Bankruptcy Abuse Prevention Act: What does it mean to physicians?

President Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 into law Wednesday. It was the most comprehensive renovation in the code's 27 year history, and can be expected to profoundly impact the 1.3 million Americans who file bankruptcy each year. While a successful tort claim (malpractice suit) may not force a doctor into bankruptcy, it may cause him/her to lose malpractice coverage and, ultimately, the ability to earn an income. Without an income, loans and other off-balance-sheet obligations may result in bankruptcy.

So what does the new law mean to physicians?

  • It specifically exempts most tax-exempt retirement plans from bankruptcy (meaning you get to keep them). Examples of exempt assets include 401k's, 403b's (the hospital doctor's version of a 401k), 457 plans (for federally-employed doctors), SEP-IRA's and SIMPLE-IRA's without limitation. It also affirms the exemption for IRA's but limits the exemption to $1 million. Doctors who plan to roll their 401k balances into an IRA should keep a good paper trail to prove the money's source and preserve the exemption. Doctor who don't already have a "cross-tested plan" (the one that lets you put away about $40K per year), really ought to check into one.
  • It also puts a cap on the "homestead exemption" or the amount of home equity a debtor may keep after bankruptcy. For Oregon doctors, this is not a big change, since Oregon's paltry $33,000 homestead exemption is WAY lower than the $125,000 cap stipulated in the new law. Oregon physicians who now own homes in states with high limits or no limit on exempt equity (including Kansas, Florida, Iowa, South Dakota and Texas) will be affected by the law change. Practitioners in high risk specialties might want to investigate the purchase of a second residence in a state other than Oregon as a means to protect assets. While this is still a decent strategy, the new law makes it more cumbersome, and requires a greater amount of diligence in the planning process.
  • The new law uses "means testing" to determine whether the bankruptcy will be Chapter 7 or Chapter 13. Chapter 7 wipes most debts clean while Chapter 13 is a "reorganization" that causes debtors to repay their debts. Due to their high earning capacity, most physicians will be forced into Chapter 13, meaning they may be forced to repay a big chunk of their debts. Ouch!

If you want to protect your assets, do your planning early. Once you're being sued, it's too late.