What is Exemption Planning | Protecting Assets Prior to Filing Bankruptcy
You have $5,000 in your bank account but have insurmountable credit card debts and a pending foreclosure. You have to file bankruptcy and you know you can spend the $5,000 on some expensive bottles of wine or whiskey and go out with a bang. Or you could take it to the casino and take one last ditch effort to save your economic situation. But what if there was a more meaningful and reasonable way to preserve these funds in a way that would benefit you in the long term without having to essentially see them wasted? This is exemption planning, an allowable way of protecting assets prior to filing bankruptcy.
Exemption planning is the conversion of nonexempt assets (such as cash) into exempt assets to preserve such values for the benefit of the debtor prior to filing bankruptcy. It is commonly known as a form of asset protection outside the bankruptcy context. It is permissible means for insolvent debtors to utilize funds in a meaningful way that would otherwise have to be spent down or lost to creditors of the estate upon filing. While it is permissible, it must be navigated carefully with experienced counsel to avoid objections to discharge or claims of a fraudulent transfer by the bankruptcy trustee.
Why is Exemption Planning Allowed?
Exemption planning is permissible absent extrinsic evidence of fraud and a valid means to protect assets prior to filing bankruptcy. Authorities are almost unanimous that while conversion of proceeds into an exempt form prior to filing bankruptcy is necessarily an intent to hinder creditors, this intent and conversion by themselves is not sufficient to deny a discharge under Section 727. See In re Cataldo, 224 B.R. 426, 429 (9th Cir. BAP 1994) (“[I]t is clear that in the Ninth Circuit a debtor may convert non-exempt property into exempt property even on the eve of bankruptcy.”). The rationale for this is that: (1) any other holding would be contrary to the very purpose of providing exemptions; and (2) the legislative history of the bankruptcy code expressly permitted this as not being fraudulent in and of itself. State exemption statutes are not conditioned on solvency so denying an exemption due to a person’s financial condition is directly contrary to the legislative purpose of these exemptions and would be targeted against the very class of insolvent parties they are precisely intended for. It is therefore critical to disclose the asset and properly claim the exemption. Do not try to conceal anything.
When is Exemption Planning Not Allowed?
Exemption planning can result in the denial of discharge where there is extrinsic evidence of intent to defraud beyond the act of the conversion itself. In order to show extrinsic evidence of fraud, courts usually reference badges of fraud which refer generally to evidence of concealment, timing, or economic justifications of the transaction or a combination thereof. To synthesize a broad array of case law on denial of discharge for pre-petition conversions, denial of discharge or the exemption is generally limited to where there is evidence of concealment or dishonesty that the exemption planning is disallowed, whether by denial of the exemption or denial of discharge.
Thus, it can generally be said that unless the creditor or trustee shows deception or concealment, an insider transaction, a fraudulent conveyance, a secretly retained possession or benefit, or lack of credibility or truthfulness, then evidence regarding timing or economic justification is insufficient to deny a discharge or exemption. To put this in context, it would not be sufficient to deny a discharge by questioning the economic justification of a debtor who purchased a $5,000 guitar on the eve of filing and claiming a tools of the trade exemption on the guitar by arguing that the debtor works small dive-bar venues for tips and makes inconsequential money such that it was a grossly imprudent economic transaction. On the other hand, a debtor who uses their last $10,000 prior to filing by paying down their mortgage and utilize the rather large homestead exemption of $150,000 in Arizona could be denied a discharge if they did not disclose the transaction on their schedules or if they intended conceal the transaction by paying with cash, cashier’s check or through an intermediary such as a relative or a non-filing spouse who makes the payment on their behalf. This outlines the nuances involved when seeking to protecting assets prior to filing bankruptcy.
What Are Some Exemptions to Maximize Prior to Filing?
The larger exemptions to maximize and to protecting assets prior to filing bankruptcy for those debtors with disposable funds are usually: (1) retirement contributions; (2) homestead allowances (i.e., paying down your mortgage); (3) six months of food and provisions; (4) tools of the trade; (5) vehicle equity; and (6) personal furnishings. It is critical that debtors consult with experienced counsel prior to planning on their own as timing of the conversion is crucial. For example, retirement contributions to an IRA made within 120 days of filing are not exempt in Arizona. Likewise, homestead exemption amounts can be reduced under 11 U.S.C. § 522(p) for debtors trying to maximize their homestead allowance up to the $150,000 permitted under state law.
Exemption planning and asset protection is one area where experienced counsel pays for itself. Do not assume it is too early to consult with bankruptcy counsel. Early consultation with a bankruptcy attorney allows to full analysis of exemption planning and protecting assets prior to filing bankruptcy may not otherwise be possible for last-minute filers. If you have assets but are still struggling with insurmountable debt, consult a bankruptcy attorney to discuss exemption planning and asset protection in full. Exemption planning is particularly important for Chapter 7 bankruptcy.