Michigan Bankruptcy Blog
On an issue of first impression before the Sixth Circuit, the Court held that post-petition income that becomes available after a debtor completes repayment of a 401(k) loan is projected disposable income that must be turned over to the Trustee for distribution to unsecured creditors pursuant to Section 1325(b)(1)(B) and may not be used to fund voluntary 401(k) plans.
In this case, both debtors (on consolidated appeal) were making payments to a 401(k) loan, which would be paid off during the life of the Chapter 13 plan. Neither debtor was making contributions to their 401(k) retirement accounts at the time the petitions were filed. The debtors proposed to use the income (available after full repayment of the 401(k) loan) to start making contributions to their 401(k) retirement accounts. The Trustee objected on the issue of whether the debtors must include the income resulting from the payoff of the 401(k) loans to their respective plans considering neither debtor was making 401(k) contributions at the time the petitions were filed.
The bankruptcy court held that Section 541(b)(7) excludes contributions to a 401(k) plan from property of the estate and disposable income, and therefore, the debtors are allowed to exclude the 401(k) contributions from disposable income. The Trustee appealed to the Bankruptcy Appellate Panel ("BAP"). A divided BAP ruled in favor of the Trustee by holding: exclusions from property of the estate and disposable income for contributions to a qualified retirement plan pursuant to Section 541(b)(7) only apply to those cases where a debtor is already contributing to a 401(k) plan at the commencement of the bankruptcy case; and post-petition income that becomes available after a debtor completes repayment of a 401(k) loan is not excluded from property of the estate or disposable income under Section 541(b)(7) and must be committed to a Chapter 13 plan pursuant to Section 1325(b). The debtors appealed.
The Sixth Circuit affirmed the BAP's decision, albeit for "slightly different reasons." After considering three competing views, the Sixth Circuit concurred with the view articulated by the Prigge[1] and McCullers[2] courts.
The Court began its analysis by noting that Congress did not treat 401(k) loan repayments and voluntary retirement contributions the same within the Code, as each is treated in separate sections. The Court noted by inference that "Congress did not treat voluntary 401(k) contributions like 401(k) loan repayments, because it did not similarly exclude them from disposable income within Chapter 13 itself." (citing to 11 U.S.C. § 1322(f)).
After noting that voluntary retirement contributions are not considered "reasonable and necessary expenses" that are deductible from disposable income, the Court recognized that § 541(b)(7) must provide some protection for voluntary retirement contributions in Chapter 13 cases. Agreeing with the McCullers court, the Sixth Circuit stated that "the most natural reading of section 541(b)(7) is that it excludes from property of the estate only those contributions made before the petition date." (emphasis added).
The Sixth Circuit noted that the BAP properly read §§ 541(a)(1) and (b) together when defining "property of the estate" as a fixed point in time (commencement of the bankruptcy case) to determine what is and is not included as property of the estate. However, the Court stated that the BAP fell short in its analysis by failing to consider the words "except that such amount" in the hanging paragraph of § 541(b)(7) excluding "such amount" from disposable income. The Court reasoned that it naturally follows § 541(b)(7) excludes from property of the estate contributions made before the petition date only - as provided by the contributions excluded by § 541(b)(7) and by the inclusion in the hanging paragraph of the phrase "such amount" - not constituting disposable income.
Restated in a simpler fashion, the Court stated "the function of § 541(b)(7) was merely to clarify that pre-petition retirement contributions do not constitute property of the estate or post-petition disposable income."
The Court specifically held that income made available after a debtor fully repays a 401(k) loan is property of the estate and projected disposable income that must be turned over to the Chapter 13 Trustee for distribution to unsecured creditors, and it may not be used to start voluntary retirement contributions.
Notably, throughout its opinion, the Court (in dicta) appears to fully agree with the Prigge and McCullers courts that no post-petition voluntary retirement contributions can be excluded from disposable income regardless of whether the debtor was making the contributions at the time the petition was filed. The Court noted in a footnote that the issue of whether continuing post-petition contributions may be excluded from disposable income if the contributions were being made as of the petition date was not before it because the Trustee has conceded this issue. The Court disagreed with the Trustee's concession.
Simply, debtor's counsel, Chapter 13 Trustees, and creditors' counsel must be aware that income that becomes available after a debtor finishes repayment of a 401(k) loan is projected disposable income that must be turned over and distributed to unsecured creditors, and such funds cannot be used to start voluntarily retirement contributions. Just as important, parties must take note of the dicta included in this case that creates an argument that no post-petition voluntary retirement contributions may be excluded from projected disposable income, regardless of whether the debtor was making the contributions pre-petition.
[1] 441 BR 667 (Bankr. D. Mont. 2010).
[2] 451 BR 498 (Bankr. N.D. CA 2011).
