A bankruptcy reform law passed in 2005 sets a means test for Chapter 7 filers. In general terms, you must not draw an income above the median for your state and family size in order to qualify for filing under Chapter 7. If your income exceeds the median, you can deduct certain expenses to qualify for Chapter 7, including charitable contributions as defined by the IRS. The size of your contribution is not limited, but you may have to show a history of making such donations for this expense to be valid. If you make a sizable charitable donation for the sole purpose of meeting the Chapter 7 means test, the bankruptcy court may object and disqualify you.
Giving money to another party to evade creditors, either in or out of bankruptcy, is known as fraudulent transfer and is punishable under federal and state laws. The bankruptcy code excludes debtors who make charitable gifts -- either during or before the bankruptcy -- from prosecution for fraudulent transfer with certain conditions covered by the Religious Liberty and Charitable Donation Protection Act of 1998. Charitable donations must not exceed 15 percent of the debtor's gross income earned in the year of the contribution, and must conform with the debtor's past history, as evidenced by federal tax returns.
Form of Donation
For the purposes of determining abuse of the bankruptcy law, your charitable donations must be in the form of cash or financial instruments. Therefore, donating jewelry, antiques, vehicles or other non-financial goods to a charity won't protect you from prosecution for fraudulent transfer. Selling these assets and then turning over the cash can also be prosecuted, especially if you are unable to show a historical pattern of charitable giving.
Chapter 13 Conversions
An individual repaying debts under a Chapter 13 plan has the option to convert the bankruptcy proceeding to a Chapter 7, which discharges, or cancels, all dischargeable debts. However, the debtor must file a petition and win the approval of the bankruptcy court to make this conversion. The bankruptcy court can deny the petition if the purpose is to donate disposable income to charity, rather than giving it to creditors under a repayment plan, which could constitute a substantial abuse of the bankruptcy system.