How to Determine if a Debtor Qualifies for Chapter 7 Bankruptcy.
This blog explores how a person may or may not qualify for chapter 7 by looking at the “means test” (big picture then mechanics).
Whether one qualifies for a chapter 7 and whether a chapter 7 is the correct chapter to file (even if one qualifies) are two completely different questions. The more important question is whether it makes sense to file a chapter 7, the answer to which is reserved for a separate blog post.
What’s the Idea Behind the Means Test?
The means test is the product of successful lobby efforts of the consumer finance industry. The product of these efforts appear in the 2005 BAPCPA amendments to the Bankruptcy Code. The idea behind the means test is simple, which is: those who can afford to pay some of their consumer debts in a chapter 13 should be forced to do so. If the means test applies, the mechanics are a bit complicated but generally, it requires consumer debtors who can afford to pay at least $13,650 over a 5-year period to file a chapter 13 instead of chapter 7. The mechanics are as follows:
Step 1: Does the means test apply?
Since the means test only applies to “an individual debtor whose debts are primarily consumer debts”, the first step is to determine if consumer debts comprise 51% or greater of the debtor’s total debt. If not, or the debtor is not an individual (i.e., corporation or LLC), the means test does not apply and the debtor may file chapter 7 without fear of dismissal for abuse under § 727. “Consumer debt means debt incurred by an individual primarily for a personal, family or household purpose.” 11 U.S.C. § 101(8).
If the debts are mostly consumer debts, go to the next step.
Step 2: Does the debtor have any “disposable income”?
If the answer is “no,” then the debtor is excused from the means test and may file chapter 7. This is the answer in a majority of consumer bankruptcies. This question turns on whether a debtor’s “current monthly income” multiplied by 12 is greater than the applicable “median family income.”
Current monthly income is calculated by averaging the debtor’s monthly income for the 6 months immediately preceding the bankruptcy filing (starting with the month immediately preceding the month in which the bankruptcy was filed). 11 U.S.C. § 101(10A). Median family income is determined by IRS standards. 11 U.S.C. § 727(b)(2)(A)(ii)(I). In Washington state, the applicable median family income is as follows (increases periodically):
Household 1 - $70,194
Household 2 - $85,189
Household 3 - $98,730
Household 4 - $112,182
Each Add’l. Individual - +$9,000
If the debtor’s income is less than that reflected, he/she can file chapter 7. If not, the next step is determine whether the debtor makes enough such that general unsecured creditors would get a distribution in a chapter 13 (in other words, if these creditor’s are not going to receive any money, it would make no sense to file chapter 13 and a chapter 7 filing should be allowed).
Step 3: Take the means test and see if you pass.
As stated, this test tries to simulate a chapter 13. In a chapter 13, the debtor will have to first pay the following before the credit card companies: attorney’s fees, a trustee fee, secured creditors and other priority creditors such as holders of domestic support claims or tax creditors. Therefore, the means test deducts from monthly income payments for secured claims, priority claims, and if there is at least $13,650 over a 60-month period, then the debtor must file chapter 13. The mechanics are as follows:
The means test takes 60 months of current monthly income, and deducts from that number:
60 months of expenses measured by IRS standards (can be found here);
60 months of other actual expenses addressed in § 707(b)(2) (e.g., transportation, clothing, etc. These can be found here); and
payments that come due over the next 60 months after filing for secured claims (liens) and priority claims (chapter 13 trustee fee, debtor’s attorney’s, tax debts, domestic debts). If the disposable income that remains, if any, is greater than $13,360, then the debtor must file chapter 13.