6th Circuit Clarifies Treatment of 401(k) Contributions in Chapter 13

Posted by NCBRC - October 6, 2020

Rejecting its own dictum in  Seafort v. Burden (In re Seafort), the Sixth Circuit held that a chapter 13 debtor’s post-petition voluntary contributions to an employer-sponsored retirement plan are not part of her disposable income so long as they are a continuation of pre-petition contributions. Davis v. Helbling (In re Davis), No. 19-3117 (6th Cir. June 1, 2020).

Well before she filed for bankruptcy, the debtor began making monthly contributions in the amount of $220.66 to her retirement account. When she filed for bankruptcy, she included those contributions in her schedule of expenses. The trustee objected to confirmation of the debtor’s proposed chapter 13 plan on the basis that, because of the monthly contributions to her 401(k), she was not proposing to contribute all of her disposable income to the plan. Adhering to dictum in Seafort v. Burden (In re Seafort), 669 F.3d 662, 674 n.7 (6th Cir. 2012), the bankruptcy court sustained the trustee’s objection. The debtor amended her plan to incorporate the 401(k) amount, and the bankruptcy court certified the case for direct appeal to the Sixth Circuit.

The trustee’s objection to the debtor’s proposed plan triggered application of section 1325(b)(1) which mandates that the court confirm the debtor’s plan only if she contributes all of her projected disposable income. Calculation of disposable income is governed by section 1325(b)(2) as current monthly income reduced by expenses reasonably necessary for the debtor’s maintenance or support. For an above-median debtor, like the debtor here, allowable expenses are listed in the National and Local Standards set forth in the Internal Revenue Code. Hamilton v. Lanning, 560 U.S. 505, 524 (2010) further instructs the bankruptcy court to consider changes in expenses and income that are known or virtually certain to occur in the future. Section 541(b)(7)(A) excludes from the calculation of disposable income wages withheld by an employer for contribution to an employee retirement plan. The hanging paragraph, added in 2005, continues, “except that such amount under this subparagraph shall not constitute disposable income as defined in Section 1325(b)(2).”

In Seafort, the Sixth Circuit faced the question of whether a debtor who pays off a 401(k) loan post-petition may begin making voluntary contributions to her retirement plan without those funds being deemed part of her disposable income. In finding that she could not, the court rejected the holding in Baxter v. Johnson (In re Johnson), 346 B.R. 256, 263 (Bankr. S.D. Ga. 2006), which found that all voluntary contributions to a 401(k), regardless of whether they began pre- or post-petition were excluded from disposable income. The Sixth Circuit went one step further, however, and stated in dictum that voluntary post-petition contributions to a 401(k) plan may never be deducted from calculation of disposable income. In so stating, the court agreed with In re Prigge, 441 B.R. 667 (Bankr. D. Mont. 2010), which reached the same holding, reasoning that because section 541 deals with the definition of estate property, exclusion of contributions to a 401(k) refers only to accumulated pre-petition contributions.

Against this background, the court looked at two additional ways courts have treated voluntary contributions to 401(k) plans. The first was expressed in In re Seafort, 437 B.R. 204, 210 (B.A.P. 6th Cir. 2010) (Seafort-BAP), where the bankruptcy appellate panel found that sections 541(b)(7)(A) and 1325(b) excluded from disposable income post-petition voluntary contributions to a 401(k) so long as they are a continuation of the amount the debtor had been making prior to filing for bankruptcy. The second method of addressing the issue (the CMI method) averages the debtor’s voluntary contributions for the six months prior to filing for bankruptcy and permits continued contributions in that amount. Under that method, a debtor who begins the contributions less than six months pre-petition may show a higher income than the Seafort-BAP debtor. Not surprisingly, the trustee argued that the Prigge approach should apply while the debtor argued that the court should apply either Seafort-BAP or the CMI approach.

The question on appeal was whether the term “such amount” in the hanging paragraph to section 541(b)(7)(A) refers only to the amount that had already accumulated in the debtor’s 401(k) pre-petition, as argued by the trustee, or whether it refers to the monthly amount the debtor had been contributing to the plan, as the debtor argued. Acknowledging the grammatical challenges presented by the seemingly meaningless words “except that” at the beginning of the hanging paragraph, the court found contextual support for both approaches. Because the hanging paragraph is part of the section governing property of the estate, it could logically refer only to property in existence at the time the petition was filed. However, the hanging paragraph makes reference to section 1325(b) which refers to monthly disposable income and is necessarily ongoing.

The court turned to canons of statutory construction. Because prior to BAPCPA, courts were in general agreement that voluntary contributions to a 401(k) counted toward disposable income, the court reasoned that the 2005 amendments must have been intended to work a change to that conclusion. Furthermore, if interpreted to exclude such contributions to disposable income, the hanging paragraph would add to section 1325(b), whereas the trustee’s view would make an irrelevant change as the pre-petition accumulated 401(k) contributions would never be considered disposable income under section 1325(b). The court reasoned that “the hanging paragraph’s express reference to § 1325(b)(2) reinforces our conclusion that Congress intended to allow a debtor to exclude from her disposable income the 401(k)-contribution amount withheld from her monthly wages prior to bankruptcy.”

The court noted that while its holding departed from its dictum in Seafort, it harmonized with the actual holding in Seafort under which the debtor was not permitted to begin making voluntary contributions to her 401(k) post-petition without subjecting those funds to inclusion in her calculation of disposable income.

In so holding, the court cautioned that, since the debtor had been making contributions to her 401(k) for more six months pre-petition, it was not choosing between the Seafort-BAP approach and the CMI approach.

The court vacated and remanded.

In a dissenting opinion, Judge Readler argued that the historical backdrop for the BAPCPA amendment was not as clear-cut as the majority found. Rather, Congress was faced with conflicting interpretations of how to treat voluntary contributions to a retirement fund. Therefore, it would be reasonable to conclude that the hanging paragraph solidified the prevailing view that such contributions are counted toward disposable income. The dissent reasoned that the hanging paragraph’s location in section 541 further supported the view that it reflected pre-petition contributions and that, had Congress intended otherwise, it could have stated so clearly.

Noting that Congress occasionally errs on the side of redundancy, the dissent listed certain circumstances under which the hanging paragraph could exclude pre-petition assets as income that might otherwise not be excluded, such as: gains and dividends, early withdrawals, mandatory withdrawals, and involuntary cash-outs. Therefore, the dissent argued, the hanging paragraph would not be rendered superfluous by a narrow reading.

The dissent further argued that the majority opinion was flawed because it encouraged manipulation by a debtor, and because it confounded those parties who had relied on the dictum in Seafort.

Davis 6th Cir June 2020


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