How are unemployment benefits handled after declaring bankruptcy? The short answer is that they are considered income and the long answer is more complicated if you’re receiving unemployment insurance.

While having spent many years helping my Connecticut clients through personal bankruptcy, I’ve found that unemployment is one of the most common reasons for filing choosing to file, second only to medical expenses. In fact, the two can be related if your unemployment is due to an illness that prevents you from working.

But in this economy, having to choose to file bankruptcy can be as simple as being laid-off due to your employer closing its business or having to cut back on the number of employees because profits are down.

In many cases, losing your job happens for reasons beyond your control.

Once you are unemployed, you will likely file for unemployment benefits until you find another job.

If you meet the criteria, you may be able to qualify for unemployment but the amount you receive is always only a small percentage of what you were earning prior to losing your job.

This is what often leads the unemployed to file for bankruptcy if they are without a job for a long time.

But if you receive unemployment benefits or other income during the bankruptcy process, how does that affect your ability to discharge your debt?

Filing for Chapter 7 bankruptcy and unemployment

One of the first questions to determine whether your unemployment benefits will be included as income for bankruptcy purposes is “what type of bankruptcy do you want to file?”

If you choose Chapter 7, the fact that you are unemployed may actually be a plus. Chapter 7 allows you to wipe out, or liquidate, most of your debt, except for debt that may not be dischargeable such as child support, alimony, student loans and taxes.

Your ability to file for Chapter 7 is based upon a means test. This test measures your income at the time of filing for bankruptcy and compares it to the median income in your state for a similar household the same size as yours.

You will qualify for Chapter 7 if your income is below the median

If your income exceeds the median, you may still qualify for Chapter 7 if your income is below an amount set by law.

While the means test is part of the federal law that governs the bankruptcy courts, each state has the ability to set its own standards for the means test so it can compare figures according to circumstances in that state.

Even if you aren’t able to qualify immediately for Chapter 7 after you lose your job, you may be able to qualify within a few months.

The limited amount of most unemployment benefits will usually be less than the median, and your financial situation may deteriorate while you are unable to pay your bills.

One exception may be if you have other money, such as payments from rental property or retirement benefits that may be counted as income.

Social security and bankruptcy

Another complication to filing personal bankruptcy, is that social security benefits are generally not included in the means test.

But some bankruptcy courts have held that unemployment compensation is a form of social security because under federal law unemployment compensation is funded through Social Security.

Again, like Connecticut, all states have made different decisions on this issue. Whether your jurisdiction views unemployment compensation as income or not, may make a difference in your ability to file Chapter 7 bankruptcy.

Either way, you are required to list unemployment compensation as part of your monthly income.

You may list it as a social security benefit and hope that it is excluded, but the Bankruptcy Trustee in your jurisdiction may disagree and include it.

Filing for Chapter 13 bankruptcy

Chapter 13 bankruptcy requires a totally different standard. Chapter 13 is a three-to-five year process that allows debtors to pay all or a portion of debt over that period of time based on their income, with “income” being the operative word.

If you have no income, or the minimal amount of income generally collected from unemployment benefits, you may not have enough resources to meet the repayment plan set up by the court.

But if you have other sources of income, such as those listed above, you may still be able to qualify.

Also, if you get a job later, you can bring this to the court’s attention with the proper documentation and then qualify for Chapter 13 if your income is then sufficient.

The opposite is also true. If you become unemployed during a Chapter 13 bankruptcy and start drawing unemployment, the bankruptcy court will have to consider whether your unemployment income will be enough for you to continue making your payments under the plan devised according to your income while you were employed.

If the court finds that you personally cannot afford the payments, your Chapter 13 plan may be dismissed.

Your plan could be converted to Chapter 7 liquidation plan if you qualify, or you may file for Chapter 13 again if you get a new job or find another source of income.

So I have Options?

Yes and as you can see, whether or not your unemployment benefits will be included in your income for bankruptcy purposes is open to interpretation depending not only on the state where you file for bankruptcy, but on many other circumstances.

Because the difference between the two options of either filing bankruptcy, or not filing at all, can be very complicated. It is very important to consult with an experienced bankruptcy attorney before making a decision.

When you have enough to worry about due to unemployment, so don’t complicate them by making uninformed decisions about bankruptcy.