Understanding how the Means Test works in Bankruptcy
On October 17, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, commonly referred to as BAPCPA, took effect as a major change in the Bankruptcy Code. One of the biggest changes that BAPCPA made to the Code was to implement the “Means Test” as a way to determine who is eligible to file for Chapter 7 bankruptcy. Before BAPCPA took effect, anyone could file for Chapter 7 bankruptcy, regardless of their household income and expenses, and it was up to the bankruptcy trustee or the U.S. trustee to object to the filing.
The Means Test was designed to prevent abuse of the Chapter 7 bankruptcy process and ensure that Chapter 7 was reserved for people who truly cannot afford to pay back even a portion of their debts. The theory was that individuals who earn more than an average household of similar size in their area would be required to file for Chapter 13 bankruptcy and repay at least a portion of their debts. In reality, while Chapter 7 filings spiked in the year leading up to the effective date of BAPCPA and Chapter 13 filings were disproportionately higher in the year after BAPCPA took effect, bankruptcy filings soon normalized in their respective proportions. To those of us who practiced bankruptcy for a living during that time it simply proved what we already knew, very few debtors abused the Chapter 7 bankruptcy process.
With that said, the Means Test is still a requirement in every consumer bankruptcy case under Chapter 7 or Chapter 13 and it can impact which chapter you are eligible to file and, in the case of Chapter 13 bankruptcies, how much you are required to repay.
The Form 122 that contains the Means Test may look intimidating, and it is a complex form, it does boil down essentially to a math problem and paperwork exercise broken down into two components. Experienced bankruptcy attorneys have become quite adept and navigating and preparing this form for you.
First is the current monthly income analysis. This requires you to calculate all of your household income from the six calendar months leading up to the bankruptcy filing, then average that into an average current monthly income figure. There are complexities to this, as certain sources of income do not need to be included in this calculation and some income can be included, then excluded as a marital adjustment. Again, this is the one of the many values of having an experienced bankruptcy attorney guide you through this process.
Once the average monthly income figure is calculated, it is compared to the median income figure for your state for a household of the same size. The median income figure comes from a series of tables published by the Internal Revenue Service and represents the mid-point income of the state, with half of the households having higher income and the other half having lower income. This brings us to the first deciding factor.
If your current monthly income is below the median income figure, then you automatically “pass” the Means Test and are eligible to file for Chapter 7 bankruptcy. You do not have to go to the second step.
Please keep in mind that “passing” the Means Test does not mean that you can only file for Chapter 7 bankruptcy. You are still able to file for Chapter 13 bankruptcy if that is the best option for your situation, it simply means that your eligible to file for Chapter 7 bankruptcy if you so choose.
If your current monthly income is above the median income figure, then you must move on to the second round of calculations to determine if you are eligible for Chapter 7. This is known as the Disposable Monthly Income calculation.
Calculating Disposable Monthly Income involves entering expenses into the calculation to offset your income. Some of the expenses used in the calculation are based on your actual expenses, such as mortgage or rent payments. Other expenses used are based on standardized expense allowances set by the Internal Revenue Service for each state. These expenses include items such as food, transportation, clothing and healthcare. There is the ability to claim expenses above the IRS standards to a degree, but these overages often have to be explained and documented in order for them to be allowed in a case.
After all of the allowed expenses are reduced from the current monthly income, the remaining amount shows whether you have money available to repay your debts. If there is no disposable monthly income left, then again you “pass” the means test and are eligible to file for Chapter 7 bankruptcy.
If there is some positive disposable monthly income left, it gets weird again. The amount of monthly disposable income is multiplied by 60. There are two threshold amounts set by the federal Judicial Conference and adjusted every three years, which leads to one of three results:
- If the monthly disposable income multiplied by 60 is below the lower threshold amount, then you “pass” the means test and are eligible for Chapter 7.
- If the monthly disposable income multiplied by 60 is above the higher threshold amound, then you “fail” the means test and are only eligible for Chapter 13.
- If the monthly disposable income multiplies by 60 is between the lower and higher threshold, then you must calculate the amount of nonpriority unsecured debt that you have. You multiply this by 25%, so one quarter of your total nonpriority unsecured debt. If the monthly disposable income multiplied by 60 is not enough to pay 25% of your nonpriority unsecured debt, you “pass”. If it is enough to pay 25% of your nonpriority unsecured debt, then you “fail”.
Just to add one more complication, if you “fail” the disposable monthly income test because the ending calculation is either over the higher threshold amount or is between the threshold amounts and is enough to pay 25% of your nonpriority unsecured debt, you still have the ability to claim “special circumstances” to dispute that you will have sufficient income to fund a Chapter 13 plan of reorganization.
Again, the Means Test is required to determine eligibility for a person to file for Chapter 7 bankruptcy, it does not limit a person who “passes” to only be able to file Chapter 7. The Means Test has no bearing on a persons eligibility to file for Chapter 13 bankruptcy, though it does come into play there as well.
If a Chapter 13 bankruptcy is the only option for a person due to the Means Test, or if Chapter 13 is the better option given the person’s financial challenges, then the Means Test still comes into play. The form is slightly different for a Chapter 13 case, but the concept is similar and the impact can be significant.
Current monthly income is calculated in substantially the same manner and is compared to the median income number for a similar household within the state. If the current monthly income is lower than the median income number, then the debtor can propose a Chapter 13 plan of reorganization that lasts a minimum of three years (the maximum is five years) without having to pay all of their debt back in full. If, however, the current monthly income is higher than the median income number, the debtor is required to propose a five year repayment plan unless they are paying their debts in full over a shorter term. If the debtor is proposing to pay their debts back in full, they can propose as short of a plan as they would like.
Also, if the current monthly income is over the median income number, then disposable monthly income must be calculated in a similar manner to above. The key difference is what the final disposable monthly income number means. In a Chapter 13 case where there is positive disposable monthly income, you multiply the disposable monthly income number by 60 and that is the minimum amount of nonpriority unsecured debt that must be paid back in the Chapter 13 plan.
This was a difficult read for you and that is appreciated, it is a complex matter, but it can impact both which chapter of bankruptcy you are eligible to file and, in Chapter 13 cases, how much you are required to pay back, so these calculations are important and must be completed accurately.
Examples of How the Means Test Works
Let’s go through a practical example that will help clarify this. My favorite neighbors and fake bankruptcy clients, John & Sarah Testperson of Chicago, IL, consult with me regarding his bankruptcy options. They are married and have two children. I gather the pertinent information and run the means test.
Scenario #1: John and Sarah have a household income of $10,000 per month ($120,000 per year). The median income number for IL for a household of four is $132,536.00 at the time of writing this. Because they are below median income, John and Sarah are eligible to file for Chapter 7 bankruptcy and do not need to complete the second part of the test. If they elect to file for Chapter 13 bankruptcy, they are permitted to propose a three-year repayment plan with no minimum payment to their nonpriority unsecured debt.
Scenario #2: John and Sarah have a household income of $15,000 per month ($180,000 per year). First, we would have to complete the disposable monthly income test to determine if they are eligible for Chapter 7. If not, because their disposable monthly income is above the threshold and there are no special circumstances, they would be required to file for Chapter 13 bankruptcy to receive the protection of the bankruptcy court. In Chapter 13, they would be required to propose a five-year repayment plan and that plan would have to account for nonpriority unsecured creditors to receive at least the disposable monthly income amount multiplied by 60.
The arguments for adopting the means test seemed very reasonable at the time. Advocates wanted to prevent abuse of the Chapter 7 process by high income households, encourage fairness by applying a uniform set of standards and promote responsibility by requiring a closer analysis of a bankrupt debtor’s finances.
The reality is that the adoption of the Means Test created unnecessary complexity in the bankruptcy process that created extra costs for struggling debtors and prevented very little abuse, if any. It did provide uniformity, consistency and more transparency, all of which are good, but the price was steep.
