What is the Chapter 7 Means Test?

What is the Chapter 7 Means Test?

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Filing for bankruptcy is often a daunting process. The intricacies of the Bankruptcy Code can often leave a debtor struggling to understand what the next best steps are. The first difficult decision to make is what chapter to file under. While there are many differences between a Chapter 7 and a Chapter 13 bankruptcy, there are certain requirements for a debtor to file under Chapter 7.


Why a Chapter 7 Bankruptcy?

To make a decision on which chapter to file, a debtor will need to know if they even qualify for a Chapter 7 bankruptcy. To make this decision, a debtor will have to understand the steps to a Chapter 7 “means test” and determine whether they meet the eligibility criteria.

A Chapter 7 bankruptcy is typically called a liquidation bankruptcy. This chapter eliminates most of the debtor’s debts after liquidating all non-exempt property of the debtor. While it is a more substantial blow to a debtor’s credit score, it allows claims to be discharged without the lengthy plans and monthly payments under a Chapter 13. A Chapter 7 case typically lasts around 90 days, and is a much more streamlined process of liquidating all non-exempt assets of a debtor to pay to the creditors. From there, the debtor can begin rebuilding their credit.


What is the Means Test?

Chapter 7 tends to be more appealing option to many debtors, as it tends to be a more streamlined process towards discharge. However, due to a debtor’s ability to wipe away debt under a Chapter 7 without making monthly payments, Congress wanted to ensure only those that could not afford to pay their debts had this option. As such, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. In this act, they established the chapter 7 means test which limited Chapter 7 filings to those who fall within certain parameters established by the United States Trustee’s office.

The means test weeds out the higher income earners from taking advantage of the benefits of a Chapter 7, which in turn deprives their creditors of recouping at least some of the monies they would receive under a Chapter 13.

Steps of the Means Test

The first step in the means test is to compare the household income of the debtor with the median income levels in their area. Specifically, the test looks at the income of the debtor for the six months prior to the bankruptcy filing date. The debtor must look at the home state median income. As of the writing of this article, New Jersey uses the following median income when determining what a single earner needs to earn to be at the median income within the state:

  • $83,898 for an individual
  • $99,056 for two people
  • $122,540 for three people
  • $155,510 for four people

The median income is based on the average over the six months prior to filing and includes all sources of revenue, such as wages, rental income, dividends from stocks, and interest income. If the debtor falls below the applicable median income, there is no reason to go any further. Congress has determined anyone below the median for their state is eligible to file Chapter 7 bankruptcy. Otherwise, a debtor must continue to the next step.

If the debtor has earned more than the state’s median income, they may still be eligible to file for Chapter 7 bankruptcy after deducting certain expenses from their income to determine the debtor’s disposable income based on the standard IRS allowances from the debtor’s income. The IRS allows subtractions for the following:

  • Food and clothing expenses
  • Out-of-pocket health care expenses
  • Housing and utilities and other non-mortgage expenses
  • Mortgage or rent expenses
  • Vehicle payments and maintenance expenses
  • Public transportation expenses
  • Tax payments
  • Life insurance payments
  • Involuntary deductions from wages for employment, such as union dues and uniform costs
  • Court-ordered payments, such as child or spousal support
  • Education payments for employment or a child with special needs
  • Telecommunications services expenses
  • Expenses for protecting the family against violence
  • Payments for education of children under age 18
  • Home energy expenses
  • Charitable expenses
  • Future payments on secured debt

Any amount remaining after these deductions have been subtracted is considered disposable income by the IRS as well as the bankruptcy trustee. The debtor then multiples that amount by 60 to see what their disposable income will be for the next five years. If that amount is less than $6,000, the debtor may file for Chapter 7 bankruptcy. If that amount is greater than $10,000, the debtor may not file for chapter 7. If that amount falls between $6,000 and $10,000, then they move to the third step in the means test.

The Third step in the means test compares the debtor’s disposable income to the amount of their non-priority unsecured debt. This includes credit cards, personal loans without collateral, and medical debt. This helps determine whether the debtor will be able to make anything more than minor payments to the creditors.

If the amount of disposable income is less than 25% of the amount of unsecured debt, the court presumes that the debtor is not going to have the ability to repay the debt in the foreseeable future, and the debtor may file under Chapter 7. If the amount of disposable income is greater than 25% of the debtor’s unsecured debts, the court presumes that the debtor does not need the protections of Chapter 7, and would be able to afford a Chapter 13 repayment plan.

While this may seem complicated, an experienced bankruptcy attorney can help potential debtors navigate through these pitfalls. Understanding the benefits of each chapter, as well as the requirements to file is essential in having a successful bankruptcy case. The Scura Law Firm can help you navigate your options, while avoiding potential pitfalls. Call one of our experienced attorneys for a free consultation today!

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Amer Mustafa

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