Disability and Bankruptcy

Disability benefits are a form of income, but they’re treated differently than other income sources under the Bankruptcy Code and other laws. This article covers the key issues you need to understand if you receive disability payments and you’re considering filing bankruptcy. Specifically, this article explains how and where to disclose your income correctly and how to protect your disability benefits.

There are three main types of disability income. The first is income paid under the Social Security Act, including Social Security Disability Insurance (SSDI) payments and Supplemental Security Income (SSI) payments. The second is Veterans Administration (VA) disability income. The third is income from private disability insurance, often paid through an employer. This article focuses only on SSI, SSDI, and VA disability.

Should I Include My Disability Payments When Calculating My Income?

When you fill out your bankruptcy forms, you’ll need to complete two different income calculations. 

• For Chapter 7 cases, you’ll fill out Forms 122A-1 and 122A-2.

• For Chapter 13 cases, you’ll fill out Forms 122C-1 and 122C-2.

Note that for simplicity, the rest of this article refers to these forms collectively as the “122 forms.” Finally, for both Chapter 7 and Chapter 13, you’ll also fill out Schedule I. This section explains these income calculations and how your disability payments fit into each.

Disability and Your Income on the 122 Forms

In Chapter 7 bankruptcy, Forms 122A-1 and 122A-2 are used to calculate your average monthly income and determine whether you qualify to file under Chapter 7. This calculation is sometimes called the means test. In Chapter 13 bankruptcy, your average monthly income is calculated on Forms 122C-1 and 122C-2. These forms are nearly identical to their Chapter 7 counterparts. The Chapter 13 forms are used to determine whether your repayment plan must last a full 60 months or if you qualify for a shorter plan term.

In both Chapter 7 and Chapter 13, all disability income issued under the Social Security Act is specifically excluded from the calculations. This includes both Social Security Disability Insurance (SSDI) payments and Supplemental Security Income (SSI) payments. There is a space to list this income on the forms, but it’s not included in the calculations. All VA disability income is also excluded from these calculations. Unlike Social Security disability benefits, you don’t need to list your VA income on these forms.

Disability and Your Income on Schedule I

The questions on Schedule I may look similar to those on the 122 forms, but Schedule I income is calculated differently and serves a different purpose. The total from Schedule I is used with the total of your estimated living expenses from Schedule J to calculate your monthly net income. In Chapter 7 bankruptcy, this net income figure is used to determine whether you can afford to reaffirm your secured debts. In Chapter 13 bankruptcy, this figure is used to calculate how much you can afford to pay into your plan each month.

One of the most important differences between the 122 forms and Schedule I involves your disability benefits. You must include your disability payments when calculating income on Schedule I. SSDI, SSI, and VA disability income must all be included on the form. If you have anything withheld from your payments, such as taxes, you should enter those deductions on Schedule I also. 

Can I Keep Disability Income That’s in My Bank Account?

According to the Social Security Administration (SSA), it takes about three to five months for the SSA to decide your disability claim. Then, it takes at least another month for you to receive your first payment. Of course, people whose disability claims are initially denied must go through the disability appeals process, which can add months or even years to the process. Similarly, according to the VA, it takes around five to six months for the VA to review a disability claim. This doesn’t include any time for appeals or reviews. 

Because of the processing time for disability claims, many people receive a lump sum payment around the same time they receive their first benefit check. These lump sum payments are meant to cover the payments you should’ve received going back to the time you filed your claim or became eligible for benefits. Some of this lump sum payment may still be in your bank account when you file bankruptcy. You might also have other unspent disability income in your possession when you file your bankruptcy case. Whether you can keep this money depends on whether you can claim it as exempt.

Exemptions and Your Bankruptcy Estate

All the property you own on the day you file bankruptcy becomes part of your bankruptcy estate. In Chapter 7 bankruptcy, the bankruptcy trustee can liquidate the assets in your bankruptcy estate to pay your creditors. Exemption laws allow you to claim some or all your assets as exempt. Exempt assets are protected from the trustee. In most Chapter 7 cases, there aren’t any non-exempt assets for the trustee to sell. 

In Chapter 13 bankruptcy, the bankruptcy trustee doesn’t liquidate any assets. But they still review your paperwork to determine the value of your non-exempt assets. The total value of everything in your estate minus the total value of all your claimed exemptions equals the total amount of your non-exempt assets. You must pay at least this amount to your unsecured creditors in your Chapter 13 plan.

Federal law contains both bankruptcy exemptions and non-bankruptcy exemptions. Each state also has its own exemption laws. If you’ve lived in your current state for less than two years, you must use the federal exemptions. If you’ve lived there for two years or longer, you may be required to use your state’s exemptions. 

If your state is one of the 16 states that hasn’t opted out of the federal exemptions, you can choose to use either your state’s exemptions or the federal exemptions. If you use your state’s exemptions, you can also use federal non-bankruptcy exemptions. But you can’t use both the federal bankruptcy exemptions and the federal non-bankruptcy exemptions.

Claiming Pre-Bankruptcy Disability Payments as Exempt

If you’re using your state’s exemption laws, then any disability payments you received before filing bankruptcy are exempt under 42 U.S.C. Section 407 (for SSI and SSDI) or 38 U.S.C. Section 5301 (for VA disability). Sections 407 and 5301 are federal non-bankruptcy exemptions. These exemptions apply in every state, but you must be using state exemptions (not federal bankruptcy exemptions).

If you’re using federal bankruptcy exemptions, the rules are less clear. Some bankruptcy courts have held that payments received before filing bankruptcy are protected under Sections 407 and 5301, even if you use federal exemptions. Other bankruptcy courts have ruled that Sections 407 and 5301 only apply if you’re using state exemptions. If you’re using federal exemptions and live in a jurisdiction where Sections 407 and 5301 don’t apply, you can still claim these payments as exempt. To do so, you’ll have to use other federal exemptions, such as the federal wildcard exemption.

If you’re using an exemption that specifically applies to Social Security or disability payments, you must be able to prove that the money is disability income. For example, say you receive a lump sum SSDI check for back payments and deposit it into your checking account. If you also deposit money from other sources — such as wages or pension payments — into that same checking account, it’s hard to prove whether the money in the account is from SSDI or from another source. If you receive disability income, it's a good practice to use a separate bank account just for disability payments.

Will I Continue To Get Disability Benefits if I File Bankruptcy?

In short, yes. The rules for protecting ongoing disability payments — those you receive after filing bankruptcy — are much more straightforward than the rules that apply to benefits you received before filing bankruptcy. If you’re using federal bankruptcy exemptions, your ongoing disability payments are exempt under 11 U.S.C. Section 522(d)(10). If you’re using your state’s exemptions, your ongoing disability payments are exempt under 42 U.S.C. Section 407 (for SSI and SSDI) and 38 U.S.C. Section 5301 (for VA disability).

Let’s Summarize…

The first way disability benefits could affect your bankruptcy is in calculating your monthly income. There are two different income calculations in your bankruptcy forms. These two calculations are based on different figures and are used for different purposes. When completing your bankruptcy paperwork, don’t include your disability benefits as monthly income on your 122 forms. Do include your disability payments as income on Schedule I. 

The other way disability benefits might affect your bankruptcy is if you received benefits before filing bankruptcy and still have some of the money when you file. Whether you can keep this money, and how much you can keep, depends on where you live and which exemption laws you use. Disability payments you receive after filing bankruptcy are always protected.