The Bankruptcy Code’s Disservice to Those Who Served

Attorneys that decide to represent veterans should understand veteran benefits because a disabled veteran may need more help besides bankruptcy. For example, a veteran rated at 70% disabled may be individually unemployable meaning the veteran cannot work and is compensated at the 100% rate. This same veteran may not be aware of the option to apply for SSDI which could result in an award with retroactive pay and a new source of income. Attorneys should take extra time to get background and history of the veteran so no stone is left unturned. Proper representation for veterans will give them the best opportunity for success and maybe avoid bankruptcy altogether.  

3. VA Disability Background and Purpose

The U.S. Department of Veterans Affairs was established in 1930 and title 38 was enacted on September 2, 1958 to administer the laws and provide benefits to veterans and their families.⁶ Veterans file claims for VA disability compensation either prior to, or immediately following discharge from service, but there is no statute of limitations for filing a claim. After review, a disability percentage is determined correlating to the compensation received.⁷

Veterans are released from active duty for a lot of different reasons.⁸ As long as the veteran leaves service with a discharge that is not under dishonorable conditions, the veteran is eligible to file a claim for benefits. A disabled veteran is defined as someone who is entitled to compensation for a disability rated at 30 percent or more, and receives compensation commensurate with the level of disability.⁹  Final ratings decisions by the VA could impact the employability of the veteran, and the wrong rating will impact a disabled veteran who cannot work.¹⁰ Table 1 lists the different rating percentages and employability determinations that affect the amount of compensation.

Table 1 – Individually Unemployable and Compensation Chart

A veteran with a spouse and child rated with a disability rating of 70 percent due to post traumatic stress disorder receives compensation of $1,566.48 per month. This veteran is permitted to work. However, if this veteran cannot work, and was properly labeled as individually unemployable, then the payment to the veteran would be $3,261.10 per month.¹¹ The proper classification results in additional compensation of $1,694.62 per month. This is important because other disability compensation programs such as SSDI can be impacted or stopped if the individual works.

4. SSDI

In 1938, Congress recognized that individuals who were permanently and totally disabled were in a desperate economic situation.¹²  Social Security Disability (SSDI) was created to provide financial assistance to workers who paid long enough into social security and due to disability cannot work.¹³  According to the Social Security Act, a disabled person is someone with a medically determinable physical or mental impairment that will either result in death or last longer than 12 months, and prevents any substantial gainful activity.”¹⁴

Individuals who apply for SSDI go through a similar process as veterans applying for VA disability compensation, but veterans are not automatically entitled to SSDI.¹⁵  Someone receiving SSDI can work, but the amount of income earned is heavily regulated.¹⁶ For a disabled veteran, VA disability compensation is not affected by receipt of SSDI.¹⁷  SSDI awards are reviewed periodically based on the classification of the disability, and the review could result in a loss of benefits.¹⁸

5. IRS Application to VA Disability and SSDI

The Internal Revenue Code defines gross income as all income regardless of the source with caveats and exceptions.¹⁹ For veterans, the IRS Code excludes amounts received for personal injuries resulting from active service in the armed forces, and disability income resulting from injuries incurred directly from military action.²⁰  The IRS Code also protects VA disability compensation from tax levy or garnishments.²¹

The IRS Code provides exclusions for gross income from SSDI, but they are not as broad.²²  Veteran disability compensation is completely excluded, whereas SSDI is exempt based on a formula.²³ The reduced taxation protection of SSDI compared to VA disability is probative of the legislative intent of protecting veterans compensation.

Exemptions overlap between VA disability and SSDI where the statute for compensation for injuries or sickness states, “gross income does not include…amounts received by an individual as disability income attributable to injuries incurred as a direct result of…military action…”.²⁴ This exception connects VA compensation and SSDI because an individual who receives compensation from both sources, if the cause of the disability is military action, can exclude all of the veteran compensation from gross income. This furthers the legislative intent that disabled veteran compensation remains with the veteran.

6. Inequities in application of acts of Congress and potential impacts

1. The chronological history and comparison of the acts of Congress

The Social Security Act was enacted on August 14, 1935.²⁵ Title 38, Veterans Benefits, was enacted on September 2, 1958.²⁶  The Internal Revenue Codes exemption of veterans’ benefits from gross income was originally amended in 1960.²⁷ The major reform of the Bankruptcy Code, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), wasn’t passed until 2005.²⁸

The Social Security Act was the baseline of how to compensate disabled persons. Veterans benefit legislation was enacted next and incorporated many of the concepts from the Social Security Act.²⁹  However, the VA provides additional benefits.³⁰ The Internal Revenue Code’s definition of gross income excludes VA disability compensation.³¹ Thus, as of the 1960 changes to the Internal Revenue Code, the acts passed by Congress created a system whereby veterans’ benefits received the same, and sometimes even more, protection as disability benefits. Following enactment of BAPCPA in 2005,³² SSDI and VA disability compensation are excluded from income under the means test in chapter 7.³³ Unfortunately, in chapter 13 SSDI is excluded unless voluntarily included by the debtor, while VA disability compensation is not.³⁴

When there are contradictions and inconsistencies in congressional acts, courts look to legislative intent but that is not always dispositive.³⁵ When congress creates legislation it often builds on previous legislation. An example is veterans disability compensation because it uses the framework of the Social Security Act but has numerous exceptions and application differences.³⁶ The Bankruptcy Code deviates from this by providing less protection to veterans than persons receiving SSDI in chapter 13.³⁷

2. Why Veterans Are Afforded So Many Protections in Other Areas of the Law, But Not in the Application of Chapter 7 Versus Chapter 13

VA disability compensation is exempted from classification as gross income. It is not subjected to means testing for under chapter 7, but is included in the disposable income calculation in chapter 13.³⁸ The compensation is the same, the purpose is the same, and the legislative intent of the compensation is the same regardless of the chapter of bankruptcy. Therefore, the compensation should be exempted from both chapters.

In chapter 7, the purpose and policy behind exempting VA disability compensation is to ensure the debtor does not end up destitute.³⁹ In chapter 13, the assumption is that the procedure for determining disposable income accounted for enough financial resources for the debtor to survive, leaving the remainder to be put towards paying the creditors.⁴⁰ A debtor that files for chapter 7 must satisfy the means test or face conversion to chapter 13 or dismissal for abuse.⁴¹ A veteran faces this same situation despite VA disability compensation being exempted, and based on the totality of the circumstances the judge can either convert the case or dismiss it.⁴² There is little dispute that anyone with the means to repay a debt should not be allowed bankruptcy protection.

In Brah, the court ruled a debtor’s decisions to pursue chapter 13 relief is voluntary, so the debtor must include VA benefits in the disposable income calculations. The justification that the debtor is filing voluntarily, or has their basic financial security resolved through the disposable income calculation to avoid being destitute, cuts against the legislative intent behind veteran disability compensation.⁴³ Congress expressly stated that VA disability compensation is exempt from tax levy or creditor garnishment.⁴⁴

Congress clearly intended the maximum protection of veteran disability compensation because it made it exempt from gross income, protects it from garnishment or levy, and prevents its use in the means test.⁴⁵ Inclusion of this compensation in chapter 13’s disposable income calculation is an outlier that contradicts legislative intent.

The case of Rowell is a good example of exclusion of VA disability compensation coupled with the authority of the court to dismiss the case for abuse. Rowell was a chapter 7 case in which the trustee moved for dismissal despite the debtor being exempted from the means test because of military service.⁴⁶ The debtors were educated professionals who lived a lavish lifestyle with a combined annual income of $443,332 dollars.⁴⁷ The court dismissed the case for abuse holding that the debtors are not needy and lived lavishly with unreasonable expenses.⁴⁸ There is no reason VA disability compensation cannot be excluded by chapter 13, and a totality of the circumstances test be used to determine when a case should be dismissed or a debtor’s disposable income adjusted to allow for additional payments to creditors under the chapter 13 plan.

3. Why is SSDI afforded more protection in the bankruptcy code than VA disability compensation?

Congress intended VA disability compensation to have broader protections and exemptions then SSDI.⁴⁹ Unfortunately, this protection of VA disability compensation stops at the gates of chapter 13.⁵⁰ On the other hand, SSDI is provided protection.⁵¹ In the case of Buren, seven individuals who received benefits under Social Security filed for chapter 13 protection, and included their Social Security benefits as part of their regular income.⁵² The court ordered the Social Security Administration to send the benefits to the trustee. On appeal the court held that the Bankruptcy Code precluded this order, and bankruptcy courts could not compel the government to pay debtor’s Social Security benefits to the trustee.⁵³

The court took the opposite approach in the case of Brah. In Brah, the trustee objected to a plan based on the debtor’s withholding VA disability compensation from the plan.⁵⁴ The debtors compared VA disability compensation to SSDI arguing that Congress intended VA disability compensation to be protected.⁵⁵ The court disagreed and held that there is a similarity between them, but no exception for VA disability exists.⁵⁶ The court never evaluated the legislative intent in drawing its conclusion.⁵⁸ The non- assignability and exempt status of benefits section of the VA Act expressly states the benefits are exempt from a claim of creditors.⁵⁸ Therefore, the protection already exists and it should preclude VA disability benefits calculated as part of disposable income.

7. Desired End-State and Takeaways

Veterans receive disability compensation because of permanent disabilities received while serving.⁵⁹ That money is paid to the veteran for life and is tax exempt, exempt from gross income calculations, and virtually free from garnishment or levy.⁶⁰ The compensation is intended to ensure financial security for the veteran, yet in a chapter 13 the veteran must include it to pay creditors. The courts have ruled this is required under the Bankruptcy Code because the debtor voluntarily files for chapter 13 protection, and inconsistency in the statutes is the responsibility of the legislature to correct.⁶¹

The argument that a debtor with multiple sources of compensation will only be required to pay an amount determined after calculation of disposable income is a strong argument.⁶² However, other legislation is equally clear that these funds are intended to remain out of creditors’ reach.⁶³ The problem with including VA disability compensation in a chapter 13 disposable income calculation is that if the debtor has the case dismissed or converted to a chapter 7 case, or never files for bankruptcy protection, the VA disability compensation cannot be attached or garnished by creditors. This inconsistency highlights the irrationality of requiring only chapter 13 debtors to include veterans benefits as income payable to creditors.