value. These are often used to exempt cash in bank accounts but can protect other assets. If you use a wildcard exemption on a bank account when it’s not needed, you won’t have the exemption available for other assets.

How does a creditor or trustee know if the money in a particular bank account is from SSDI, SSI, or VA Disability? 

First, there is a federal regulation that requires banks not to honor a garnishment from the bankruptcy trustee and non-government creditors to the extent of the SSDI, SSI, or VA Disability received within the last two months if the money for these benefits is direct-deposited into your account. If you deposit checks received by mail from these government agencies for these benefits, this rule will not help you.

So what happens to lump-sum payments that are from more than three months ago, if the lump-sum proceeds are still in the account? In this case, the bank has no power of its own to stop the garnishment. You must go to court to stop the garnishment. In a bankruptcy setting, this means the bankruptcy judge will make this determination. The easiest way to make sure that these exempt payments remain protected while in your bank account is to set up a separate account that only has exempt federal benefit payments deposited into it. Do not commingle funds by depositing money from other sources into this account. For example, if you do receive a paycheck, don’t deposit that paycheck into the same account as your disability benefits. If you keep these disability payments in a separate account, the court can simply look at your bank statements to see that all funds in the account are exempt. These days, you can find online and mobile banking accounts that will be happy to provide you with a bank account with no monthly fee and no other bank fees.

Conclusion

Disability benefits do require some special considerations in bankruptcy. You do not need to include either SSDI, SSI, or VA Disability for purposes of your bankruptcy means test. You can include this income for purposes of the disposable income. It’s a good idea to carefully consider how you will claim your available exemptions, especially when considering the exemption for VA Disability Compensation.