§ 125.7 — Special Deduction Order Problems: Entitlements, Pensions and Government Employers
Revised: June 8, 2004
Chapter 13 debtors sometimes fund the plan with deductions from social security or other benefits to which the debtor is entitled.1 There are three ways to do this: (1) the debtor can receive the monthly benefits check, cash it and remit to the trustee the amount required to fund the plan; (2) the debtor can instruct the Social Security Administration by written assignment to send the benefits check directly to the Chapter 13 trustee; or (3) an income deduction order can be sent to the Social Security Administration requiring it to remit some or all of the debtor’s benefits to the Chapter 13 trustee, with the balance payable to the debtor. There are problems with each of these procedures.
There is disagreement in the reported decisions whether social security benefits are regular income for purposes of eligibility for Chapter 13.2 Even if social security benefits are regular income and are property of the estate, after the 1983 amendments to 42 U.S.C. § 407 of the Social Security Act, there is doubt whether a bankruptcy court can issue an income deduction order to the Social Security Administration.3 Although the 1983 amendments to § 407 are not clear, most jurisdictions stopped sending income deduction orders directly to the Administration rather than litigate.
Without the option of an income deduction order, a Chapter 13 debtor who wishes to fund the plan from social security benefits must either assign the entire benefits check directly to the Chapter 13 trustee or must receive the monthly check and divide it, essentially in the manner of a direct-pay case.4
Direct assignment of benefits is not always implemented by the Social Security Administration because assignment to a Chapter 13 trustee does not fit easily into any of the recognized categories of entities to whom a direct assignment of benefits is permitted. Also, the amount required to be paid to the Chapter 13 trustee each month is typically less than the total benefits check payable to the debtor. If the debtor assigns the entire check to the trustee, the trustee must then cash the check and refund a portion to the debtor—a practice most Chapter 13 trustees resist and that is frowned upon by the U.S. trustee.
It has thus developed in many jurisdictions that plans funded from social security benefits are direct-pay plans where the debtor receives the benefits check and sends a portion to the trustee. Such cases suffer the same feasibility problems as other direct-pay cases.
Not all entitlements programs are as difficult to work with as the Social Security Administration. Debtors often receive benefits or assistance from public agencies5 that can be required by income deduction order to remit to the Chapter 13 trustee. For example, in In re Hammonds,6 the U.S. Court of Appeals for the Eleventh Circuit held that AFDC benefits can be directed to a Chapter 13 trustee by income deduction order under § 1325(c). This holding was applied by a district court to require the state of Pennsylvania to distribute a Chapter 13 debtor’s AFDC benefits to the Chapter 13 trustee.7 These courts reasoned that because the statutes and regulations that control the payment of AFDC permit assignment to third parties under certain circumstances, AFDC benefits are within the reach of income deduction orders under § 1325(c). Similarly, it has been held that an income deduction order can require a state to remit unemployment benefits directly to the trustee.8
Income deduction orders to the IRS to remit tax refunds to the trustee work just fine in some districts and not at all in others. One court held that an income deduction order can require the IRS to remit a tax refund to the Chapter 13 trustee because no provision of federal law like § 407 of the Social Security Act protects tax refunds from deduction orders under § 1325(c).9 The Bankruptcy Court for the Western District of Washington routinely orders the IRS to remit tax refunds to the Chapter 13 trustee and has held that § 1325(c) “impliedly modified” the Assignment of Claims Act to allow the assignment of tax refunds to the trustee.10 A district court for the (same) Western District of Washington has held that sovereign immunity prohibits income deduction orders to the IRS in Chapter 13 cases.11
When the benefit or entitlement is protected by federal law with an anti-assignment provision like § 407 of the Social Security Act do the courts refuse to enforce income deduction orders.12 Provisions of state law prohibiting assignment of benefits or entitlements have been held to give way to 11 U.S.C. § 1325(c) under the supremacy clause.13 One court rejected an Eleventh Amendment defense by the state of Pennsylvania to an income deduction order to remit AFDC benefits, reasoning that the deduction order was issued after state funds were awarded to the debtor; therefore, the funds no longer belonged to the state and the order did not implicate Eleventh Amendment analysis.14
It is hard to understand the resistance of benefits and entitlements programs to the issuance of income deduction orders in Chapter 13 cases. It is a misguided sense of protecting beneficiaries that leads the Veterans Administration, for example, to resist efforts by veterans to fund Chapter 13 plans with income deduction orders.15 During the court hearings in Hildebrand v. Social Security Administration (In re Buren),16 the Social Security Administration admitted it opposed income deduction orders for purely administrative reasons—the inconvenience to the Administration of compliance. Debtors and trustees in litigation with a state or federal agency over the efficacy of an income deduction order should carefully review the statutes and regulations that control the payment of benefits by the agency involved. If the agency’s rules allow the assignment of benefits, for example, to spouses or to suppliers of necessary goods and services, the courts are more likely to enforce an income deduction order under § 1325(c).
Although there is some disagreement, a majority of reported decisions hold that pension benefits are regular income for eligibility purposes.17 Several courts have held that an income deduction order can be sent to the pension fund requiring payment of benefits to the Chapter 13 trustee.18
In McLean v. Central States, Southeast & Southwest Areas Health & Welfare Pension Fund (In re McLean),19 the U.S. Court of Appeals for the Fourth Circuit concluded to the contrary that an ERISA-qualified pension plan was a spendthrift trust; thus, the debtor’s benefits were not estate property, and the pension fund was not subject to an income deduction order.20 It is not obvious why the power to order an income deduction under § 1325(c) is limited to property of the estate.21 Even ERISA-qualified pension benefits are income to the Chapter 13 debtor.22 Section 1325(c) permits the bankruptcy court to order “any entity from whom the debtor receives income” to pay part or all of that income to the Chapter 13 trustee. The phrase of art “property of the estate” appears nowhere in § 1325(c). The court in McLean inappropriately limited the reach of § 1325(c). The Supreme Court’s decision in Mackey v. Lanier Collection Agency & Service, Inc.23 may affect McLean and similar cases that restrict the use of ERISA-qualified pension benefits in Chapter 13 cases.
One reported opinion finds a jurisdictional reason why a bankruptcy court cannot enforce an income deduction order to a pension fund. In In re Vega,24 the debtor received income from a public school retirement system. It was routine in the district that a pay order issued pursuant to § 1325(c). The retirement system objected to the pay order, and the bankruptcy court sustained the objection:
Missouri law provides that funds in the [Public School Retirement System] and benefits accruing therefrom are inalienable and may not be assigned. . . . A pay order is, first and foremost, a court order. It cannot be issued unless the court has the subject matter jurisdiction to do so. The party against whom such an order is directed is not otherwise a party to the proceeding. It is only by virtue of the debtor’s property interest in the fund in question that the court has the jurisdiction to enter an order binding on a third party. Congress has conferred broad and exclusive jurisdiction in the district court (and by extension the bankruptcy court) over property of a bankruptcy estate in Section 1334(d) of Title 28, and it is via that jurisdiction that a bankruptcy court is justified in issuing orders under Section 1325(c) to those who hold property of the estate, such as entities from whom a debtor is receiving income, to pay all or a portion of that income to the trustee. No other source of jurisdiction is available to support the validity of Section 1325(c). . . . [T]he only interpretation of Section 1325(c) that saves it from invalidity (for conferring a power beyond the subject matter of the courts to exercise in the first place) is one that limits its reach to the scope of property of the estate as found in Section 1306. The [Public School Retirement System] cannot be compelled to honor a pay order if the res in question lies outside the subject matter jurisdiction of this court. Of course, once the funds are paid over to the debtor, they become (at least conceivably) property of the estate, so it is legitimate for the trustee to consider the income realized by the debtor from this fund when she considers whether to recommend confirmation of the debtor’s plan. And similarly, the debtor is free to use these funds to fund her plan upon her receipt of them. But these are different issues from the one presented by [the Public School Retirement System]. [The Public School Retirement System] simply wants to be free of the onus of having to honor pay orders from bankruptcy courts. This court concludes they should be.25
The outcome in Vega is odd. The debtor had a vested interest in benefits from the retirement system. It may be true that the debtor’s interest did not become property of the bankruptcy estate because of the special character of the public school retirement system;26 however, one of two things must be true about that interest: the debtor’s entitlement to retirement benefits is either property of the estate or property of the debtor. By either characterization, that property interest is within the jurisdiction of the bankruptcy court under 28 U.S.C. § 1334.27
That benefits due the debtor from the retirement fund are inalienable under nonbankruptcy law may be relevant to whether those benefits are property of the estate, are property of the debtor, are exempt property and so forth, but nothing in § 1325(c) limits the power of a bankruptcy court to issue an income deduction order based on whether the income is property of the estate, property of the debtor or alienable. Vega unnecessarily insulates the retirement system from an income deduction order based on an imagined jurisdictional limitation.
Military pay can be used to fund a Chapter 13 plan,28 but the mechanics may involve more than just an income deduction order. Members of the armed forces are permitted to make allotments of their pay by filing a form with the military paymaster. A Chapter 13 debtor in the armed forces can file the pay allotment form and cause a portion or all of the debtor’s pay to be sent to the Chapter 13 trustee.
The process is cumbersome and typically takes as long as 60 days before the allotment is effective. During the interim, the debtor must make payments directly to the Chapter 13 trustee.
Other government employees can fund Chapter 13 plans in the normal way—with an income deduction order to the appropriate paying authority. In 1993, Congress eliminated most restrictions on garnishment of federal employees,29 eliminating in the process whatever resistence existed under prior law to deduction orders in Chapter 13 cases. But as detailed elsewhere,30 some federal agencies are now authorized by statute to charge a fee for honoring garnishments and similar collection devices. An income deduction order in a Chapter 13 case is not a garnishment and should not be subject to any collection fee.31
1 The eligibility of debtors receiving income from social security or other entitlement programs is discussed beginning at § 12.5 Social Security.
2 Compare United States v. Devall, 704 F.2d 1513 (11th Cir. 1983) (Decided before 1983 amendments to 42 U.S.C. § 407, social security benefits are available to fund plan. Income deduction order can be sent to the Social Security Administration.), with Hildebrand v. Social Security Admin. (In re Buren), 725 F.2d 1080 (6th Cir.), cert. denied, 469 U.S. 818, 105 S. Ct. 87, 83 L. Ed. 2d 34 (1984) (Social security benefits are not available to fund plan because of (former) § 407 of Social Security Act. 1983 amendments to that section confirm this holding.). See § 9.5 [ Social Security ] § 12.5 Social Security.
3 See Hildebrand v. Social Security Admin. (In re Buren), 725 F.2d 1080 (6th Cir.), cert. denied, 469 U.S. 818, 105 S. Ct. 87, 83 L. Ed. 2d 34 (1984) (Social Security Administration is immune from income deduction orders in Chapter 13 cases.); United States v. Carey, 36 B.R. 194 (Bankr. D. Kan. 1983) (Section 407 of the Social Security Act and the 1983 amendments to that section prohibit payroll deduction orders to the Social Security Administration.). But see In re Baxter, 34 B.R. 911 (Bankr. E.D. Tenn. 1983) (1983 amendments to § 407 of the Social Security Act unconstitutionally deny Chapter 13 relief to social security recipients.).
4 See § 250.1 [ Direct-Pay Orders ] § 125.3 Direct-Pay Orders.
5 See §§ 9.7 [ AFDC, Welfare and Other Entitlements ] § 12.7 Family Assistance, Welfare and Other Entitlements and 9.8 [ Unemployment Benefits, Strike Benefits and the Like ] § 12.8 Unemployment Benefits, Strike Benefits and the Like.
6 729 F.2d 1391 (11th Cir. 1984).
7 Howell v. Pennsylvania Dep’t of Pub. Welfare (In re Howell), 138 B.R. 484, 487, 489 (W.D. Pa. 1992) (Because AFDC benefits are property of the Chapter 13 estate, they are subject to an income deduction order under § 1325(c) unless some other federal law prohibits application of § 1325(c). Unlike 42 U.S.C. § 407, which insulates social security benefits from the operation of “any bankruptcy law,” 42 U.S.C. § 606(b) permits the payment of AFDC benefits to third parties who are supplying goods or services to an AFDC recipient. The regulations, found at 45 C.F.R. § 234.60(a)(1) et seq., permit disbursements of AFDC benefits to third parties under appropriate circumstances. “In conjunction with the authorization within the Chapter 13 Bankruptcy Code to subject welfare benefits to attachment, the court finds that no federal law removes AFDC benefits from operation of 11 U.S.C. § 1325(c).” Although an income deduction order with respect to AFDC benefits is voluntary and can be terminated at any time, “the . . . success of the Chapter 13 plan often times depends on an income attachment order.”).
8 In re Jenkins, 58 B.R. 702 (Bankr. W.D. Mich.), aff’d, 64 B.R. 195 (W.D. Mich. 1986) (Despite anti-assignment provisions of Michigan law, § 1325(c) empowers bankruptcy court to order Michigan Employment Security Commission to remit unemployment benefits directly to the Chapter 13 trustee.).
9 In re Cochran, 141 B.R. 270, 273 (M.D. Ga. 1992) (A tax refund constitutes income. A tax refund is a repayment of an overpayment of taxes on income, thus it should be classified as income for Chapter 13 purposes. The Anti-Assignment Act, 31 U.S.C. § 3727, does not prohibit a bankruptcy court from issuing an income deduction order to the IRS directing that any tax refunds due the debtor be paid directly to the U.S. trustee for distribution under the debtor’s Chapter 13 plan. “[S]imilarly to the court in Devall, [United States v. Devall, 704 F.2d 1513 (11th Cir. 1983),] . . . § 1325(c) has impliedly modified the Anti-Assignment Act to allow the assignment of tax refunds to the trustee via income deduction orders. . . . This holding is supported by the fact that there appears to have been no action taken by Congress in the area of tax law forbidding the application of income deduction orders to tax refunds similar to that body’s modification of § 407 [the anti-assignment provision of the Social Security Act, 42 U.S.C. § 407,] to prevent bankruptcy income deduction orders from applying to social security benefits.”). Accord In re McMillan, 285 B.R. 480 (Bankr. W.D. Wash. 2002) (Bankruptcy court can order the IRS to remit tax refunds to the Chapter 13 trustee. Congress has not restricted the use of income deduction orders to the IRS as it did under the Social Security Act in 42 U.S.C. § 407.).
10 In re McMillan, 285 B.R. 480, 483–84 (Bankr. W.D. Wash. 2002) (“[T]ax refunds qualify as income for purposes of 11 U.S.C. § 1325(c). . . . The Assignment of Claims Act [31 U.S.C. § 3727] prohibits the assignment of income tax refunds prior to submission of the tax return and allowance of the refund by the IRS. . . . [T]he court in [In re Cochran, 141 B.R. 270 (M.D. Ga. 1992),] determined that 11 U.S.C. § 1325(c) impliedly modified the more general Assignment of Claims Act to allow the assignment of tax refunds to the trustee. . . . [T]his Court concludes that it is not barred in the instant cases from ordering the IRS to remit tax refunds directly to the Trustee by the Assignment of Claims Act.”).
11 In re Knapp, 294 B.R. 334, 337–38 (W.D. Wash. 2003) (“In order to comply with the bankruptcy court’s order, the IRS would have to override the existing system and manually process the refund. This process would ‘require a significant expenditure of resources’ . . . . [S]overeign immunity has not been waived. . . . Several bankruptcy codes [sic] are specifically listed in § 106(a), however, § 1325 is not one of them. . . . Although the IRS filed a ‘proof of claim,’ the order under § 1325(c) requiring refunds to be sent to the trustee is not a ‘claim against [the United States] that is property of the estate.’”).
12 See, e.g., In re Roach, 90 B.R. 286 (Bankr. W.D. Mich. 1988) (Finding Hildebrand v. Social Security Admin. (In re Buren), 725 F.2d 1080 (6th Cir.), cert. denied, 469 U.S. 818, 105 S. Ct. 87, 83 L. Ed. 2d 34 (1984), to be controlling and disagreeing with In re Baxter, 34 B.R. 911 (Bankr. E.D. Tenn. 1983), the anti-assignment provisions applicable to veterans benefits, 38 U.S.C. § 1301(a), are rationally based on legitimate state interests and do not conflict with the equal protection clause of the Fifth Amendment. The anti-assignment of benefits provision was not impliedly repealed by 11 U.S.C. § 1325(c); thus, the bankruptcy court is without authority to order the Veterans Administration to remit funds directly to the Chapter 13 trustee.), aff’d, 94 B.R. 440 (W.D. Mich. 1988).
13 See In re Jenkins, 64 B.R. 195 (W.D. Mich. 1986) (Section 1325(c) overcomes anti-assignment provisions of Michigan law with respect to unemployment benefits.).
14 In re Howell, 136 B.R. 120 (Bankr. W.D. Pa. 1991), aff’d, 138 B.R. 484 (W.D. Pa. 1992).
15 See In re Roach, 90 B.R. 286 (Bankr. W.D. Mich.), aff’d, 94 B.R. 440 (W.D. Mich. 1988).
16 725 F.2d 1080 (6th Cir.), cert. denied, 469 U.S. 818, 105 S. Ct. 87, 83 L. Ed. 2d 34 (1984).
17 See § 9.4 [ Pensions ] § 12.4 Retirement Income.
18 See Regan v. Ross, 691 F.2d 81 (2d Cir. 1982); In re Simmons, 94 B.R. 74 (Bankr. W.D. Pa. 1988); Miles Fin. Co. v. Robinson, 39 B.R. 47 (Bankr. E.D. Va. 1984); In re Kelley, 31 B.R. 786 (Bankr. N.D. Ohio 1983); In re Wood, 23 B.R. 552 (Bankr. E.D. Tenn. 1982).
19 762 F.2d 1204 (4th Cir. 1985).
20 Accord Chrysler-UAW Pension Plan v. Watkins (In re Watkins), 95 B.R. 483 (W.D. Mich. 1988) (Pension plan was enforceable spendthrift trust. Debtor’s interest was excluded from property of the Chapter 13 estate, and the bankruptcy court could not direct the pension plan to pay a portion of the debtor’s monthly pension benefits to the trustee.); In re Snipe, 276 B.R. 723, 723–24 (Bankr. D.D.C. 2002) (Section 1325(c) does not authorize bankruptcy court to compel income deduction from an ERISA-qualified pension plan. Citing Patterson v. Shumate, 504 U.S. 753, 112 S. Ct. 2242, 119 L. Ed. 2d 519 (1992), “the [Washington Suburban Sanitary Commission] Retirement Plan qualifies as an ERISA-qualified pension plan and hence is not property of the estate. . . . That concession necessarily precludes issuing a § 1325(c) payment order to the WSSC Retirement Plan. . . . ERISA does not distinguish between voluntary and involuntary assignments: both types of assignments are barred by ERISA’s antialienation provision. . . . There is no evidence that Congress intended to override ERISA’s antiassignment provision by virtue of § 1325(c). . . . I find persuasive . . . the reasoning of Hildebrand v. Social Sec. Admin. (In re Buren), 725 F.2d 1080 (6th Cir.), cert. denied, 469 U.S. 818, 105 S. Ct. 87, 83 L. Ed. 2d 34 (1984), which held that § 1325(c) could not be viewed as amending by implication 42 U.S.C. § 407 to create an exception to its antialienation provision.”). See also In re Burgette, 114 B.R. 188 (Bankr. W.D. Mo. 1990) (Debtor’s interest in a state-mandated retirement system probably is property of the Chapter 13 estate but is exempt under state law and excluded from the best-interests-of-creditors-test calculation in § 1325(a)(4).).
23 486 U.S. 825, 108 S. Ct. 2182, 100 L. Ed. 2d 836 (1988).
24 163 B.R. 489 (Bankr. W.D. Tex. 1994).
25 163 B.R. at 490–92.
26 See 11 U.S.C. § 541(c).
27 Section 1334 provides as follows:
The district court in which a case under title 11 is commenced or is pending shall have exclusive jurisdiction of all of the property, wherever located, of the debtor as of the commencement of such case, and of property of the estate.
28 U.S.C. § 1334(e), as redesignated by Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 104, 108 Stat. 4106 (1994) (emphasis added).
28 See In re Adams, 115 B.R. 59, 63 (Bankr. D.N.J. 1990) (Court can order the Navy to send a portion of a debtor’s wages to the Chapter 13 trustee and a portion to the debtor’s mortgage company. “A wage order is in the nature of injunctive relief, not ‘monetary recovery’ within the meaning of [Hoffman v. Connecticut Dep’t of Income Maintenance, 492 U.S. 96, 109 S. Ct. 2818, 106 L. Ed. 2d 76 (1989)]. . . . Navy’s argument that . . . wage orders violate sovereign immunity is without merit.”). See also In re Williams, 20 B.R. 154 (Bankr. E.D. Ark. 1982) (After confirmation, § 1325(b) permits income deduction order to a seaman notwithstanding 46 U.S.C. § 601.).
29 See Pub. L. No. 103-94, 107 Stat. 1001 (Oct. 6, 1993).
30 See § 249.1 [ Can Employer Charge a Fee? ] § 125.2 Can Employer Charge a Fee?.
31 See, e.g., Hudson v. United States Postal Serv. (In re Hudson), 216 B.R. 244 (Bankr. W.D. Tenn. 1997), aff’d, 230 B.R. 542 (W.D. Tenn. 1999) (Postal Service assessment of $50 administrative fee on income deduction orders in a Chapter 13 case pursuant to 5 U.S.C. § 5520a violated the automatic stay.); United States v. Santoro, 208 B.R. 645 (E.D. Va. 1997) (Bankruptcy court has jurisdiction to stop Postal Service from deducting $50 administrative fee on income deduction orders in Chapter 13 cases under the pre-1996 version of 5 U.S.C. § 5520a; income deduction order is not in the nature of garnishment and is not subject to the administrative fee.).