Avoid the Surplus Income Penalty with a Consumer Proposal

Most people who file a consumer proposal do it to deal with their debts while avoiding bankruptcy in Canada. Why would you want to avoid bankruptcy? Because in a bankruptcy the amount of money you are required to pay is based on your income. Each month you are required to provide your trustee with copies of your pay stubs and proof of any other income; the more you make, the more you pay.

It’s called surplus income, and if you earn more than the government allowed limit, you are required to pay half of the amount you are over the limit. The surplus income during bankruptcy in Canada limits for 2014 are as follows:

Family SizeIncome Limit
1
$2,014
2
$2,508
3
$3,083
4
$3,743
5
$4,245
6
$4,788
7
$5,331

So, if you are a family of three (you and your spouse and one child) and you earn $4,083 after tax in a month (and your spouse is not working), you are $1,000 over the limit, so you are required to make a surplus income payment of half of that amount, or $500.

At the end of the first six or seven months of your bankruptcy your trustee will average your income, so if you have one high income month followed by a low income month, you are not penalized for one or two high months. However, if your average income is more than $200 over the limit each month, your bankruptcy will be extended for an additional year.

In our example, if you were $1,000 over the limit for the first seven months of the bankruptcy, (and assuming it’s your first bankruptcy), you would be required to make surplus income payments of $500 per month for 21 months! That’s $10,500.

As you can see, it can get expensive if you expect your income to increase, or if you are expecting a bonus, or overtime. So what’s the solution?

File a consumer proposal.

In a proposal, once the creditors agree to the payment terms, that’s it. Even if your income increases, your payments in the consumer proposal are fixed.

Overtime may be mandatory where you work, but you know that in a bankruptcy you are paying half of your overtime to the trustee, so you don’t want to work overtime. A proposal solves that problem, since your payments don’t increase if your income increases.

In the example above, instead of filing bankruptcy and potentially paying $500 per month for 21 months or $10,500, you might consider offering a consumer proposal where you pay $200 per month for 60 months, or $12,000.

Why would you offer $12,000 when a bankruptcy may only cost you $10,500? Two reasons:

First, if your income increases in a bankruptcy, or if you get a tax refund, or have other assets, your bankruptcy could easily cost more than $10,500.

Second, payments of $500 per month might be a strain on your monthly budget, while $200 per month is easily affordable. So, for you, paying $200 per month for a longer period may be preferable to paying $500 per month for a shorter period.

Also, you can pay off a consumer proposal anytime, so if you do work overtime you can pay extra in your proposal, and pay it off quicker. It’s possible that you could have your proposal paid off even sooner than the bankruptcy would last, so you get the best of both worlds.

The cure for high surplus income payments in a bankruptcy in Canada? File a consumer proposal.

2 thoughts on “Avoid the Surplus Income Penalty with a Consumer Proposal

  • louise

    I pay 200 a month for m’y bancrupcy for 9 months but i Will Be over for surplus Can i Just pay m’y surplus when i get to 9 months instaed of extending it to 21 months cause i want to sell m’y home anyway around This situation

    Reply
  • J. Douglas Hoyes Post author

    Hi Louise. No, the rules say that if you are over the surplus income limit as set by the government, your bankruptcy is automatically extended for an additional year. Also, selling your house while bankrupt may be an issue if you end up with more equity than expected.

    I would suggest you discuss this with your trustee. The two main reasons Canadians choose to file a consumer proposal instead of a bankruptcy are to avoid the surplus income penalty in a bankruptcy, and because they own a house. If you will have a lot of surplus income or house equity, it may be possible to file a consumer proposal while you are bankrupt. Again, this is something to discuss with your trustee.

    Reply

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