Ninth Circuit Holds that a Debtor Cannot Use a 401(k) Loan Repayment to Reduce Disposable Income for the Means Test

This article is provided by the Gilbert Bankruptcy Attorneys at Wilson-Goodman & Fong, P.C.

A three judge panel of the Ninth Circuit recently ruled that a 401(k) loan repayment does not qualify as a “monthly payment on account of secured debts” or an “other necessary expense” that can be used to reduce a debtor’s income for purposes of passing the Means Test in bankruptcy. Egebjerg v. Anderson, 2009 U.S. App. LEXIS 11651 (9th Cir. 2009).

The debtor, Lee Egebjerg, had taken out a loan from his 401(k) retirement account and was making regular repayments when he filed for Chapter 7 bankruptcy protection. In calculating his disposable income, Egebjerg included his loan payments as a necessary expense. The trustee moved to dismiss his petition, arguing that such repayments should not be included and that, absent them, Egebjerg’s petition was presumptively abusive under the Means Test. The trustee also argued that, even if not presumptively abusive, Egebjerg’s petition should still be dismissed because, under the totality of the circumstances, he still had the ability to repay his debts.

The bankruptcy court agreed with the trustee as to the latter argument and the Ninth Circuit affirmed. Not only did the appeals court agree that, under the totality of the circumstances, Egebjerg was able to repay his debts, the court also held that 401(k) loan payments do not count as payments on a secured debt (contrary to the lower court’s ruling). The Ninth Circuit reasoned that the loan was not, in fact, a debt: “Egebjerg’s obligation is essentially a debt to himself – he has borrowed his own money. Egebjerg contributed the money to the account in the first place; should he fail to repay himself, the administrator has no personal recourse against him” (internal citations omitted).

The court also rejected Egebjerg’s claim that his loan repayments were an “other necessary expense.” Relying heavily on Internal Revenue Service policy, the court reasoned that his repayments were the “functional equivalent of voluntary contributions to a retirement plan.” The payments also failed to qualify as a “special circumstance” under the Bankruptcy Code, as Egebjerg could not demonstrate that he took out the loan for any particularly extraordinary or compelling reason; rather, 401(k) loans are a common offshoot of the general financial problems that precede bankruptcy.

If you need answers to your chapter 7 bankruptcy or chapter 13 bankruptcy questions, please contact the lawyers at Wilson-Goodman & Fong, P.C. through their website or you can call them directly at 480-503-9217. They have offices in Gilbert and Queen Creek to serve the entire East Valley.