What is Bankruptcy?
In a Chapter 7 bankruptcy case, you petition a federal court for protection from your creditors. A court-appointed trustee seizes all of your assets that are not legally exempt to apply toward repayment of the creditors. The law protects "exempt" assets from seizure. In a Chapter 13 bankruptcy, you set up a schedule to repay a percentage of your debts. In drawing up the plan, the trustee may consider any income you are earning, unless it is exempt. When you have completed the requirements for a bankruptcy case, the law allows discharge (cancellation) of all debts that can be legally discharged.
Property you own that can be seized by the trustee is part of your bankruptcy estate. Income or assets that are exempt are held out of the estate. You are allowed to keep exempt assets, and in a Chapter 13 bankruptcy the trustee does not consider those assets in drawing up a repayment plan. Exemptions include a portion of your equity in your principal residence, as well as a car, books, a limited amount of jewelry, business tools that you need to earn a living, as well as Social Security disability benefits.
Bankruptcy law exempts various kinds of disability benefits. These include monthly benefits you may be receiving from the Social Security Administration, no matter what the amount. The trustee may not seize these assets to repay creditors, nor may the court consider Social Security disability benefits as income in the "means test" calculation that determines if you are eligible for bankruptcy protection. State and private disability payments are included in the means test, since the bankruptcy law does not specifically exclude them.
In effect, all types of Social Security disability benefits are exempt in bankruptcy. This includes lump-sum back benefit payments paid when Social Security approves a disability claim. The law is not as clear on private disability benefits, for example those received through an employer-sponsored disability plan. Several court decisions have found that these benefits are partially exempt, meaning you can only protect that portion of the benefit that provides for the support of yourself and your dependents, and no more. In a Chapter 7, the rest of the benefit can be subject to seizure by the trustee. In a Chapter 13, the trustee can consider only the excess amount in drawing up a repayment plan.
While Social Security disability benefits are exempt according to the bankruptcy law, other types of disability benefits are only partially exempt. It's important to document the source of any disability benefits if you are preparing to file for bankruptcy, and fully disclose to the court any and all benefits you are receiving. Evasion of the disclosure rules can result in the court rejecting your bankruptcy petition, or dismissing your case if you already have one in progress.