Most people are familiar with the idea that in bankruptcy, you must sell certain assets like property, investments, or equity in vehicles, and the proceeds are distributed to your creditors.
But that may not be everything that your creditors are entitled to. Depending on how much money you earn and how large your family is, you could owe even more due to surplus income.
What Is Surplus Income?
It’s important to know that the bankruptcy process is far from instant. You probably know that bankruptcy will remain on your credit history for six to seven years from the date of your discharge (the first time), but the bankruptcy process itself can take months to years.
During that period, if your average monthly income exceeds the surplus income limit, your creditors will be entitled to surplus income payments, not just the assets already included in the bankruptcy process. In addition to non-registered retirement savings, equity in vehicles and property above a certain threshold, and other non-exempt assets, you could have to pay 50% of any income you earn above a Government controlled limit.
As with your assets, according to the Bankruptcy and Insolvency Act, these payments must be received by your Licensed Insolvency Trustee, who then distributes them to the appropriate creditors in their order of priority.
Surplus income limits change every year to reflect inflation. You can find updated surplus income limits posted by the government of Canada.
Limits also vary based on the size of your household. With each additional household member, the more you can earn before you have to pay part of it into your bankruptcy estate. However, if you are not the only household member who earns income, there income must also be included in the calculations.
Bankruptcy and Surplus Income
Going over the surplus income limit does not mean you have to hand over everything. The money you earn beyond your surplus income limit is charged at a rate of 50 percent, so you pay half of your surplus income to your bankruptcy trustee. The bankruptcy trustee disburses that income to your creditors, much like your assets. Your surplus income is calculated after tax.
Surplus income can also increase the length of time you are in bankruptcy. If surplus income exists, the length of the bankruptcy may be increased from 9 months to 21 months for first-time bankrupts or from 24 up to 36 months for second-time bankrupts.
According to the Bankruptcy and Insolvency Act, there are non-discretionary expenses that can be deducted from the family’s total monthly income before surplus income is determined. Some of the non-discretionary expenses can include:
- Legally mandated support payments to children or spouses
- Child care expenses
- Some medical expenses
- Court-imposed fines or penalties
- Some employment expenses
If you have non-discretionary expenses, make sure your Licensed Insolvency Trustee is aware of them.
How Is Surplus Income Calculated?
Although the idea of surplus income is a straightforward concept, applying the rules and guidelines for it can be complex. It is recommended that you discuss this with a Licensed Insolvency Trustee who can also help you with a surplus income calculator that accounts for your deductible expenses.
In addition to non-discretionary expenses, how much you owe can be further complicated by several factors or changes.
#1 Increase in Income
First of all, if your income rises part-way through the process, your surplus income payments are based on your average monthly income for the bankruptcy period. By averaging payments out, you generally save money. For example, if you went from making no surplus income payments to earning $1000 above the surplus income limit, you might worry that you would have to pay $500 for each month. However, your new income will be spread out across your entire bankruptcy period, including those months you did not have to make payments, potentially meaning more income will fall within the limit.
#2 Household Income
Second, there’s your household income. Surplus income is calculated using the net (after tax) income of the entire household. So, while more members of your household raise your limit, multiple incomes are taken into account.
Let’s take a look at this example: Peter has filed for bankruptcy individually, for debts entirely in his own name. His job pays him a salary of $2,000 per month, while his partner earns an additional $1,800 per month. The surplus income limit for 2021 for a two-member household is $2,799. As a household, they are $1,001 over the limit, but the family situation adjustment is applied. This adjusts Peter’s surplus income to a percentage of household income. Since Peter earns 52% of the household income, the $1,001 becomes roughly $520. He must pay 50% of that to his creditors, so he pays roughly $260 each month.
If the non-bankrupt partner does not divulge their income, only 50% of the surplus income limit for a family of 2 is applied to the bankrupt’s income.
#3 Lump Sum Earnings
Finally, there are lump sum payments of pre-bankruptcy income. This is when money owed to the bankrupt before they filed is finally paid, such as a legal settlement or a pending transaction. This is considered income rather than an asset, the way a windfall such as an inheritance or lottery winnings would be, so only 50% is collected.
Depending on when the lumpsum is received, if the bankrupt’s income falls short of the monthly limit, that shortfall can be deducted from the lump sum. To return to our previous example, if Peter lives alone with the same income, he is $248 short of the limit each month. He happens to receive a $10,000 lump sum payment from a dispute with a previous employer. His shortfall is multiplied by the 9 months of his entire bankruptcy, equalling $2,232. This is deducted from the lump sum income, reducing it to $7,677, however, the bankrupt pays this full amount to the estate, but the length of the bankrupt remains at 9 or 24 months with no extension for having surplus income.
It can be a complicated process. If you’re worried about how to calculate surplus income, it’s best to talk to a Licensed Insolvency Trustee about it. There are many factors that can change the equation.
Getting Out of Debt with Bankruptcy
All in all, bankruptcy should help you get back on your feet. Bankruptcy is meant to be a reformative measure, not punitive. You can rebuild your credit and even qualify for a mortgage down the line if you’re smart about using credit. Your spouse’s credit won’t be affected, and your job will not be affected in most cases. In fact, there’s no reason for your employer to even find out unless there is a garnishment on your wages.
Bankruptcy can be a valuable way to get out of debt. But there are also alternative options to bankruptcy that are easier to manage and have a smaller impact on your finances. The most popular of these is a consumer proposal. Your bankruptcy trustee at David Sklar & Associates can help you decide between a consumer proposal and filing for bankruptcy. The choice is yours; we help you figure out the best way forward.
Are Consumer Proposals a Good Idea?
If you do not own too many non-exempt assets, bankruptcy can initially look like an appealing way to get out of debt. Your credit score will take a hit, but you don’t have to worry about losing anything. If you rent an apartment, don’t own a car, and your only savings are in an RRSP, there may be very little creditors can seize. It’s one of the reasons that bankruptcy may actually be your best option.
However, surplus income limits may be surprisingly low, and depending on how much you earn each month, you could easily find yourself over the limit. It can be worthwhile comparing a consumer proposal vs. bankruptcy if you are in debt trouble but you’re earning an income.
A consumer proposal can make more sense than bankruptcy for a variety of reasons. All of your assets are protected in a consumer proposal. Instead of liquidating assets and distributing the proceeds to your creditors, you make a fixed monthly payment for up to five years. That payment is based on how much you owe, how much you make, and essential expenses. Most importantly, even if your income goes up, your payments don’t change. That includes regular income and lump sum payments.
If you receive a windfall such as an inheritance during bankruptcy, that money becomes an asset that goes to your creditors. A consumer proposal protects that money.
A consumer proposal also takes into consideration your financial reality in a way that bankruptcy rules do not. A consumer proposal gives you an opportunity to propose a fair payment to your creditors and keep better control of your finances throughout the insolvency process.
Personal bankruptcy doesn’t have to be a grand mystery. Get informed by reading our website and blog and by asking our experienced licensed insolvency trustees for help. Learning the answers to your questions could make this debt relief option a lot less intimidating.
There are many ways to get out of debt. The best solution for your money problems isn’t always obvious. Factors like surplus income in bankruptcy can change the equation. A Licensed Insolvency Trustee can help you find the best course of action.