23 September 2017

The Chapter 7 Means Test Explained

If you have been researching filing for bankruptcy, you may have heard of the “means test” and been wondering why it is such an important step in the bankruptcy process. The means test is important because it is used to determine whether or not a debtor qualifies for a Chapter 7 case and can obtain a discharge of all debts.

The reason the means test is used in Chapter 7 cases is because a debtor is not required to make any payments to creditors in a Chapter 7. In addition, if a debtor does not have any assets which can be liquidated by the trustee, creditors in a Chapter 7 will receive nothing.

In order to protect these creditors, Congress instituted the means test in 2005 through the Bankruptcy Abuse Prevention and Consumer Protection Act. The means test ensures that debtors are truly incapable of repaying their creditors by calculating the debtor’s income and subtracting “reasonable expenses”. The expenses used in the means test are determined by IRS standards for the locality in which the debtor lives.

If a debtor has sufficiently low “net income” after this calculation, they will qualify for a Chapter 7. On the other hand, high income filers who fail the means test will have to file a Chapter 13 case and repay some portion of their debt on a monthly basis through a Chapter 13 Plan.

There are certain circumstances in which higher income filers can qualify for a Chapter 7 case. While IRS standards are used to determine most of the debtor’s monthly expenses, these standards do not apply to all expenses. In particular, debtors can deduct their actual home mortgage payments, vehicle loan payments and tax payments in the means test no matter how high they are.

The first step of the means test process is to determine your "current monthly income". This is your average income over the six calendar months before you file for bankruptcy. If your current monthly income is lower than the “median” income for your particular region, then you immediately qualify for Chapter 7. In this case, you will not even have to look at your expenses
because your income is low enough that you simply pass.

On the other hand if you are an "above-median" debtor, then the expenses come into play and you must end up with negative net income in order to qualify for Chapter 7. If after the means test calculation you have some excess disposable income that can be used to pay creditors, then you will have to file a Chapter 13 case or you will be converted into one after you file a Chapter 7.

The income levels and standardized expenses that are applied in the means test calculation vary based on the state/county you live in and your household size. The result of the 2005 amendments to the Bankruptcy Code is that the determination of whether you qualify for a Chapter 7 case is much more rigid and formulaic.

In any case you will want to be as thorough as possible in working with your income figures and identifying your monthly expenses. The more expenses you can come up with, the greater chance they will provide you with a deduction that can help you qualify for the means test.

While the IRS standards are applied in many circumstances, I have always found that if you continue to examine your expenses you will find some that can decrease your net income further. Many times this can be the difference between your qualifying for a Chapter 7 and having to go into a Chapter 13.

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Tag: Bankruptcy, Chapter 7, Means Test, Discharge, Filing Bankruptcy