Exempt Disability Income Loses Benefits In Bankruptcy

Disability insurance proceeds, from either private insurance or social security, cannot be garnished by a judgment creditor in Florida, and courts will protect the same proceeds after they are deposited in a debtor’s bank account. That’s the law in state court collections, but treatment of disability income is somewhat different in bankruptcy. 

Disability proceeds in the debtor’s account are exempt- that’s not the problem. Disability income counts as income for purposes of means test analysis and abuse. Consider a highly paid professional who can no longer work for medical reasons and who collects about $30,000 per month from a private disability policy. The same professional has unsecured debts, including a large judgment related to a failed real estate venture. The debtor wants to file Chapter 7 bankruptcy. 

Although an exempt asset, the disability income counts as income for the means test. Obviously, the debtor with $30,000 per month disability income could not pass the means test. However, the debtor is exempt from the means test because most of his debt relates to the failed real estate venture, a non-consumer debt.

 The problem in this scenario is the “abuse standard.” With so much income - albeit exempt income- this debtor can afford to pay a substantial amount of his debts over time. The facts in this case led me to believe that this Chapter 7 would be challenged as abusive because of the large monthly income. The debtor’s unsecured debt exceeded the Chapter 13 ceiling. The debtor can get no help in bankruptcy other than filing an expensive and complicated Chapter 11 bankruptcy. 

I recommended that the debtor not file Chapter 11, continue living off his exempt disability income, and go on with his life subject to the judgment. 

The point of this story is another example of the difference in Florida exemptions in and out of bankruptcy. The intent of the Florida disability income statute is to protect disability income from creditors without limit. However, bankruptcy law indirectly imposes practical limits on exempt disability income. A large amount of disability income can prevent a debtor from discharging debts in bankruptcy or require the bankrupt debtor to repay a significant portion of unsecured debts from his exempt disability income. 

The result is the same for debtors with exempt income from other sources such as pensions or required IRA distributions.