What Is the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)?
The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 is a piece of legislation that revised the United States Bankruptcy Code for cases filed on or after October 17, 2005. In April 2005, BAPCPA was passed by Congress and signed into law by President George W. Bush as a move to reform the bankruptcy system.
- The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), passed in 2005, is a law that reformed the personal bankruptcy process in the U.S.
- Under BAPCPA, filing for Chapter 7 personal bankruptcy became more difficult as more stringent guidelines and eligibility requirements were defined.
- The goal was to prevent the bankruptcy process from being abused and to encourage Chapter 13 filings instead of the more forgiving Chapter 7.
- Certain retirement assets—including traditional and Roth IRAs—were given federal bankruptcy protection for the first time under BAPCPA.
Understanding the Bankruptcy Abuse Prevention and Consumer Protection Act
Under Chapter 7 bankruptcy, most unsecured consumer and business debts are forgiven or discharged. This bankruptcy plan also allows for the liquidation and sale of certain assets by a designated trustee in order to repay creditors. Alternatively, bankruptcy filed under Chapter 13 requires debtors to repay a portion of the debt before a debt discharge is considered. Chapter 13 bankruptcy requires debtors to restructure their debts and create a three- to five-year repayment plan, under which the debtor will use future income to pay off creditors in part or in full. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was introduced to make it more difficult for debtors to file for Chapter 7 bankruptcy and, instead, force them to file for Chapter 13.
The Act created a bankruptcy means test that determines whether individuals filing for bankruptcy can file for Chapter 7 bankruptcy, which discharges many debts in full—or whether they must opt for Chapter 13 bankruptcy, which requires at least partial repayment of debts. Furthermore, the Act increased the waiting period from when an individual last filed Chapter 7 bankruptcy to when they may file again to eight years.
BAPCPA and Chapter 7
Essentially, the purpose of BAPCPA was to make it more difficult for higher-income individuals to qualify for Chapter 7 bankruptcy by more closely examining the filer's ability to repay their debts. The means test compares the debtor's monthly income to the median income (which depends on the size of the household) in their state of residence and provides an allowance for assumed monthly expenses, at rates determined by the IRS, as well as an allowance for actual monthly expenses.
If the individual exceeds the median income and has some money left over after accounting for living expenses, they usually will not qualify for Chapter 7 bankruptcy. In effect, three outcomes are possible from the means test:
- A debtor will pass the means test if their monthly disposable income is less than $136. They will, thus, be able to file for Chapter 7 bankruptcy without any problem.
- A debtor will fail the test if their disposable income each month is more than $227. In this case, they must proceed under Chapter 13.
- If a debtor’s disposable income lies between $136 and $227 per month, the income should be multiplied by 60 (BAPCPA’s assumption that the debt will be paid off in approximately five years, or 60 months). If the resulting value can cover at least 25% of the non-priority unsecured debt, the debtor will fail the test. Otherwise, they can proceed to file for bankruptcy under Chapter 7.
Consumers and businesses that plan to file for bankruptcy must complete an accredited nonprofit credit counseling program no more than 180 days prior to filing.
To complete a means test, a debtor must submit either Form 122A—1 for Chapter 7 or Form 122C for Chapter 13 to the Bankruptcy Court before the court will hear the case.
BAPCPA also set in place mandatory credit counseling for consumers and businesses looking to file for bankruptcy.
To avoid potential abuse of the bankruptcy system, BAPCPA exempts certain debts from discharge. Some of these debts are:
- More than $750 in cash advances on a credit card taken out within 90 days of filing
- More than $500 charged on a credit card for luxury goods within 90 days of filing
- All federal and private student loans
Most studies that have looked into the effectiveness of BAPCPA to reform bankruptcy have concluded that the profile of consumer bankruptcy debtors hasn't changed. This suggests that the means test has not led to more high-income debtors providing more payments to creditors. Instead, it may be that those in need are simply delaying seeking bankruptcy relief.
BAPCPA and IRA Protections
The enactment of BAPCPA brought about another change: federal protection for individual retirement accounts, or IRAs. Although federal bankruptcy laws have long protected 401(k) plans, pensions, and similar employer-sponsored, qualified retirement plans, before BAPCPA was passed, IRA protections were defined at the state level, or not at all. After the law's passage, people in every state were afforded bankruptcy protection for IRA assets.
Protection under BAPCPA varies, depending on the type of IRA. Traditional IRAs and Roth IRAs are currently protected to a value of $1,362,800, with adjustments for inflation made every three years (the next adjustment is in 2022). SEP IRAs, SIMPLE IRAs, and most rollover IRAs are fully protected from creditors in a bankruptcy, regardless of the dollar value.