Means Test

Posted by Kevin on September 21, 2009 under Bankruptcy Blog | Be the First to Comment

In 1978, the Bankruptcy Code underwent a major overhaul. It gave bankruptcy judges more power. It established the Office of the United States Trustee. It allowed consumers to file for bankruptcy without proving insolvency. Moreover, a debtor could choose whether he or she wanted to file under Chapter 7 or Chapter 13 irrespective of his or her income. Almost from the beginning, creditors complained that the law, especially in consumer bankruptcies, was too pro-debtor.

Over the years, Congress amended the 1978 Code to make it less pro-debtor. But the outcry for a new law continued. Creditor groups argued that too many people were filing. More importantly, they argued that too many people who could afford to pay something to their creditors were filing under Chapter 7, and paid nothing.

Starting in the early 1990’s and continuing until 2005, the credit card and banking industries lobbied Congress for a new bankruptcy law. In October, 2005, Congress enacted BAPCPA. In the area of consumer bankruptcy, one of its main purposes was to make more people file under Chapter 13 so that payments could be made to creditors.

To accomplish this objective, BAPCPA puts restrictions on filing Chapter 7 based on the income of the debtor. To determine whether a prospective debtor qualified for Chapter 7, BAPCPA adopted the so-called means test. The means test was adapted from the test used by the IRS to determine whether a taxpayer could qualify for a payout plan and how much he or she could pay.

The means test is a three part test. The first part appears to be straightforward. The debtor must calculate his or her average income for the 6 months prior to the bankruptcy filing. Note that income does not include social security or unemployment. This average figure is multiplied by 12 to arrive at an annual income. The debtor’s annual income is compared to the median income for your State based on your household size. If the debtor’s income is below the median income, then he or she can qualify for Chapter 7. If not, then the debtor must proceed to the second part of the means test.

The second part of the means test tries to determine what money would be available for creditors after you deduct your expenses from your average income. This portion of the means test focuses on expenses- but not necessarily actual expenses. Remember, the means test is based on the IRS test for how much money should be available to pay back Uncle Sam. The IRS test has both National Standards (food, clothing) and Local Standards (housing, transportation). The means test incorporates the National Standard and Local Standards with some actual expenses. It also allows a debtor to deduct 1/60 of any secured debt (mortgages). If your net income (what’s left over after you subtract your means test expenses from your means test income) multiplied by 60 is less than $6575, you qualify for Chapter 7. If it’s greater than $10.950, then the debtor must file under Chapter 13. If it’s between, then you go to step 3.

In step 3, you compare your net income to your unsecured debt. If your net income is less than 25% of your unsecured debt, you may file under Chapter 7. If the income is above 25% of unsecured debt, then you are relegated to Chapter 13.

Sounds easy, right? Well, there are additional bumps in the road along the way of the means test. First, the Code does not define household size. Second, the line item expenses in the test are not fully explained. This has led to lots of litigation all over the country. If the statute is not clear and the parties cannot agree, then a judge must decide.

Now, for the last bump in the road. Even if you pass the means test and qualify for Chapter 7, the trustee can object to a Chapter 7 filing based on your actual income and expenses. But that’s for another lesson.

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