In 2005, the immensely powerful and influential credit card and banking lobby convinced Congress to incorporate this test into the new bankruptcy code in order to make it more difficult for middle-income debtors to qualify for a Chapter 7 discharge. It’s also created a gap into which a small but not insignificant number of debtors fall. These debtors may have too much debt to file a Chapter 13 but make too much money to file a Chapter 7. They, essentially, fall through the cracks. This is especially true of middle-income debtors with significant student loan balances that exceed the Chapter 13 debt limit.
Very little in bankruptcy causes more confusion and anxiety than the Chapter 7 means test. Many people assume that the means test will automatically force them into a Chapter 13 payment plan or prevent them from filing for bankruptcy at all. Although these assumptions are not true in most cases, the confusion is understandable. The means is unnecessarily complicated and not entirely rational. Yet despite its complexity, a basic understanding of the test can maximize your chances of passing it or avoiding it altogether. Fortunately, an experienced bankruptcy can help you navigate the bankruptcy means test by take the proper deductions and using the appropriate strategies to successfully receive a Chapter 7 discharge.
The Means Test only applies to individuals and those with primarily consumer debts. So if a company files or you have debts that are primarily non-consumer on nature such as business guarantees, taxes (this shocks some people), rental property mortgages, and depending on what the courts in your district hold, graduate student loans.
Figuring Out the Means Test for Chapter 7
The first step of calculating in tackling the means test is calculating your “Current Monthly Income (also referred to as “CMI”). CMI is capitalized because the meaning is a legal term rather than what it sounds like. CMI is not your actual current income but an average of your income from the six months prior to filing.
Income is defined in very broad terms, and except for child support, alimony, and social security income, includes all the money you’ve earned in the last 6 months, including gifts from family and friends, selling items for a capital gain, and cash received “under the table.” The income used for Means Testing is your gross, not net, income.
If you are self-employed, the monthly gross income is calculated as gross revenues minus necessary and legitimate business expenses. Taking your income over the past six months and dividing by six will give you your “Current Monthly Income” that will be compared to the median income for the county in which you live for a family of your size.
Example: To obtain your CMI, you must average your monthly gross income (your income before taxes and other deductions) for the six months prior to the month in which you will file for bankruptcy. In other words, add up all of your gross income for the previous six months and divide by six. The resulting figure is your CMI. It is important to keep in mind that in calculating your CMI, you do not include the month that you file. Thus, if you file in October, you would average your income for the months of April through September..
Example: April walks into my office and turns over her paystubs showing that she earns a relatively high hourly wage but with inconsistent hours. She also received a performance bonus at work during July that accounts for such a high income that month.
In this case, to calculate April’s CMI, she’ll need to add up six sequential months of income ($3,600 + $3,400 + $4,600 + $3,000 + $5,200 + $2,500 = $22,300) and divide by six ($22,300/6) to get $3,716.66.
The next step is to figure out if your income is over or below the median income for a family of your size. If your CMI is below the median income for your county, you are not required to take the means test. You can find Georgia’s median income numbers (and all other states as well) from the Department of Justice’s website.
Example 1: In the example above, April calculates her CMI as $3,716.66 per month($44,600 per year). Fortunately, April’s income is just below the median for a household of 1. If April’s income for August were $6,900 instead of $2,500, her CMI would be $45,333.33 – slightly above the median income for 1 person. As a result, she’ll have to take the means test in order to see if she can qualify for a Chapter 7. The good news is that if her income is this close to the median, just deducting the taxes taken from her pay would allow her to pass the means test and receive a discharge of her debts. If she had a child, however; the family size goes up to 2 and the median income for a family of two is higher than a family of one, allowing her to avoid the means test.
I got ahead of myself in the previous example. The next step is to deduct your necessary expenses that largely based on IRS standards to arrive at your “disposable income.” For example, certain expenses, such as housing, clothing, utilities, health care expenses, and transportation are determined based upon the IRS Collection Financial Standards for your county.
These standards are also used by the IRS in determining how much the tax man may collect on back taxes. You are also allowed to deduct certain actual expenses such as life insurance, health insurance (though not car insurance), and payments on secured debts contractually owed in the next 60 months.
Unfortunately, this does not include judgment liens, as a judgment is not a contract between you and your creditor. Instead, a judgment is merely the decision of a court that you are liable to someone else. If after deducting the appropriate expenses your disposable income falls below a certain number, you’ll still qualify for the means test.
Next, we’ll see if your disposable income is too high based on the deductions you can take.
If the Means Test determines your disposable income, multiplied by 60, is either (1) greater than or equal to $7,700 or 25 percent of the debtor’s nonpriority unsecured debts, whichever is greater or (2) greater than or equal to $12,850, then the case is presumed to be an abuse. In other words, if the Means Test determines your monthly disposable income to be less $128.33 per month or $7,700 over 60 months, you may file a Chapter 7.
Example: Jodi’s disposable income is determined to be $198.00 per month. Her bankruptcy schedules reveal she has $38,500.00 in non-priority unsecured debts. 25% of $38,500 is $9,625.00. If we multiply Jodi’s disposable income of $198.00 per month by 60, we get $11,880.00. Since $11,880 is more than 25% of Jodi’s unsecured debt of $9,625.00, she must file a Chapter 13.
Means Test and Chapter 13
You thought we were done? Oh no. The same Means Test used to determine whether you can qualify for a Chapter 7 is also one way to determine how much your monthly Chapter 13 plan payment should be. The forms for each chapter’s Means Test are slightly different, but the principal is the same. They’re designed prevent abuse of the bankruptcy code, though they’re really just a credit card company’s machination.
There are a few differences in what deductions you can make. For instance, in a Chapter 7, you may deduct ANY secured debts you are contractually obligated to pay within the next 60 days from your income, even if you are surrendering the house to the creditor. In a Chapter 13, if you are surrendering the collateral that secured the debt to the creditor, you can’t deduct the monthly payment from the Means Test because you won’t actually be making the payment anymore. The Chapter 13 Means Test is slightly more “forward-looking” than the Chapter 7 Means Test.
When you file a Chapter 13 to save your home or car and make above the median income as we discussed above, you must complete the Means Test to determine what your disposable income will be. Whatever that number is after subtracting out the appropriate expenses and IRS Collection standard deductions will be the amount you’ll have to pay to your unsecured creditors.
Example: The numbers change nominally almost every year, but if your disposable income is determined to be, for instance, $225.00 per month, that’s how much you must pay your unsecured creditors. This does not mean that your plan payment will be $225.00 per month.
You must still pay your attorneys’ fees, the trustee’s fee (a small percentage of the amount disbursed every month), past-due mortgage payments, and in some districts, including the Northern District of Goergia, your car note, through the Chapter 13 plan. Let’s say your past-due mortgage payments total $6,000.00, and your attorney lowers your car payment to $250.00 by modifying the interest rate and extending the note out to the 5-year maximum time period.
You also owe your attorney $3,000 in attorneys’ fees that will be paid through the plan. Since you’ll want the lowest payment possible, your Chapter 13 plan will last 60 months, or five years. We must divide $6,000 by 60 to arrive at $100.00 for back mortgage payments. Your attorneys’ fees will be $50.00 per month. If we total your attorneys’ fees ($50), car payment ($250.00), mortgage arrears ($100), and amount the Means Test determines you must pay to your unsecured creditors, we get $625.00 per month. Adding in a 5% trustee’s fee, and the payment comes to $656.25 per month for 60 months.
As you can see, the Means Test is no joke. It is, pun completely intended, a mean test. It’s one of the reasons why almost no one can successfully confirm a Chapter 13 plan (after being means tested) without the help of an attorney and why so many people who refuse to hire an attorney get kicked out of a Chapter 7.