Earned Income Tax Credit (EITC) Exemption is Constitutional, Says Kansas Bankruptcy Court

In a victory for debtors, a Kansas Bankruptcy Court has upheld the constitutionality of Kansas’ newest bankruptcy exemption. The new exemption, which became effective on April 14, 2011, allows Chapter 7 bankruptcy debtors to protect money they receive as a result of the Earned Income Tax Credit (EITC).

How Bankruptcy Exemptions Protect Your Property in Chapter 7 Bankruptcy

In Chapter 7 bankruptcy, the bankruptcy trustee takes all nonexempt property (including tax refunds, cash, personal property, and real estate), sells the property, and uses the proceeds to pay the debtor’s creditors. However, if a debtor’s property is deemed “exempt” by state or federal law, the trustee cannot take the property. In most Chapter 7 bankruptcies, the debtor loses little or no property, because most or all of the debtor’s property is exempt.

For a comprehensive explanation of how exemptions work, which exemptions apply to you, and more, see Nolo’s Bankruptcy Exemptions area.

Kansas’ New Exemption:  EITC

In April, 2011, the Kansas legislature created a new bankruptcy exemption. The new law allows bankruptcy debtors to protect their EITC money. This tax credit is designed to assist low- and moderate-income families. The Kansas law does not allow debtors to protect this money from creditors outside of bankruptcy.

The Trustee’s Challenge to the Kansas EITC Bankruptcy Exemption

The Chapter 7 bankruptcy trustee, in In re Westby, No. 11-40986, 2012 Bankr. LEXIS 1428, (Bankr. Kan. April 4, 2012), challenged the constitutionality of the Kansas exemption. She argued that because the statute applied to bankruptcy proceedings only, and not to other debt collection proceedings, it violated the Uniformity Clause of the Constitution. She also made other constitutional challenges to the law.

Several other courts, most notably the Bankruptcy Appellate Panel in the 6th Circuit, have held that bankruptcy-only exemptions (exemptions that apply in bankruptcy, but do not apply when creditors are trying to collect against a debtor that has not filed for bankruptcy), are unconstitutional. That 6th Circuit BAP decision, In re Schafer, is currently on appeal. Most courts have held that bankruptcy-only exemptions are constitutional.

In this case, the judge, in a 55-page opinion, found that Kansas’ EITC bankruptcy exemption did not violate the Uniformity Clause or any other constitutional provision.

Hold onto your hats, however, because the bankruptcy trustee is likely to appeal the decision.

You can read the full opinion on the website of the Kansas Bankruptcy Court, here: http://www.ksb.uscourts.gov/images/ksb_opinions/JMK_11-40986-45.pdf.