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If You Owe Lots of Business Debt You Can Maybe Skip the “Means Test” and Qualify for Chapter 7

One benefit of owing more business debt than consumer debt is that it gives you a largely free pass into a Chapter 7 bankruptcy case. 

 

The Role of the “Means Test”

If your income is too high, you have to pass a “means test” to discharge—legally write off—your debts through a Chapter 7 “straight bankruptcy.” The point of this test is to prevent you from discharging your debts if you have the “means” to pay a meaningful portion of them. So it’s essentially an income and expenses test.

If you don’t pass the “means test,” you could be found to be under a “presumption of abuse” of the bankruptcy laws. If so, you would not be allowed to continue with your Chapter 7 case.  

One way to get out of the “means test” is by having less income than the permitted “median family income” for your state and family size. Most people who file under Chapter 7 have low enough income to avoid the “means test.” But the “median family income” amounts are quite low. If your income is above permitted amount, you have to go through the “means test.” As a result you may be forced into a lengthy and relatively expensive 3-to-5-year Chapter 13 payment plan instead of a usually-less-than-four-month Chapter 7 case.

If You Owe More Non-Consumer Debts than Consumer Debts

Because the “means test” was intended for consumer bankruptcies not business ones, it only applies to consumer cases. What’s critical is how the law distinguishes between the two.

You can avoid taking the “means test” altogether—including the “median family income” step—if your debts are not “primarily consumer debts.” That’s the standard. If your debts are not “primarily consumer debts,” you would be eligible for a Chapter 7 case regardless of your income, even if it’s above the “median” amount.

In fact if you don’t have “primarily consumer debts,” you avoid other kinds of “presumptions of abuse” as well. You can avoid not just the income-and-expense “means test,” but also other ways that your Chapter 7 case could be challenged in a consumer case. Congress has apparently decided that if your debts are mostly from a failed business, you should be permitted an immediate Chapter 7 “fresh start” without the precautions in the law supposedly designed to prevent abuse of the bankruptcy laws by consumers.

What’s “Consumer Debt”?

To determine whether you can avoid the “means test,” we need to be clear what a “consumer debt” is. The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.” (Emphasis added.)

The focus is on the purpose for which you initially incurred the debt, even if the debt would otherwise seem like a consumer debt. Small business owners often finance their business’s start-up and ongoing operation with their consumer credit—credit cards, home equity lines of credit and such. Given their purpose, these might qualify as non-consumer debts in calculating whether you have “primarily consumer debts.” This is definitely something to discuss with your attorney to learn how the local bankruptcy judges are interpreting this issue.

 What Does “Primarily Consumer Debts” Mean?

If the total amount of your “consumer debt” is less than the total amount of your debts that are not “consumer debts,” then your debts are not “primarily consumer debts.”

So you have to decide (with the help of your attorney) separately for each one of your debts whether it is a “consumer debt” or not. Then you add up the two columns of debts, and if the total for those that are not “consumer debts” is larger than the total for those that are “consumer debts,” then you do not owe “primarily consumer debts.” And you can skip the “means test.”

Some Business Debts May Be Larger Than You Think

Even after looking closely to see if some of your seemingly “consumer debts” may have actually had a business purpose, you may still believe that you have more of the “consumer debts.” But sometimes business owners have business debts that end up being larger than they thought they were. That could push their not-“consumer debt” higher than their “consumer debt.”

For example, if you had to break a commercial lease for your business premises when you closed your business, the unpaid lease payments projected out over the intended term of the broken lease could be huge. Same thing with a business equipment lease.

Or closing your business may have left you with other hidden or unexpected debts, such as obligations to business partners or unresolved litigation, with potentially large damages owed (and to be discharged in bankruptcy).

Conclusion

The potential good news about such larger-than-expected business debts is that they may result in your non-“consumer debts” outweighing your “consumer debts.” That would enable you to skip the “means test” and avoid other “presumptions for abuse.” That would allow you to discharge all your debts through a Chapter 7 case instead of being forced to pay all you could afford to pay of those debts under a lengthy Chapter 13 case.

 

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Are You Eligible to File a Chapter 7 Bankruptcy Case? How About a Chapter 13 One?

Eligibility depends on 1) the kind of debtor, 2) the kinds and amounts of debts, 3) the amount of income and 4) of expenses.

 

1) The Kind of Debtor

If you are a human person, you may be eligible for either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” case. You and your spouse may also be eligible to file one or the other of these together in a joint case.

However, if you are the owner or part-owner of a business partnership, corporation, limited liability company or other similar business entity, that business entity could not file its own Chapter 13 case. But it could file a Chapter 7 one. Regardless what your business entity itself could file, you could individually file either a Chapter 7 or 13 case, to address your own personal liabilities (beyond whatever liability for which the business itself would be responsible).

2) The Kinds and Amounts of Debts

If your debts are “primarily consumer debts” (more than 50% by dollar amount), then to be able to file a successful Chapter 7 case you have to pass the “means test.” That’s a test related to your income and expenses (discussed more below.)  If 50% or more of your debts are not consumer debts, than you can skip the “means test.”

Chapter 7 does not limit the amount of debt you can have to be eligible to file a case. However, you cannot file a Chapter 13 case if your debts exceed the maximums of $383,175 in unsecured debts and $1,149,525 in secured debts (or if you do file a case it will very likely be “dismissed” (thrown  out)).

3) Amount of Income

You can quickly and easily satisfy the “means test” and be eligible for a Chapter 7 case if your income is no more than the regularly adjusted and published “median income” for your family size and state.

To be eligible for Chapter 13 you must have “regular income.” That is defined not very helpfully as income “sufficiently stable and regular” to enable you to “make payments under a [Chapter 13] plan.”

Also for Chapter 13, if your income is less than the “median income” for your family size and state of residence, then the plan generally must last a minimum of three years (but in many situations it can last longer, especially if you need it to, but for no longer than five years). If your income is at or above the applicable “median income” amount, the plan must almost always last five years.

4) The Amount of Expenses

In Chapter 7, if your income is NOT less than “median income” for your family size and state of residence, then you may still pass the “means test” and be eligible for filing a Chapter 7 case IF, after accounting for all your allowed expenses, you don’t have enough money left over to pay a meaningful amount to your creditors.

In Chapter 13, a similar accounting of your allowed expenses determines the amount of your “disposable income,” the amount you must pay into your plan each month.

Summary

Once you recognize that you need relief from your creditors, choosing between Chapter 7 and 13 is often not difficult. But because there are many, many differences between them, the choice can sometimes turn into a delicate balancing act between the advantages and disadvantages of those two options. That’s why when you have your initial meeting with your bankruptcy attorney, it’s smart to be aware of and communicate your goals, but also be open-minded about how best to accomplish them.

 

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Choosing the Right Solution in a Closed-Business Bankruptcy Case

Whether to file under Chapter 7 or Chapter 13 depends largely on your business assets, taxes, and other nondischargeable debts.

 

Hoping to File a Chapter 7 “Straight Bankruptcy”

Once you’ve closed down your business and are considering bankruptcy, it would be understandable if you preferred to file under Chapter 7 instead of under a Chapter 13 “adjustment of debts.”

After all you’ve been through the last few years trying to keep your business afloat, you just want a fresh, clean start, as quickly as possible. You likely feel like just putting the debts behind you. The last thing you likely want is to do is stretch things out for the next three to five years that a Chapter 13 case would usually take.

Likely Can File Under Chapter 7 Under the “Means Test”

The “means test” determines whether, with your income and expenses, you can file a Chapter 7 case. In my last blog I described how you can avoid the “means test” altogether if more than half of your debts are business debts instead of consumer debts.

But even if that does not apply to you, the “means test” will still not likely be a problem if you closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income. So, there is a very good chance that your income for “means test” purposes is less than the published median income amount for your family size, in your state. If your prior 6-month income is less than the median amount, by that fact alone you’ve passed the means test and qualified for Chapter 7.

Three Factors about Filing Chapter 7 vs. 13—Business Assets, Taxes, and Other Non-Discharged Debt

The following three factors seem to come up all the time when deciding between filing Chapter 7 or 13:

1. Business assets: A Chapter 7 case is either “asset” or “no asset.” In a “no asset” case, the Chapter 7 trustee decides—usually quite quickly—that all of your assets are exempt (protected by exemptions) and so cannot be taken from you to pay creditors.

If you had a recently closed business, there more likely are assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, discuss with your attorney where the money from the proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that result is in your best interest compared to what would happen to those assets in a Chapter 13 case.

2. Taxes: It seems like every person who has recently closed a business and is considering bankruptcy has tax debts. Although some taxes can be discharged in a Chapter 7 case, many cannot. Especially in situations in which a lot of taxes would not be discharged, Chapter 13 is often a better way to deal with them. Which option is better depends on the precise kind of tax—personal income tax, employee withholding tax, sales tax—and on a series of other factors such as when the tax became due, whether a tax return was filed, if so when, and whether a tax lien was recorded.

3. Other nondischargeable debts: Bankruptcies involving former businesses get more than the usual amount of challenges by creditors. These challenges are usually by creditors trying to avoid the discharge (legal write-off) of its debts based on allegations of fraud or misrepresentation. The business owner may be accused of acting in some fraudulent fashion against a former business partner, his or her business landlord, or some other major creditor.  These kinds of disputes can greatly complicate a bankruptcy case, regardless whether occurring under Chapter 7 or 13. But in some situations Chapter 13 could give you certain legal and tactical advantages over Chapter 7.

These three factors will be the topics of my next three blogs. After reviewing them you will have a much better idea whether your business bankruptcy case should be in a Chapter 7 or Chapter 13.

 

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Close Down Your Small Business, Get a Fresh Financial Start

Closing down a business can leave you with huge debts and no income to pay them. Bankruptcy may be necessary, and be easier than you think.

 

A Business Bankruptcy Means a Messy One?

A bankruptcy cleaning up the financial fallout from a closed business can be more complicated than a consumer bankruptcy case. But is not necessarily so.

In the next few blog posts I will show how a business bankruptcy can be quite a simple and effective solution.

Today I present one way a business bankruptcy can actually be easier than a consumer one. 

How so? Because under certain conditions a business bankruptcy case can avoid the Chapter 7 “means test,” allowing you to legally write off (“discharge”) all your debts quickly.

The Purpose of the “Means Test”

The point of the means test is to require people who have the means to pay a meaningful amount to their creditors over a reasonable period of time to in fact do so. They aren’t allowed to simply discharge their debts.

Essentially this disqualifies people who do not pass the means test from going through a Chapter 7 case, which allows a quick discharge of most debts. Instead they must go through Chapter 13, which generally requires them to pay creditors all that they can afford to pay them over a 3-to-5-year period.

The Challenge of Passing the Means Test

To pass the means test requires either having a relatively low income (no more than the published median income amount for the person’s state and family size) or having enough allowed expenses so that little or no “disposable income” is left over. Again, otherwise you will be stuck in a 3-to-5-year Chapter 13 payment plan.

In many scenarios, a former business owner needing bankruptcy relief would not be able to pass the means test and so would have to go through Chapter 13. For example:

  • If, after closing his business, the owner of that business gets a well-paying job before filing bankruptcy, the income from that job may be larger than the “median income” applicable to her state and family size.
  • If the business was operated by one spouse while the other continued working and earned a good income, that employed spouse’s income alone may bump the couple above their applicable “median income” amount, thereby not passing the “means test.”
  • A former business owner who now earns more than median income can’t deduct monthly payments to secured creditors on business collateral she is surrendering—vehicles and equipment, for example—or for other business expenses, such as rent on the former business premises. This reduces the likelihood that she will have enough allowed expenses to pass the “means test.”

Skip the “Means Test” in Business Bankruptcies

The good news is that you do not have to pass the means test at all if your “debts are primarily consumer debts.” (Section 707(b)(1) of the Bankruptcy Code.) So if your debts are primarily business debts—more than 50%–you avoid the means test altogether.

Let’s be clear about the difference between these two types of debts. A “consumer debt is a “debt incurred by an individual primarily for a personal, family, or household purpose.” (Section 101(8).)  The focus is on the intent at the time the debt was incurred. So, for example, if you had taken out a second mortgage on your home for the clear purpose of financing your business, that second mortgage would likely be considered a business debt for this purpose.

Certainly there are times when the line between a business and consumer debt is not clear. Given what may be riding on this—the ability to discharge all or most of your debts in about four month under Chapter 7 vs. paying on them for up to 5 years under Chapter 13—be sure to discuss this thoroughly with your attorney. Find out if you can avoid the means test under this “primarily business debts” exception. 

 

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Taking the “Means Test” All the Way to Its End

If your income is higher than the median and you have too much disposable income, you’ll need “special circumstances” to do a Chapter 7.

  

The “Presumption of Abuse”

The means test determines whether you qualify to file a Chapter 7 “straight bankruptcy” case—or whether instead you have too much “means” to do so. If you don’t pass the means test, your case is said to be presumed to be an abuse of Chapter 7. That’s just another way of saying you are not legally appropriate for this type of bankruptcy relief. Then you can’t proceed with your Chapter 7 bankruptcy case, and your case will either be dismissed (thrown out) or more likely converted into a Chapter 13 “adjustment of debts” type of bankruptcy instead.

There are a number of levels to this test. Once you pass it at any of the levels, you don’t have to go any further. My last few blog posts explored the earlier levels; today is about the final level. You only get here if you haven’t passed the means test on any of the earlier levels.

The Earlier Levels of the Means Test

You can avoid this presumption of abuse IF ANY of the following apply to you:

First, your income is no more than the median family income for your state and your size of family. See this website for the current median income amounts. Caution: “income” has a very specific and unusual definition for means test purposes. See my recent blog posts for more about this.

Second, if your income is more than the applicable median family income amount but, after subtracting a list of allowable expenses, your remaining monthly disposable income is less than about $125 per month, then you pass the means test.

Third, if your income is more than the applicable median family income amount, AND your remaining monthly disposable income after the allowable expenses is more than about $125 per month but no more than about $208 per month, then you may be able to still pass the means test. But that’s only if, when you multiply your monthly disposable income amount by 60, that total is less than 25% of your “non-priority unsecured debts” (debts not secured by collateral, excluding special “priority debts”—certain taxes, support payments, and such).

It’s somewhat rare that a person who needs and wants to file a Chapter 7 case would not have passed the means test through one of the above levels. A large percentage of people pass on the first level by simply having low enough income. Others pass at the second level because their income is low enough compared to their expenses. And others pass because the amount of their disposable income after expenses is low enough compared to the amount of their debt.

The Last Level

BUT, if after all this you haven’t passed the means test that your case is still under a presumption of abuse, you still have one more last chance, one last level of the means test to pass. You can show “special circumstances.” The Bankruptcy Code lays out this out as follows:

[T]he presumption of abuse may… be rebutted by demonstrating special circumstances, such as a serious medical condition or a call or order to active duty in the Armed Forces, to the extent such special circumstances… justify additional expenses or adjustments of current monthly income for which there is no reasonable alternative.

Congress did not make clear what counts for “special circumstances” beyond the two examples provided.

The Means Test Ends Up Being Not So “Objective”

So when pushed to the last level, a test that was intended to be an objective way to decide who qualifies to file a Chapter 7 bankruptcy comes down to a very subjective question about whether any “special circumstances” apply. Talk to your attorney about how this phrase is being interpreted in your local bankruptcy court.

 

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The “Means Test” Tries to Be Objective

The point of the “means test” is to objectively judge whether you have the means to pay your creditors. But this test is very arbitrary.

 

As we explained in last week’s blog post, the “means test” is supposed to be an objective way to decide who qualifies to file a Chapter 7 bankruptcy. That decision used to be more in the hands of bankruptcy judges, who were apparently seen as being too lenient with debtors (which is odd because the majority of the judges are former creditor attorneys!).

The “Objective” Rule

As also discussed in the last blog post, there is a very specific formula for determining if you can do a Chapter 7 case: if your budget shows that you have some money left over each month—some “disposable income”—it all depends on its amount and how it compares to the amount of your debts. This is how “objective” this rule is:

  1. If your “monthly disposable income” is less than $125, then you pass the means test and qualify for Chapter 7.
  2. If your “monthly disposable income” is between $125 and $208, then you go a step further: multiply that “disposable income” amount by 60, and compare that to the total amount of your regular (not “priority”) unsecured debts. If that multiplied “disposable income” amount is less than 25% of those debts, then you still pass the “means test” and qualify for Chapter 7.
  3. If EITHER you can pay 25% or more of those debts, OR if your “monthly disposable income” is $208 or more, then you do NOT pass the means test. BUT you still might be able to do a Chapter 7 case IF you can show “special circumstances,” such as “a serious medical condition or a call or order to active duty in the Armed Forces.”

Where Do Those Crucial Amounts—$125 and $208—Come From?

Notice the huge difference in effect of these numbers. If you have less than $125 to spare, you are “presumed” to qualify for Chapter 7; if you have more than $208 to spare, you are
“presumed” to not qualify for Chapter 7, unless you can show “special circumstances.” And if you have an amount in between, then you must apply that 25% extra condition.

That’s a huge difference in consequences for a spread of only $83 per month.

So where do these hugely important numbers come from?  The Bankruptcy Code actually refers to those numbers multiplied by 60—$7,475 and $12,475. When the law was originally passed in 2005 these amounts were actually $6,000 and $10,000 (therefore, $100 and $167 monthly), but they have been adjusted for inflation since then.

So where did those original $6,000 and $10,000 amounts come from?

They are arbitrary. Why was anything less than $6,000 (now $7,475) considered low enough to allow a Chapter 7 to proceed, while anything more than $10,000 (now $12,475) was considered high enough to not allow it? Some creditor lobbyist or Congressional staffer likely just came up with those numbers, and maybe they were negotiated in Congress. In any event, somewhere in the process Congress decided that it needed to use certain numbers, and those are the ones that made it into the legislation. It’s the law, regardless that there doesn’t seem to be any real principled reason for using those amounts in determining whether a person should or shouldn’t be allowed to file a Chapter 7 case.

The Bottom Line

Sensible or not (and there is a lot in the “means test” which is not!), if your income is under the published median income amount, then you pass the “means test” and can proceed under Chapter 7 (see our earlier blog about that). But if you are over the median income amount, then the amount of your “monthly disposable income” largely determines whether you are able to file a Chapter 7 case. (Remember that most people needing a Chapter 7 case qualify easily by having low enough income, skipping the complications covered in today’s blog post.)

 

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The Expenses Step of the Chapter 7 “Means Test”

If your income is higher than “median income,” you may still file a Chapter 7 case by going through the expenses step of the means test.

 

The Easy, Income Step of the Means Test

The last couple of blog posts have covered the first step of the means test, the income step. It says that if your “income”—as that term is uniquely defined in this law—is no more than the published median amount for your state of residence and for your size of family, you can skip the rest of the means test, and you generally qualify for a Chapter 7 “straight bankruptcy” case. You don’t have to go through the rest of the means test.

The Admittedly Complicated, Expenses Step of the Means Test

If on the other hand your “income” is greater than the median income amount applicable to your state and family size, then you have to go through the detailed expenses step to see whether you can participate in a Chapter 7 case.

The Challenge of the Means Test

The concept behind the means test is pretty straightforward: people who have the means to pay a meaningful amount to their creditors over a reasonable period of time should be required to do so. But putting that concept into law resulted in an amazingly complicated set of rules.

These expense rules are detailed and rigid because Congress was trying to be objective. The assumption was debtors would just inflate their anticipated expenses to show that they had no money left over for their creditors—no “means” to pay them anything.

One of the complications is that the allowed expenses include some based on your stated actual expense amounts, while others are based on standard amounts. The standard amounts are based on Internal Revenue Service tables of expenses, but some of those standards are national, some vary by state, and some even vary among specific metropolitan areas within a state. There are even some expenses which are partly standard and partly actual (certain components of transportation expenses).

There are also rules about when to allow and how to determine the allowed amounts for secured debt payments (vehicle, mortgage) and for “priority debts” (income taxes, accrued child support).

If You Have Disposable Income

After all that, if after subtracting all the allowed expenses from your “income” you have some money left over, whether you can be in Chapter 7 depends on the amount of that money and how that compares to the amount of your debts:

  1. If the amount left over—the “monthly disposable income”—is no more than $125, then you still pass the means test and qualify for Chapter 7.
  2. If your “monthly disposable income” is between $125 and $208, then apply the following formula: multiply that amount by 60, and compare that to the total amount of your regular (not “priority”) unsecured debts. If the multiplied total is less than 25% of those debts, then you still pass the means test and qualify for Chapter 7.
  3. If after applying the above formula you can pay 25% or more of those debts, OR if your “monthly disposable income” is more than $208, then you do NOT pass the means test, UNLESS you can show “special circumstances,” such as “a serious medical condition or a call or order to active duty in the Armed Forces.”

THAT’s Complicated!

True enough. So you certainly want to have an attorney who fully understands these often confounding rules and how they are being interpreted by the local bankruptcy judges and the pertinent appeals courts.

If you don’t pass the means test you will instead likely end up in a 3-to-5-year Chapter 13 case. Not only would that mean getting full relief from your debts years later than under Chapter 7, with a similar delay in rebuilding your credit, you may well also end up paying thousands, or even tens of thousands, more dollars to your creditors. It’s definitely worth going through the effort to find a competent bankruptcy attorney to help you, whenever possible, find a way to pass the means test. 

 

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Taking Advantage of the Rigidity of the Chapter 7 “Means Test”

Because of how precisely the amount of your “income” is calculated, filing bankruptcy just a day or two later can make all the difference.

 

Passing the “Means Test”

Our last blog post was about most people passing the “means test” by making no more than the median income for their state and family size. We also made clear that “income” for this purpose has a very broad meaning, by including non-taxable received from irregular sources such as child and spousal support payments, insurance settlements, cash gifts from relatives, and unemployment benefits. Also, we showed how time-sensitive the “means test” definition of “income” is in that it is based on the amount of money received during precisely the 6 FULL CALENDAR months before the date of filing. This means that your “income” can shift by waiting just a month or two, or even by waiting just a few days until the turn of the month (since that changes which 6 months of income is at issue).

Why is the Definition of “Income” for the “Means Test” So Rigid?

One of the much-touted goals of the last major amendments to the bankruptcy law in 2005 was to prevent people from filing Chapter 7 who were considered not deserving. The most direct means to that end was to try to force more people to pay a portion of their debts through Chapter 13 “adjustment of debts” instead of writing them off Chapter 7 “straight bankruptcy.”

The primary tool intended to accomplish this is the “means test,” Its rationale was that instead of allowing judges to decide who was abusing the bankruptcy system, a rigid financial test would determine who had the “means” to pay a meaningful amount to their creditors in a Chapter 13 case, and therefore could not file a Chapter 7 case.

The Unintended Consequences of the “Means Test”

The last blog post explained the first part of the means test: comparing the income and money you received from virtually all sources during the six full calendar months before filing bankruptcy to a standard median income amount for your state and your family size. If your income is at or under the applicable median income, then you generally get to file a Chapter 7 case. If your income is higher than the median amount, you may still be able to file a Chapter 7 case but you have to jump through a whole bunch of extra hoops to do so. Having income below the median income amount makes qualifying for Chapter 7 much simpler and less risky.

Filing your case a day earlier or later can matter so much because of the means test’s fixation on the six prior full calendar months, AND because you include ALL income during that precise period (other than social security). 

So if you receive some irregular chunk of money, that can push you over your applicable median income amount, and jeopardize your ability to qualify for Chapter 7.  

An Example

It does not necessarily take a large irregular chunk of money to make this difference, especially if your income without that is already close to the median income amount. An income tax refund, some catch-up child support payments, or an insurance settlement or reimbursement could be enough. 

Imagine having received $3,000 from one of these sources on October 15 of last year. Your only other income is from your job, where make a $42,000 salary, or $3,500 gross per month. Let’s assume the median annual income for your state and family size is $45,000.

So imagine that now in the early part of April 2014, your Chapter 7 bankruptcy paperwork is ready to file, and you would like to get it filed to get protection from your aggressive creditors. If your case is filed on or before April 30, then the last six full calendar month period would be from October 1, 2013 through March 31, 2014. That period includes that $3,000 extra money you received in mid-October. Your work income of 6 times $3,500 equals $21,000, plus the extra $3,000 received, totals $24,000 received during that 6-month period. Multiply that by 2 for the annual amount—$48,000. Since that’s larger than the applicable $45,000 median income, you would have failed the income portion of the “means test.”

But if you just wait to file until May 1, then the applicable 6-month period jumps forward by one full month to the period from November 1 of last year through April 30 of this year. Now that new period no longer includes the $3,000 you received in mid-October. So now your income during the 6-month period is $21,000, multiplied by 2 is $42,000. This results in your income being less than the $45,000 median income amount. You’ve now passed the “means test,” and qualified for Chapter 7. 

 

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The Easiest Way to Pass the Chapter 7 “Means Test”

Most people considering Chapter 7 “straight bankruptcy” have low enough income to qualify.  Find out if you do.

 

The “Means” Part of the “Means Test”

When Congress passed the last major set of changes to the bankruptcy laws nine years ago, it explicitly said that wanted to make it harder for some people to file Chapter 7.  The idea was that those who have the means to pay a significant amount of their debts should do so. Specifically, those who can pay a certain amount to their creditors within a three-to-five-year Chapter 13 payment plan ought to do so, instead of just being able to write off all their debts in a Chapter 7 case.

How the Law Determines Whether You Have Too Much “Means”

The “means test” measures people’s “means” in a peculiar, two-part way, the first part based on income, the second part based on expenses.

The income part is relatively straightforward; the expense part involves an amazingly complicated formula of allowed expenses.

The good news is that if your income is low enough on the income part of the “means test,” then you’re done: you’ve passed the test and can skip the rest of the test. The other good news is that most people who want to file a Chapter 7 case DO have low enough income so that they do pass the “means test” based simply on their income.

Is YOUR Income Low Enough to Pass the “Means Test”?

Your income is low enough if it is no higher than the published “median income” for a household of your size in your state. You can look at your “median income” on this website (for bankruptcy cases filed on or after April 1, 2014).

A Peculiar Definition of “Income”

Here’s what you need to know to compare your “income” (as used for this purpose) to the “median income” applicable to your state and family size:

1. Determine the exact amount of “income” you received during the SIX FULL calendar months before your bankruptcy case is filed. It’s easiest to explain this by example: if your Chapter 7 case is filed on March 25, 2014, count every dollar you received during the six-month period from September1, 2013 through February 28, 2014. After coming up with that six-month total, divide it by six for the monthly average.

2.When adding up your “income” include all that you’ve acquired from all sources during that six-month period of time, including unconventional sources like child and spousal support payments, insurance settlements, unemployment benefits, and bonuses. But EXCLUDE any income from Social Security.

3. Multiply your six-month average monthly income by 12 for your annual income. Compare that amount to the published median income for your state and your size of family in the link provided above. (Make sure you’re using the current table.)

Conclusion

If your “income”—calculated in the precise way detailed here—is no more than the median income for your state and family size, then you have passed the “means test” and can file a Chapter 7 case.

But if your income is higher than that, you may still be able to pass the “means test” and file a Chapter 7 case. That’s covered in the next blog post.  

 

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When Chapter 7 “Straight Bankruptcy” is Not So Straightforward

How can you tell if your Chapter 7 case will be straightforward? Avoid 4 problems.

 

Most Chapter 7 cases ARE straightforward. Your bankruptcy documents are prepared by your attorney and filed at court, about a month later you go to a simple 10-minute hearing with your attorney, and then two more months later your debts are discharged—written off. There’s a lot going on behind the scenes but that’s usually the gist of it.

But some cases ARE more complicated. How can you tell if your case will likely be straightforward or instead will be one of the relatively few more complicated ones?

The four main problem areas are: 1) income, 2) assets, 3) creditor challenges, and 4) trustee challenges.

1) Income

Most people filing under Chapter 7 have less income than the median income amounts for their state and family size. That enables them to easily pass the “means test.” But if instead you made or received too much money during the precise period of 6 full calendar months before your case is filed, you can be disqualified from Chapter 7. Or you may have to jump through some more complicated steps to establish that you are not “abusing” Chapter 7. Otherwise you could be forced into a 3-to-5 year Chapter 13 case or your case could be dismissed—thrown out of court. These results can sometimes be avoided with careful timing of your case, or even by making change to your income before filing.

2) Assets

Under Chapter 7 if you have an asset which is not protected (“exempt”), the Chapter 7 trustee can take and sell that asset, and pay the proceeds to the creditors. You may be willing to surrender a particular asset you don’t need in return for the discharge of your debts. That could especially be true if the trustee would use those proceeds in part to pay a debt that you want and need to be paid anyway, such as back payments of child support or income taxes. Or you may want to pay off the trustee through monthly payments in return for the privilege of keeping that asset. In these “asset” scenarios, there are complications not present in the more common “no asset” cases.

3) Creditor Challenges to the Dischargeability of a Debt

Creditors have a limited right to raise objections to the discharge of their individual debts. This is limited to grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. With most of these, the creditor must raise such objections to dischargeability within about three months of the filing of your Chapter 7 case—precisely 60 days after your “Meeting of Creditors.” Once that deadline passes your creditors can no longer complain, assuming that they received notice of your bankruptcy case.

4) Trustee Challenges to the Discharge of All Debts

In rare circumstances, such as if you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the trustee’s Meeting of Creditors, or if you don’t cooperate with the trustee’s review of your financial circumstances, you could possibly lose the right to discharge any of your debts. The bankruptcy system largely relies on the honesty and accuracy of debtors. So it is quite harsh towards those who abuse the system through deceit.

No Surprises

Most of the time, Chapter 7s are straightforward. The most important thing you can do towards that end is to be completely honest and thorough with your attorney during your meetings and through the information and documents you provide. That way you will find out if there are likely to be any complications, and if so whether they can be avoided, or, if not, how they can be addressed in the best way possible. 

 

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