Can You File Bankruptcy on Unemployment?

Unemployment Benefits and Bankruptcy Eligibility

Navigating financial challenges can lead individuals to consider bankruptcy. For those receiving unemployment benefits, questions often arise regarding how these benefits interact with the bankruptcy process. Bankruptcy provides a legal pathway for individuals to address overwhelming debt, offering either liquidation of assets under Chapter 7 or a repayment plan under Chapter 13. Understanding how unemployment benefits factor into eligibility for these bankruptcy types is a common concern. This article aims to clarify the implications of receiving unemployment benefits when contemplating or undergoing bankruptcy.

Unemployment benefits are generally considered income when determining eligibility for bankruptcy. This inclusion is significant because bankruptcy law assesses an individual’s financial capacity to repay their outstanding debts. The specific impact of unemployment benefits on eligibility depends on the type of bankruptcy being pursued.

For Chapter 7 bankruptcy, eligibility is primarily determined by the “means test.” This test evaluates an individual’s “current monthly income” (CMI) over a specific period. CMI is calculated as the average monthly income from all sources received during the full six-month period prior to filing for bankruptcy. Unemployment compensation is typically included in this calculation, just like wages, salaries, commissions, or other forms of income.

The CMI is then compared to the median income for a household of a similar size in the individual’s state. If the individual’s annualized CMI is below the state’s median income, they generally qualify for Chapter 7 bankruptcy. If the CMI exceeds the state median, a more detailed analysis is required. In this analysis, certain allowed expenses are deducted to determine if there is sufficient disposable income to repay creditors. Receiving unemployment benefits, which are typically lower than prior employment wages, can sometimes help an individual pass the means test by reducing their average income over the six-month look-back period. This can potentially make them eligible for Chapter 7 when they might not have been previously.

In Chapter 13 bankruptcy, unemployment benefits also play a significant role in determining eligibility and the structure of a repayment plan. Chapter 13 requires debtors to propose a plan to repay all or a portion of their debts over three to five years, based on their “disposable income.” Disposable income is the amount remaining after deducting reasonably necessary living expenses from all income sources.

Unemployment benefits are included when calculating disposable income for a Chapter 13 plan. While unemployment payments provide a regular income stream, they are often less than previous wages, which can affect the feasibility of a Chapter 13 repayment plan. Individuals must demonstrate a stable and sufficient income, including unemployment benefits, to fund their proposed payment plan, as the bankruptcy court must confirm the plan. It is important to note that unemployment income is generally considered taxable income by the Internal Revenue Service (IRS), and this taxability is consistent with its inclusion in bankruptcy income calculations.

Discharging Unemployment Debts in Bankruptcy

For individuals who have received unemployment benefits, a common concern is the dischargeability of any overpayments in bankruptcy. Unemployment benefit overpayments occur when a recipient receives more funds than they were legally entitled to. This can happen due to various reasons, including administrative errors or misreporting of information. The ability to discharge these debts in bankruptcy depends largely on the circumstances surrounding the overpayment.

Generally, unemployment benefit overpayments that resulted from an administrative error or an honest mistake on the part of the recipient may be dischargeable in Chapter 7. These are often treated like other unsecured, non-priority debts, such as credit card debt or medical bills. In such cases, if the overpayment was not due to any intentional misrepresentation or fraud by the debtor, the obligation to repay it can typically be eliminated through the bankruptcy process.

However, the situation changes significantly if the unemployment overpayment was obtained through fraud. Debts incurred by false pretenses, false representation, or actual fraud are generally not dischargeable in bankruptcy. This non-dischargeability is outlined under 11 U.S.C. § 523. For example, intentionally misrepresenting income, failing to report earnings from employment, or withholding other relevant information to continue receiving benefits would constitute fraud.

If the state unemployment agency or another governmental unit alleges that an overpayment was fraudulent, they can initiate an “adversary proceeding” within the bankruptcy court. An adversary proceeding is essentially a lawsuit filed within the bankruptcy case, where the agency would seek a court order declaring the specific debt non-dischargeable. To prove fraud, the agency would typically need to demonstrate that the debtor made a material misrepresentation, knew it was false, intended to deceive, and that the agency justifiably relied on the misrepresentation, leading to the overpayment.

In Chapter 13 bankruptcy, even if a fraudulent overpayment debt is deemed non-dischargeable, it may still be addressed within the repayment plan. While the underlying debt obligation remains, the Chapter 13 plan can provide a structured way to repay the debt over three to five years, potentially at a reduced percentage compared to the total amount owed. This contrasts with Chapter 7, where a non-dischargeable fraudulent debt would typically survive the bankruptcy and remain fully collectible after the case is closed.

Effect of Bankruptcy on Unemployment Benefits

Filing for bankruptcy generally does not prevent an individual from receiving ongoing or future unemployment benefits for which they are otherwise eligible. The bankruptcy system and the unemployment benefits system operate independently, addressing distinct aspects of an individual’s financial situation. Bankruptcy primarily deals with the discharge of debts, while unemployment benefits are a form of government assistance based on an individual’s work history and eligibility criteria established by state law.

An individual’s eligibility for unemployment benefits is determined by factors such as their reason for job loss, their availability for work, and their history of covered employment, not their bankruptcy status. Therefore, pursuing a Chapter 7 or Chapter 13 bankruptcy does not typically disqualify someone from receiving unemployment benefits.

A specific consideration arises if an individual has an existing unemployment overpayment that is subject to collection. Even if an unemployment overpayment debt is discharged in bankruptcy, the unemployment agency may still be able to “recoup” future benefits to recover the discharged amount. Recoupment means the agency can deduct amounts from future unemployment payments to offset a prior overpayment, especially if the overpayment and the future benefits arise from the same transaction or claim. This is an administrative offset that can occur even after a debt has been discharged in bankruptcy, as it is considered an adjustment to a continuing financial relationship rather than a collection of a discharged debt.