How Having a Car Loan Can Help in Bankruptcy
The U.S. Supreme Court in Ransom v. FIA Card Services instructs that above-median debtors can take a vehicle ownership deduction of around $500 on the Means Test when calculating Projected Disposable Income, but only if there is a lien on the vehicle at the time the bankruptcy case is filed.
Ransom gives debtors a great incentive to ensure there is at least one vehicle with a lien on it for a single person, and that two vehicles have liens if filing jointly. If there are no financed vehicles, then the debtor cannot claim the approximately $500 per month deduction, which (over a five year plan) has the potential to amount to an extra $30,000 dividend paid out to unsecured creditors. That number is doubled for married couples with no vehicle liens. Instead of paying off one or more car notes during a bankruptcy, that money is used to pay unsecured creditors.
Car Title Loan
Putting aside the question of whether obtaining a title loan (or a small loan from a family member secured by the debtor’s car) just prior to filing for bankruptcy could incur a bad faith objection, let’s ask a more intriguing question: does taking a title loan on a car to create a lien trigger the vehicle ownership deduction in the first place? Several bankruptcy courts have addressed the matter, and found that a title loan is not sufficient to qualify for the vehicle ownership deduction. These courts looked to the language found in the IRS Manual, and concluded that “the intent of the deduction for vehicle ownership expenses is to accommodate the costs of acquiring a vehicle, and not expenses incurred by a debtor using the vehicle as collateral for some other sort of debt, such as a title loan.” In re Carroll, Case No. 12-41350-JDP, slip op., 4 (Bankr. Idaho April 15, 2013); see also In re Alexander, 2012 WL3156760 (Bankr. W.D.Mo. 2012); and In re King, 13-10689-WHD (Bankr. N.D.Ga. 2013).
Trade for another Vehicle
While the bankruptcy trend is to disallow an attempt to qualify for the ownership deduction with a title loan, the debtor may consider a vehicle trade to a new, used vehicle with a small amount financed. A Chapter 13 debtor may also consider financing a new vehicle just prior to filing bankruptcy to ensure case success.
Make Sure the Loan is “Perfected”
It is important that the debtor’s vehicle is used to secure a loan in order to receive the vehicle ownership deduction. For most states that means executing a promissory note and recording (“perfecting”) the lien with the Department of Motor Vehicles. As a general rule, simply writing on the title or taking possession of the title is not enough.
In theory, giving a security interest before bankruptcy can protect otherwise non-exempt property during the bankruptcy case. For example: suppose the debtor “borrowed” money from mom to buy a car. No lien was ever recorded (because good sons always repay their mothers!). On the eve of bankruptcy, the debtor owes mom $8,000 and the car is worth $8,000 (or $5,000 more than his state’s exemption law will allow him to protect). So, the debtor can simply give his mother an $8,000 secured interest in the car, right? Then the Chapter 7 trustee would have to pay mom $8,000 should he liquidate the car. In other words, the car is fully secured, mom’s secured interest survives the bankruptcy (and the debt may be reaffirmed by the good son), and there is no longer an equity issue.
A lien given for an antecedent debt on the eve of bankruptcy is a preferential transfer that the trustee can avoid. The debtor received nothing new when he gave his mother the lien. The trustee can take and sell the property without paying mom (who would be just a general, unsecured creditor after the lien is avoided).
The Bankruptcy Code is chock full of protections to shield income, property, and assets from creditors. Working with an experienced bankruptcy attorney can help you get the most out of the bankruptcy laws.