How Bankruptcy is Affected By Your Worker’s Comp Settlement

In my last article, I discussed why keeping your worker’s compensation funds in a separate, dedicated account is the only way to ensure they remain “traceable” and exempt from creditors. But when it comes to bankruptcy, that alone isn’t enough to qualify because of the Means Test and Disposable Income Test.

Many people assume that because worker’s compensation is an “injury benefit,” it is exempt from bankruptcy, unlike a personal injury case where the settlement funds are part of the estate. While that is true for Social Security, the Bankruptcy Code treats workers’ compensation funds differently.

By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).

Key Takeaways: Worker’s Comp, the Means Test, and the Schedules I and J

• Worker’s Comp Funds: Unlike Social Security, worker’s compensation benefits are generally included in the 6-month Current Monthly Income (CMI) calculation for the Means Test.
• The Lookback vs. The Snapshot: The Means Test averages your income over the last 6 months, while Schedule I focuses on income for the month of filing.
• Schedule I vs. Schedule J: Slashing your expenses on Schedule J increases the gap between income and spending, resulting in more “Disposable Income.”
• Document Every Injury-Related Expense: To reduce disposable income, Schedule J should include additional expenses related to your injury, such as medical co-pays, specialized transport, and “reasonably anticipated” future medical costs, to accurately reflect your needs.
• Strategy in Timing: Depending on the facts, sometimes filing should be delayed to reduce the 6-month average income, as a strategy to avoid a 5-year Chapter 13 plan.

The Means Test: A Six-Month Lookback

When you file for bankruptcy, the court looks at your Current Monthly Income (CMI), which is a debtor’s income averaged out over the prior six months. This is known as the Means Test.

Unlike Social Security, which is explicitly excluded from the Means Test, worker’s compensation is generally included. If you received a large lump-sum settlement or high weekly benefits during those six months, your “average” income might look much higher than it actually is today.

This can push you above the state median, triggering the “presumption of abuse,” pushing a debtor to Chapter 13 bankruptcy. But passing the Means Test is only the first step when it comes to income calculations.

Schedule I (Income) vs. The Means Test

While the Means Test looks at the past, Schedule I looks at the present, a debtor’s income for the month of filing.

If worker’s compensation benefits have recently ended or been reduced, Schedule I (Income) reflects that. But Schedule I doesn’t stand alone, as it has to be compared to Schedule J (Expenses). The difference between Schedules I and J is where the real danger is for injured workers.

When people are injured and out of work, they naturally try to survive financially by “tightening their belts.” They cut back on groceries, find cheaper rent, and maybe even rent out a room in their home. While this is smart for survival, it can be a disaster in a bankruptcy petition.

If your Schedule I (Income) shows you are receiving $3,000 a month in worker’s comp, but your Schedule J (Expenses) only shows $2,200 because you’ve slashed your expenses, there’s an $800 monthly surplus.

To a Bankruptcy Trustee, that $800 is “Disposable Income.” Even if that money is legally exempt from workers’ comp, the court may argue that since you aren’t spending it on “reasonable and necessary” support, it should be paid into a Chapter 13 plan to satisfy your creditors.

The Disposable Income Test

To avoid falling into the disposable income trap, Schedule J must reflect the true cost of your situation. This includes:

• Ongoing medical co-pays and therapy.
• Increased utility costs from being home-bound.
• Specialized transportation or home maintenance you can no longer do yourself.
• Future medical expenses that are “reasonably anticipated.”

The Professor’s Conclusion

Don’t let the math of your injury settlement work against you. Understanding how the Means Test and Schedules I and J work into your budget is the difference between a total discharge and a five-year payment plan.

I always tell my clients that bankruptcy strategy sometimes requires speeding up or slowing down a case. If your worker’s compensation funds are working against you, then delaying filing could be your best option to avoid Chapter 13.

Don’t forget to read my series on personal injury settlements and bankruptcy, which includes a deep dive on the process, how settlements are handled in Chapter 7 and 13, and how to protect your settlement.