Legal Sidebari

Veterans’ Benefits and Bankruptcy
January 25, 2019
Although federal law entitles veterans to certain types of monetary benefits—such as compensation for
disabled veterans injured in the line of duty—these benefits are not always enough to satisfy veterans’
financial needs and obligations. Statistics from the U.S. Census Bureau indicate that the veteran poverty
rate has increased 8.7% in recent years, and that close to half of disabled veterans between the ages of 55
and 64 are below the poverty line.
One way that a veteran facing particularly difficult financial circumstances may potentially obtain relief
from certain debts is by filing for bankruptcy. However, bankruptcy relief comes at a cost: a debtor must
ordinarily sacrifice some of his income or his assets to satisfy the claims of his creditors in whole or in
part. As relevant here, depending on the circumstances, a veteran may need to relinquish some of his
veterans’ benefits to his creditors. Existing bankruptcy law thus treats veterans’ benefits less favorably
than social security benefits, the latter of which the Bankruptcy Code insulates from the claims of
creditors under specified circumstances.
Several commentators—as well as some Members of Congress—have advocated amending the
Bankruptcy Code to make it easier for debtors to shield veterans’ benefits from creditors. Proponents of
such an amendment argue that “benefits paid to veterans through the Department of Veterans Affairs”
should be treated no differently in bankruptcy “than benefits received by individuals from the Social
Security Administration.” As discussed below, these proposals raise complex legal questions.
This Sidebar surveys the legal issues surrounding the treatment of veterans’ benefits in bankruptcy. After
providing an overview of the U.S. bankruptcy system, the Sidebar analyzes how veterans’ benefits are
treated in the two most common types of bankruptcy proceedings for individual debtors. The Sidebar
concludes by discussing proposals to modify the treatment of veterans’ benefits in bankruptcy and
identifies pertinent considerations for Congress when developing and debating such proposals.
Background on Bankruptcy Law
One way that an individual may potentially obtain relief from debts he cannot repay is by filing for
personal bankruptcy. “A central purpose of” bankruptcy law “is to provide a procedure by which insolvent
debtors can reorder their affairs, make peace with their creditors, and enjoy ‘a new opportunity in life
with a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.’”
To fulfill that purpose, the federal Bankruptcy Code allows certain debtors to “discharge”—that is,
eliminate his obligation to repay—some or all of his debts if he satisfies certain statutory prerequisites. In
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exchange for that discharge, however, the debtor must relinquish either a subset of his assets or a portion
of his future income to his creditors.
The Bankruptcy Code creates a menu of different types of bankruptcy proceedings that a debtor may
potentially utilize, each with its own eligibility requirements and substantive and procedural
characteristics. Two of those types of proceedings are especially relevant for individual debtors:
 Liquidation proceedings under Chapter 7 of the Bankruptcy Code; and
 Debt adjustment proceedings under Chapter 13.
As explained below, whereas a veteran who declares bankruptcy under Chapter 7 may (subject to
certain caveats) be able to protect his veterans’ benefits from his creditors, under certain
circumstances a veteran who declares bankruptcy under Chapter 13 may be required to relinquish
some of his benefits before he may obtain a discharge.
Veterans’ Benefits in Chapter 7
“Chapter 7 allows an individual who is overwhelmed by debt to obtain a ‘fresh start’ in the form of
discharge of most types of debts by surrendering for distribution” some of “his or her . . . property” to a
trustee. “The trustee then sells the property . . . and distributes the proceeds to the debtors’ creditors.”
With few exceptions, a discharge under Chapter 7 absolves an individual debtor of his responsibility to
repay any portion of the debts that remains unpaid after the trustee has distributed those proceeds.
Although Chapter 7 requires the debtor to relinquish some of his assets in partial satisfaction of his
creditors’ claims, it is not intended to leave the debtor destitute. Section 522 of the Bankruptcy Code
permits individual debtors to shield certain “property which is necessary for the survival of both the
debtor and the debtor’s family” from their creditors. The Bankruptcy Code’s exemption scheme is highly
intricate. Section 522(d) first creates a number of federal bankruptcy exemptions that allow debtors to
shield their interests in a variety of assets, such as residential property, motor vehicles, clothes, household
goods, and the debtor’s “right to receive” certain government benefits. At the same time, however,
Section 522 also empowers the states to prohibit their citizens from claiming those federal exemptions.
Many states have exercised this “opt-out” power, thereby forbidding their citizens from claiming the
federal bankruptcy exemptions in Section 522(d). A debtor who lives in an opt-out state may therefore
claim property as exempt only to the extent that state or federal nonbankruptcy law insulates such assets
from the claims of creditors. A debtor who lives in a non-opt-out state, by contrast, can choose between
either the federal exemptions in Section 522(d) or the exemptions available under state law and
nonbankruptcy federal law. Critically, a debtor in a non-opt-out state may not mix and match those
exemptions; he must choose either the exemptions available under Section 522(d) or those available under
state and federal nonbankruptcy law.
As relevant here, several federal laws permit Chapter 7 debtors to claim their entitlement to veterans’
benefits as exempt assets. If the debtor lives in a state that permits its citizens to claim the federal
bankruptcy exemptions (i.e., a non-opt-out state), he may exempt his “right to receive . . . a veterans’
benefit” by invoking Section 522(d)(10). If the debtor instead lives in an opt-out state—or lives in a non-
opt-out state but claims the exemptions available under state law and federal nonbankruptcy law—then he
may instead claim veterans’ benefits as exempt pursuant to 38 U.S.C. § 5301, which provides that
“payments of benefits due or to become due under any law administered by the Secretary [of Veterans
Affairs] . . . shall be exempt from the claim of creditors.”
Depending on the circumstances, however, it may be unclear whether a Chapter 7 debtor may exempt
veterans’ benefits he has already received, such as unspent benefits he deposited into a bank account
before declaring bankruptcy. Section 522(d)(10) does not authorize an exemption for “veterans’ benefits”
per se; the provision only entitles a debtor who lives in a non-opt-out state to claim an exemption in his

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“right to receive . . . a veterans’ benefit.” Courts have not agreed what this “right to receive” language
means. Some courts have concluded that the “right to receive” an asset does not include the asset itself.
Under this interpretation, “once money from an exempt [source] is paid out and placed in a bank account,
such money typically loses its exempt status” under Section 522(d)(10). A debtor who lives in one of
these jurisdictions who attempts to claim veterans’ benefits as exempt under Section 522(d)(10) may
therefore be unable to exempt benefits he has received in the past. A few other courts, however, have
reached the opposite conclusion that the Section 522(d)(10) exemption is not “limited to payments not yet
received when the bankruptcy case was filed.” Under this approach, “a deposit of exempt funds in a bank
does not affect a debtor’s exemption, nor change the exempt character of the fund, so long as the source
of the exempt funds is reasonably traceable.” Thus, debtors in jurisdictions that have adopted this
alternative interpretation of Section 522(d)(10) may be entitled to shield at least a portion of the veterans’
benefits sitting in their bank accounts from their creditors.
The question of whether a debtor may claim an exemption in veterans’ benefits he has already received
does not arise, however, when a debtor invokes the exemption for veterans benefits codified at 38 U.S.C.
§ 5301 as opposed to Section 522(d)(10). Unlike Section 522(d)(10), 38 U.S.C. § 5301 explicitly states
that veterans’ benefits retain their exempt status even “after receipt by the beneficiary.” Courts have
therefore concluded that “funds in . . . bank accounts traceable to . . . federal veterans benefits are
exempt” if the debtor claims an exemption under 38 U.S.C. § 5301. Because the “selection of one form of
exemptions or another is exclusive,” however, a debtor in a non-opt-out state who invokes 38 U.S.C.
§ 5301’s broad exemption for veterans’ benefits will be disqualified from claiming other federal
exemptions codified in Section 522(d).
Veterans’ Benefits in Chapter 13
Veterans’ benefits do not necessarily receive the same protection in Chapter 13 cases as they do in
Chapter 7 cases. Whereas Chapter 7 contemplates that the debtor will partially repay his creditors out of
his existing non-exempt assets, Chapter 13 contemplates that the debtor will instead partially or
completely repay his debts out of his future income. Specifically, a Chapter 13 debtor must propose a plan
to pay a portion of his income to his creditors in regular installments over a three- to five-year period. If
that plan does not propose to pay unsecured creditors in full, and if a party to the case objects, “then the
court may not approve the plan unless” the debtor commits to pay “all of the debtor’s projected
disposable income . . . to unsecured creditors” over the duration of the plan.
The Bankruptcy Code defines “disposable income” to include “income from all sources that the debtor
receives” minus certain expenses and exclusions specified by statute. Notably, the Bankruptcy Code
explicitly “excludes benefits received under the Social Security Act” from the calculation of disposable
income. The Bankruptcy Code does not, however, contain a comparable exclusion for veterans’ benefits.
Courts have therefore overwhelmingly concluded that veterans’ benefits qualify as “disposable income”
that a debtor may be required to relinquish to his creditors before he may obtain bankruptcy relief under
Chapter 13. Significantly, the fact that Section 522(d)(10) and 38 U.S.C. § 5301 would allow the debtor to
claim an exemption in veterans’ benefits ordinarily does not protect those benefits from the claims of
creditors in a Chapter 13 case because the Bankruptcy Code’s definition of disposable income implicitly
includes income from exempt assets.
The Means Test
Because veterans’ benefits qualify as “disposable income” for the purposes of Chapter 13, an indebted
veteran might prefer to protect his benefits by declaring bankruptcy under Chapter 7 instead. Depending
on the circumstances, however, a debtor who receives veterans’ benefits may be ineligible to proceed
under Chapter 7. Because “creditors often receive more money under successful Chapter 13 plans than

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they would under a Chapter 7 liquidation bankruptcy,” Congress has enacted a provision—known as the
“means test”—intended to shift consumer debtors out of Chapter 7 and into Chapter 13. If a Chapter 7
debtor’s “current monthly income” reduced by certain allowable expenses exceeds certain statutory
thresholds, then the court must (with limited exceptions) either dismiss the debtor’s Chapter 7 case or
convert the case to a Chapter 13 proceeding.
The Bankruptcy Code defines “current monthly income” as “the average monthly income from all sources
that the debtor receives.” Although the Bankruptcy Code explicitly “excludes benefits received under the
Social Security Act” from the definition of current monthly income, it contains no comparable exclusion
for veterans’ benefits. A debtor’s entitlement to veterans’ benefits could therefore potentially cause his
current monthly income to exceed the means test threshold, thereby rendering him ineligible for Chapter 7
relief. Instead, some veterans may be required to seek relief under Chapter 13, where they may need to
relinquish some of their benefits to creditors for the reasons described above.
The means test does, however, contain a special exception for veterans. Section 707(b)(2)(D) of the
Bankruptcy Code provides that a court “may not dismiss or convert a case based on any form of means
testing” if “the debtor is a disabled veteran,” but only if “the indebtedness occurred primarily during a
period during which he or she was . . . on active duty.” Veterans who qualify for this exception may
therefore be eligible for Chapter 7 bankruptcy even if their veterans’ benefits cause their current monthly
income to exceed the means test threshold. As some commentators have noted, however, this exception to
the means test “is narrow, offering no protection for a veteran” whose indebtedness occurred outside a
period of active duty.
Legal Considerations for Congress
In response to calls to modify the legal principles discussed above, Members of a recent Congress
introduced a legislative proposal to change the way bankruptcy law treats veterans’ benefits. Proposals to
treat veterans in bankruptcy more favorably raise a variety of legal questions.
One question is whether—and, if so, how—to alter the Bankruptcy Code’s definitions of “disposable
income” and “current monthly income.” Amending these definitions to exclude veterans’ benefits could
insulate those benefits from the claims of creditors in certain categories of Chapter 13 cases. Excluding
veterans’ benefits from the calculation of “current monthly income” could also result in the means test
shifting fewer debtors from Chapter 7 to Chapter 13.
A related question is whether to grant veterans greater flexibility to choose between Chapter 7 and
Chapter 13. For instance, Congress could expand Section 707(b)(2)(D) to exempt a broader subset of
veterans from the means testing requirement and thereby reduce the likelihood that veterans for whom
Chapter 7 bankruptcy would be most favorable will instead be forced to proceed under Chapter 13.
An additional question is whether to modify Section 522’s exemption scheme. For instance, Congress
could expand Section 522(d)(10) to explicitly cover not just “the debtor’s right to receive . . . a veterans’
benefit,” but also the proceeds of those benefits so long as those proceeds remain traceable to an exempt
source. Alternatively, Congress could also grant veterans who live in opt-out states greater flexibility to
pick and choose between federal bankruptcy exemptions, federal non-bankruptcy exemptions, and state
exemptions, thereby allowing veterans to select whichever exemptions are most favorable.
Notably, allowing debtors to shield a larger share of their income or their assets from their
creditors would likely decrease the amount of money creditors may recover in bankruptcy.
Similarly, granting debtors increased flexibility to select whichever Chapter of the Bankruptcy
Code would be most favorable to them might also decrease total creditor recovery.

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Author Information

Kevin M. Lewis

Legislative Attorney




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