Chapter 13 Denial Of Payroll Deductions May Be Unconstitutional

Courts around the country continue to refuse Chapter 13 debtors the right to make payroll contributions into their 401(k) plans at the expense of creditors.Two recent cases have continued this trend:In re Parks, No. 11-1366 (B.A.P. 9th Cir. August 6, 2012), and In re Jenkins, No. 11-16960 (Bankr. E.D. Tenn. July 5, 2012).

The rationale behind these decisions (notwithstanding a fairly convoluted statutory construction) is understandable and even sympathetic: funding 401(k) payments during a repayment plan takes money out of creditors’ pockets and puts it into debtors’. Of course, this analysis ignores the reality that the 401(k) payment is an exclusion of a debtor’s pay that reduces their tax bill. Also, many employers match a portion of the 401(k) contribution, and this money is also lost to the debtor. Thus Uncle Sam and the debtors’ employers are enriched by the rule, with no equivalent benefit to creditors.

Especially troubling is the difference between Chapter 13 and Chapter 7. Debtors who qualify for Chapter 7 may take all the payroll deductions they want, even though creditors are enjoying no return to mitigate their losses. Chapter 13 debtors, however, are denied payroll deductions for the life of their repayment plan, between 3-5 years, even though creditors are receiving some compensation.

Walls closing inAs courts grow more comfortable with BAPCPA the walls are closing in. Chapter 13 used to be thought of as a voluntary repayment mechanism, but with the “presumption of abuse” shutting the Chapter 7 door Chapter 13 becomes the only real choice for many debtors to get any bankruptcy relief. Congress and the Courts may insist that the choice is “Chapter 7 or no Chapter 7” but the truth is more like “Chapter 13 or no bankruptcy.”

When debtors have no options, depriving them of 5 years of 401(k) deposits and income tax deductions while their Chapter 7 counterparts enjoy both makes no rational sense. When those who qualify for Chapter 7 can make payroll contributions yet those who don’t cannot, a classification scheme is created that imposes real hardship.

In other words, can BAPCPA survive an equal protection challenge?

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