Chapter 7 bankruptcy allows a debtor to eliminate – or discharge – most unsecured debts, like medical bills and credit card debt. Chapter 13 bankruptcy, by contrast, allows a debtor to restructure their debts under a court-approved repayment plan that generally lasts from 3 to 5 years. At the end of a Chapter 13 plan, any unsecured debts that have not been paid in full are discharged.
Which type of bankruptcy you file – Chapter 7 or Chapter 13 – can depend on several factors, but in most cases the determining factor is the bankruptcy means test analysis.
What Is The Bankruptcy Means Test?
The bankruptcy means test analyzes your income to determine whether or not you are eligible to file Chapter 7 bankruptcy. Consisting of two steps, the means test is used to determine if you have sufficient disposable income to pay off your debts.
It’s important to bear in mind that only those with primarily consumer debts – not business debts – must take the means test. In addition, some veterans and military members aren’t required to take the means test.
How Does The Bankruptcy Means Test Work?
The first step of the means test compares your current monthly income to your state’s median income for your family’s size. (Median income levels vary by state and household size, so check the appropriate chart on the U.S. Trustee Program website.)
Current monthly income is your gross income earned over the six calendar months before filing for bankruptcy multiplied by two. If your current monthly income is below the median, then you pass the means test and are eligible to file Chapter 7 bankruptcy. Most people (over 80%) pass the means test at this first step.
If your income exceeds the median, you may still qualify to file Chapter 7 bankruptcy but will need to perform the second step of the means test.
The second step involves deducting certain allowed expenses from your current monthly income to determine if you have sufficient disposable income to pay down your unsecured debts, such as credit card bills.
These expenses can be broken down as follows:
- Standardized Expenses: These include expenses for food, clothing, out of pocket health care costs, housing and utilities, and transportation. However, the amounts entered for these expenses are not your actual expenses but based on national standards established by the Internal Revenue Service (IRS).
- Payments to secured and priority creditors: If you want to keep certain property like your home or car, you can deduct your home mortgage and car loan payments from your monthly expenses. Also, expenses related to priority debts, such as tax debts, that wouldn’t be discharged as part of the Chapter 7 case can be deducted.
- Actual expenses: Debtors can increase deductions in certain expense categories if they can show that their actual, reasonable and necessary expenses for a particular category are greater than the number allowed under the IRS standards. Additionally, certain actual expenses, including payments of domestic support obligations pursuant to a court order, are considered as part of this analysis.
- Administrative expenses: Finally, the means test deducts administrative expenses that are a standard part of a Chapter 13 case to determine if you have sufficient disposable income to pay your creditors.
If step two of the means test shows you do not have sufficient disposable income to pay at least 25% of your unsecured debts over a hypothetical five-year Chapter 13 plan, you are eligible to file Chapter 7.
What Happens If I Fail The Means Test?
If you fail the means test but your income has recently decreased or your expenses have recently increased, you may still be eligible to file Chapter 7 provided you can hold off on filing for a while.
Finally, bear in mind that just because you are eligible for Chapter 7 relief doesn’t mean you might not be better off filing Chapter 13 bankruptcy. If you want to hold onto certain assets like a home or car by getting caught up on your mortgage or loan payments, Chapter 13 may be the right option to pursue.
If you are considering bankruptcy, it is important to consult with an experienced bankruptcy attorney who can analyze your financial circumstance, present the options available to you, and explain the bankruptcy process, including the bankruptcy means test.