To determine whether or not a severance pay will affect bankruptcy we first need to look at the bankruptcy qualifications, then the type of bankruptcy. Lastly, we will need to look at whether or not we can protect the severance income.
Bankruptcy Qualifications
There are two main types of consumer bankruptcy, Chapter 7 and Chapter 13. You can learn more about the different types of bankruptcy at the links provided.
Chapter 7
To qualify for Chapter 7 you must pass the means test. This test compares your household income and expenses to the average family with the same amount of family members. If your income is less than the average family, then you pass a major hurdle in qualifying for Chapter 7. If your household income is more than the average family, then you might not qualify for Chapter 7. To determine your income, we use all income received in the six months prior to filing bankruptcy. There are some types of income that are excluded such as social security income or income related to the CARES act, economic stimulus package, that was passed during the COVID-19 pandemic.
Severance pay is not excluded from the test. It is added to all other income you receive in the six months prior to filing bankruptcy. Therefore, the amount of severance received could determine whether or not you qualify for Chapter 7 at that moment.
Chapter 13
Chapter 13 is a payment plan. The payment plan is calculated using all income received in the six months prior to filing the bankruptcy case. Due to this, your severance income will affect the plan payment calculation. There are scenarios that you can argue that the severance was a one type payment, and therefore should not be used to calculate the plan payment. However, it is a flag on the case and will need to be explained.
Liquidation in Chapter 7
As explained in the Chapter 7 Overview article, Chapter 7 is liquidation. This means that the trustee looks at all your property and will liquidate property that is not protected/exempted by statute. If you received a large severance and still have the funds, then we have to determine whether the money can be protected. Each state has different exemption laws to protect your property. You can learn more about California exemptions here. Please keep in mind that the amounts change each year.
How to Solve Some of These Issues
First, you should definitely talk to a qualified bankruptcy attorney. Each case is different so there is no one answer that solves the problem for every case. However, for example, in Chapter 7, if the severance is the reason why you don’t qualify, the easiest fix might be to wait and file the case. Again, speak to an attorney because waiting to file might cause additional problems that cannot be undone. For example, you might get your wages garnished or home foreclosed on, if you do not file the bankruptcy case now.