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CHAPTER 7 BANKRUPTCY AND COLLEGE TUITION ISSUES

November 18, 2019
Indiana Bankruptcy Attorney Steven Taylor

COLLEGE TUITION CLAWBACKS

Hoosiers struggling with debt often continue to fund college tuition payments for adult children attending a college or university. Unfortunately, if the parents subsequently file bankruptcy, a bankruptcy trustee (“usually a Chapter 7 Trustee”) has the power to try and recover the pre-petition tuition already paid to the college from the parent debtors’ assets. This is called a “clawback”. In Indiana, this can occur within four years of filing under bankruptcy law which incorporates the longer limitations period under Indiana. The goal of the “clawback” is commonly is to recover the tuition payments to a Chapter 7 bankruptcy trustee for distribution to creditors.

RESULTING ISSUES

While there has been a split of results in the underlying bankruptcy courts supporting the parents or Chapter 7 Trustee, recently the 1st Circuit has found that because the parents do not receive a direct economic benefit that was reasonably equivalent to the tuition payments, there is a basis for recovery of the funds. The problems that then arise are (1) Is the tuition liability part of the debts that get distribution from the trustee, (2) Does the college expect to repay the amount taken by the Trustee, (3) If not received already, how does it impact received your degree or transcript?

AVOIDING THE PROBLEM

There are some ways to avoid the issue that are good pointers regardless of whether or not you believe that bankruptcy may be in your future. Generally, the “clawback” only applies to tuition payments made on behalf of adult children. In Indiana, the age of majority is eighteen years of age. Obviously this can be confusing as the date for automatic emancipation is nineteen years of age and federally you can maintain insurance until age 26 for a child. Secondly, it applies to payments from debtors’ non exempt assets (and are not commingled with debtors’s other assets). It appears that signing a PLUS loan is fine as long as the funds are directly paid to the college or deposited into an account at the college that is controlled solely by the student. Courts have found that no transfer of the debtor’s property occurred, and therefore the payment could not be avoided. . Paying tuition from a 529 account or ROTH account is fine as well (again as long as the funds are directly paid to the college or deposited into an account at the college that is controlled solely by the student) from limitations on avoidance powers even before a determination of value.

CONTACT YOUR INDIANA BANKRUPTCY ATTORNEY

This area of law is evolving and you should check with a local bankruptcy attorney about your possible exposure prior to filing bankruptcy if you have paid tuition on behalf of an adult child in the prior four years.

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