Bankruptcy Means Test

The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act was bought in the “Bankruptcy Means Test”. The thinking behind it was to tighten up the US bankruptcy laws, specifically to try and ensure that debtors could no longer simply walk away from their debts under a chapter 7 bankruptcy if they could, in reality, afford to pay their creditors.

The bottom line is that if you fail the Means Test you no longer qualify for bankruptcy under chapter 7, instead a chapter 13 bankruptcy is enforced by the US bankruptcy court which means that your only option is to repay a portion, or all of your debts by means of a repayment plan that lasts 60 months. However, if it is later found that you are unable to maintain the payments you may be able to convert to a chapter 7 filing.

The bankruptcy Means Test is directed at those debtors whose debts are made up primarily of what are called consumer debts. The Bankruptcy Code defines "consumer debt" as "debt incurred by an individual primarily for personal, family, or household purpose." However, this is still open to interpretation and different courts may interpret consumer debt in different ways. For example, most consider home mortgages to be consumer debts but any income tax liabilities are not considered as such. When it comes to something like student loans, courts appear to be evenly split as to whether or not this is consumer debt.

This is one of many reasons why any debtor considering filing for bankruptcy should always employ the services of a local bankruptcy lawyer. Further, paralegals and legal advisers should be avoided. This is because it is the lawyer who represents you in court, and who will therefore both something about the attitude towards the various grey areas that the judge usually adopts. In this way it is a lawyer who can best represent your case and secure the best outcome. In addition, the Means Test is complicated and an experienced bankruptcy lawyer will be able to arrange your financial affairs to give you the maximum possible chance of passing the bankruptcy Means Test.

As a note, if the debtor’s debts are not primarily consumer debts, the Means Test does not apply.

There are basically two parts to the bankruptcy Means Test. The first is what is called the "Median Test", and the second is the Means Test itself. If you pass the Median Test, you do not have to take the Means Test and you are eligible for chapter 7 bankruptcy.

The Median Test

The first figure you have to calculate is your average monthly income over the past six calendar months up until the date you filed bankruptcy and then multiply this figure by 12. You use full calendar months, in other words it is the six-month period that ends on the last day of the calendar month prior to the month in which you filed bankruptcy. For example, if you file bankruptcy on 22 August, you take the average income for the period 1 February to 31st of July.

The bankruptcy code allows the three exemptions:

1. Social security payments that you may receive

2. Any payments you may receive as a result of a terrorist act

3. Any payments you may receive if you are a victim of a war crime or a crime against humanity.

Any other income has to be included even if it is not taxable. This includes less obvious things such as tax refunds, any rental income, any alimony payments, financial gifts (including inheritances), any financial crisis and awards (including any educational benefits such as scholarships) and any retirement income. If you have a spouse and they are not filing for bankruptcy, you have to include their income as well. However, if you are separated you have only to include the amount that your spouse contributes to the overall income of the household, not their full income.

Having arrived at the figure that represents your average monthly income for the six months prior to filing your bankruptcy petition, it is then compared to the median income for households of the same size and in the same state. This figure is based on US Census Bureau figures. These figures vary according to which state you live in, and adjusted annually to reflect changes in the Consumer Price Index.

If your average monthly income is less than the state median income, you are eligible to file chapter 7 bankruptcy. If your average monthly income is more than the median income for a household of the same size in the same state, you have then to proceed with the Means Test.

It may be interesting to note that even if you are considering filing chapter 13, it is beneficial if you're income is below the median because if it is in excess of the state median your repayment plan has to run for five years.

The Means Test

The means test takes your average monthly income and deducts certain monthly expenses to arrive at what is called your "disposable income." The rules are slightly different in that unlike the Median Test where you include the income of your spouse unless you are separated, (see above), the process of the means test your income should only include your spouse is income to the extent that they contribute towards your living expenses. Therefore your income figure for the Median Test will in all likelihood be different to the income figure required for the Means Test.

The next step is to calculate and deducts your expenses, and this can be tricky and complicated. You may think that you simply work out how much you have spent on what you may consider "essentials" and how much disposable income you require, but unfortunately, this is not the way it works.

The amount of living expenses one can claim are strictly regulated by IRS national and local standards. These are allowable amounts of expense which are based on family size and gross monthly income. In order to arrive at an expense figure that will satisfy the court trustee you have to refer to the IRS tables. Again, these amounts are adjusted annually and the most recent can be obtained from the clerk of the bankruptcy court.

Certain types of debt payments are allowed to be considered as expense and therefore deducted from your monthly income. Perhaps the two most common worries are one's house and car. If you have more than five years remaining on your mortgage payment for example, you are allowed to deduct the full amount of your monthly payment as an expense. If you have less than five years, often common on a car purchase, you are allowed to add all the remaining payments together and then divide the total by 60. The figure arrived at is then and allowable expense.

If you are behind on these payments, you simply take the total amount of arrears and divide by 60, the resultant figure is then considered as an allowable expense.

Having arrived at a figure for your current monthly income, your allowable deductions are then subtracted to ride a figure – your monthly disposable income.

This figure is then multiplied by 60. If this amount is less than $6000, the Means Test has been passed. If it is greater than $10,000 you have fail the means test.

However, if your monthly disposable income multiplied by 60 gives a result of not less than $6000 and no more than $10,000, you then take your total amount of non-priority unsecured debt and multiply that by .25. If your monthly disposable income multiplied by 60 is equal to or greater than this amount you have fail the means test, and if it is less you pass the means test.

However, it may be that you are eligible for chapter 7 bankruptcy regardless of your level of debt if, after deducting expenses, your monthly income is less than $100. If it is, you pass the Means Test. If the figure is $167 or more, you fail the means test, and if your monthly income after deducting expenses falls between $100 and $167 the court takes in to account your actual amount of debt. In that case, if your monthly income (after deducting expenses) is insufficient to pay off 25% of your debt in 5 years, you pass the Means Test. 

One of the most important things you can do is to hire a bankruptcy attorney. This is because there are certain (legal) adjustments you can make your financial situation that will improve your chances of passing the means test. For example if you have no health insurance is in your interest to invest in some prior to filing bankruptcy, because payments can be deducted for purposes of the means test, giving you a win – win situation. In addition, high mortgage and car repayments can also assist in passing the means test. These and other things are for your legal attorney to advise on.