In order to qualify for a Chapter 7 bankruptcy, a debtor must pass a means test. Simply put, the means test calculates a debtor’s monthly disposable income. This hypothetical monthly disposable income will determine whether a debtor is able to file a Chapter 7 bankruptcy or whether a debtor must file under Chapter 13. The calculation also aids in determining how much a debtor will pay creditors under a Chapter 13 if a Chapter 7 bankruptcy is not available. Accordingly, it is very important to understand how the means test works.
The first step of the means test is to determine the debtor’s current monthly income. This is the average monthly household income over the six months prior to the filing of a bankruptcy. What is included in the calculation of the average monthly household income may be difficult to determine. For instance, social security income is not included and there are many sources of income that inexperienced individuals may overlook. As such, it is strongly recommended to discuss with an experienced attorney to assist with this calculation. Once the average monthly income is calculated, it is compared to the median household income the same size as the debtor’s in the debtor’s state. If the average monthly income is less than the median household income in the debtor’s state, then the debtor is presumed eligible to file a Chapter 7 bankruptcy. If the average monthly income is more, then the debtor must continue with the means test.
The second step of the means test determines the debtor’s disposable monthly income. Here, it is necessary to determine the debtor’s allowable expenses. The means test allows the debtor to deduct certain standard expenses like housing, food, clothing, transportation, healthcare, and other standard items as provided by the Internal Revenue Service (based on the debtor’s domicile). Also, the debtor may be allowed to take into account certain standard expenses such as collateralized debt payments for real estate and vehicles, as well as payments for taxes (including payment plans for federal, state, and local taxes).
As with the determination of the debtor’s current monthly income, the calculation of the debtor’s disposable income can be extremely tricky. Certain items that seem like they must be deductible are often not. As such, it is extremely important to have experienced legal counsel assist with this calculation.
If the debtor’s disposable income is less than a certain amount (an amount that changes regularly) then the debtor may file a Chapter 7 bankruptcy. If the debtor’s disposable income is more than that certain amount then the debtor will not be eligible to file a Chapter 7 bankruptcy and will be required to file a Chapter 13 bankruptcy if the debtor still wants to file. If the debtor’s disposable income is between the two amounts, then it must be determined whether the debtor’s disposable income will enable the debtor to pay off at least 25% of their non-priority unsecured debt over a sixty-month period. If so, a Chapter 13 bankruptcy is the only option available (absent extraordinary circumstances). If not, then a Chapter 7 bankruptcy is still available.
If a debtor does not qualify for a Chapter 7 bankruptcy, they should not despair! An interesting thing to know is that a Chapter 13 bankruptcy actually gives an individual person the most protection against creditors available. Not only can it eliminate debt, it can also serve to protect a debtor’s assets. Since the means test was instituted, the most common misconception is that bankruptcy is only available to people who have little or no income. In fact, Chapter 13 bankruptcy is just as, if not more, useful to protect a debtor from creditor and debt issues. Accordingly, it is important for debtors to seek guidance when they begin having financial issues, as early on as possible. When individuals wait too long, their options become much more limited. (See our Bankruptcy FAQs).
Determining what type of bankruptcy is available is an important first step for any debtor. So is experienced legal counsel. In addition to assisting a debtor with the calculation, an experienced attorney may also be able to help their client “plan” for a bankruptcy based on their advanced knowledge of the factors relating to the means test. At Arenstein & Andersen Co., LPA, we have guided many clients through the bankruptcy process and have the experience necessary to assist individuals in their Chapter 7 and Chapter 13 bankruptcy needs.
About Arenstein & Andersen Co., LPA
Arenstein & Andersen Co., LPA, located in Dublin, Ohio, provides comprehensive litigation representation services. Samplings of our bankruptcy services include: filing Chapter 7 bankruptcies for individuals and couples; filing Chapter 13 bankruptcies for individuals and couples; defending clients in post-bankruptcy challenges by creditors to the discharge of certain debts; assisting with creditors prior to, during, and after a bankruptcy is filed; and handling conversions from Chapter 7 to Chapter 13 bankruptcies and vice-versa.