Residency for the Purposes of Applying State Exemption Laws Must Be Analyzed as it Existed on the Petition Date

By:  Christopher McCune

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In the Matter of Willis, the Bankruptcy Court for the Western District of Wisconsin decided that under section 522(b)(3) of the Bankruptcy Code, a debtor must be domiciled in a given state at the time of filing a bankruptcy petition in order to access—or be bound by—that state’s exemption laws.[1]  In Willis, the debtors claimed the federal exemptions in their bankruptcy petitions, rather than attempting to assert any state exemptions.[2]  The debtors resided in two different states during the 730-day period immediately preceding the filing of their bankruptcy petitions; they were domiciled in Illinois first, and then moved to Wisconsin.[3]  Going back further, the debtors were domiciled solely in Illinois (an “opt out” state) during the 180 days prior to the aforementioned 730-day period.[4]  However, the debtor’s were domiciled in Wisconsin at the time that they filed their petitions.  Due to that fact, the court ruled that Illinois’ exemption laws did not apply, notwithstanding all of the time the debtors spent domiciled there.[5]  However, since the debtors also had not been domiciled in Wisconsin for the requisite number of days prior to filing the petition, they also could not invoke the state exemption laws of their current residence, even if they wished to.[6]  Faced with no applicable state law exemptions, the Willis court found that the debtors were therefore necessarily entitled to claim the federal exemptions.[7]

Under section 522(b)(1), a debtor ordinarily may choose to invoke either the federal exemptions or the exemptions available under applicable state law, such that the debtor may exercise discretion in choosing the more favorable option.[8] However, the availability of the federal exemptions to state residents is restricted if the state has elected to “opt out” of the federal exemptions and passed its own exemptions. Thus, depending on where a debtor lives, he or she will have to consider three possibilities when seeking bankruptcy exemptions: (1) only the federal exemptions apply, (2) only the applicable state exemptions apply, or (3) both federal and state exemptions are available such that the debtor may choose which to invoke. According to section 522(b)(3), a debtor’s domicile (during certain fixed time periods) determines which of these three options will apply.[9]  Specifically, section 522(b)(3) directs the court to look to “the place in which the debtor’s domicile has been located for the 730 days immediately preceding date of filing of petition or, if debtor’s domicile is not located in a single state for such 730-day period, the place in which debtor’s domicile was located for the 180 days immediately preceding that 730-day period . . . .”[10]  Additionally, the hanging paragraph attached to section 522(b)(3) provides that “[i]f the effect of the above domicile requirement is to render the debtor ineligible for any exemption...then the debtor may elect to exempt property under federal law.”[11]  The primary purpose of section 522(b)(3) is to remove the incentive for debtors to change their domicile immediately before filing for bankruptcy, in order to take advantage of a particular state’s more favorable exemption laws.[12] However, bankruptcy courts remain divided concerning the effect of section 522(b)(3) in those rare cases, such as Willis, where both (1) the debtor’s domicile varied between states during the 730-day period preceding the filing of his  petition, and (2) the debtor’s domicile on the petition filing date is not identical to his or her state of residence during the 180-day window.[13]  This has led to a split among Bankruptcy Courts at the District-level, with some holding the federal exemptions must apply in the situation described above. Those courts have decided state exemptions are available to—and in the case of “opt out” states binding upon—only debtors currently residing in that state at the time they filed their bankruptcy petition.[14] Conversely, other courts have decided that the exemption laws of the state where the debtor lived during the 180-day window must apply, regardless of the debtor’s current residence on the petition date.[15]

As a result of the split created by Willis, attorneys advising clients who have changed domiciles within the last two years should be aware of the risk that a bankruptcy court could choose to either enforce the “opt out” provisions of a state where the potential debtor is no longer domiciled, or else enforce the federal exemptions. The differences between the federal and state exemption schemes can be very significant in determining whether a debtor should even file for bankruptcy.  For example, the federal homestead exemption is currently $146,450 when adjusted for inflation.[16]However, other states such as Florida permit the majority of debtors to invoke an unlimited homestead exemption.[17]  Accordingly, whichever side of the aforementioned “split” that the court in a given jurisdiction elects to implement can play a critical role in determining whether a more or less favorable exemption is available to a particular debtor. Since this issue could very well influence an attorney’s advice to the client whether to file for bankruptcy at all, it is critical that attorneys are aware of the risk inherent in advising clients who have changed their state of residence within the two years prior to potentially filing for bankruptcy.