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Qualifying for Bankruptcy

Chapter 7:
A “means test” was added to the U.S. Bankruptcy Code in 2005 to create objective standards for determining which individuals qualify for relief under Chapter 7. It applies only to “individuals” and only those individuals whose debt is primarily consumer debt (as opposed to primarily business debt).

The means test is calculated by multiplying the debtor’s average gross monthly income for the past six months by twelve to “annualize” the income. The annualized income is then compared to the median family income for households of the same size in the debtor’s state of residence. If the debtor’s income is not more than the applicable state median income, he is exempt from completing the means test and does not need to complete or file Official Form 122A-2 (“Chapter 7 Means Test Calculation”).

If the debtor’s annual gross income exceeds the state median income, a further analysis is performed looking at the debtor’s calculated ability to repay all or a portion of his debts over 60 months under a hypothetical Chapter 13 repayment plan. The debtor’s monthly disposable income is calculated on Official Form 122A-2 by subtracting a mix of actual and standardized expenses from his average gross monthly income. “Disposable income” is the amount left over each month after subtracting all allowable living expenses. If the debtor’s disposable income is not sufficient to pay at least $7,700 in five years or as little as $128.33/month to creditors, he passes the “means test” and no legal presumption of abuse arises that his Chapter 7 filing is “abusive”.

If the debtor can pay at least $7,700, but not more than $12,850, to creditors over 60 months, but this will not be sufficient to pay at least 25% of his non-priority unsecured debts, then he will still pass the means test and no legal presumption of abuse will arise.

If the debtor can pay at least $7,700 over 60 months, and his disposable income is sufficient to pay at least 25% of his non-priority unsecured debts within such time, then he will fail the means test and a legal presumption of abuse will arise that his Chapter 7 filing is abusive. In such case, on the court’s own motion, or the motion of the United States Trustee, the Chapter 7  trustee, or a creditor, after notice and a hearing, the court may dismiss the bankruptcy case unless the debtor voluntarily converts the case to a case under Chapter 13.

If the debtor can pay more than $12,850 over 60 months, he will fail the means test, regardless of whether his disposable income is sufficient to pay at least 25% of his non-priority unsecured debts.

The legal “presumption of abuse” may be rebutted by the debtor by presenting facts and circumstances not provided for in the prescribed test. One frequently raised “special circumstance” is that the debtor is now unemployed or his income has otherwise decreased and he doesn’t really have the ability to pay what the hypothetical means test form suggests.

An estimated 85% of individuals filing under Chapter 7 are exempt from completing the means test (Official Form 122A-2) because their annual gross income does not exceed the state median income for their family size. Those that are required to complete the means test form typically qualify for Chapter 7 anyway after completing the test.

Because the means test is based on average monthly income over the past 6 months (rather than the debtor’s actual current income, which may have changed), bankruptcy courts essentially disregard the means test when there has been a change of circumstances (such as a change of income or expenses) and determine a debtor’s eligibility for Chapter 7 based on “monthly net income” on line 23c of Official Form 106J (“Schedule J: Your Expenses”).

When determining median family income based on a debtor’s family size, the debtor should include himself, his spouse (unless separated), and any relatives (including children) for whom he provides at least one half of the support, whether or not they reside with him. If the debtor has a girlfriend, fiance, etc., with whom he has resided as a single economic family unit for an extended period of time, he may also include that person (and any children he supports) in determining his family size. However, if he includes an unmarried partner as a family member he must also include that person’s income on his bankruptcy forms.

The income of a debtor’s spouse must be included on Official Forms 106I (“Schedule I: Your Income”) and on Official Form 122A-1 (“Chapter 7 Statement of Your Current Monthly Income”) unless the debtor and spouse are separated. The income of the debtor’s spouse must be included even if the spouse is not filing bankruptcy. However, certain portions of the non-filing spouse’s income may be excluded in Part 1 of Official Form 122A-2 (“Chapter 7 Means Test Calculation”) if that income is not regularly used to pay for the household expenses of the debtor or his dependents.

Unlike Chapter 13 bankruptcy, there is no statutory limit or “debt ceiling” on the amount of debt a debtor may owe in order to file for Chapter 7 bankruptcy relief, nor is there a statutory minimum amount of debt.

Chapter 13:
Individuals with regular income from any source that owe noncontingent, liquidated, unsecured debts (no collateral) of less than $394,725 and noncontingent, liquidated, secured debts (debts that are secured by collateral, such as mortgages and vehicle loans) of less than $1,184,200 qualify to file bankruptcy under Chapter 13 if they have sufficient disposable income to contribute to a 3 to 5 year debt repayment plan. There is no minimum amount of debt required to file under Chapter 13.

In most Chapter 13 proceedings the primary issue is not whether the debtor qualifies, but rather how much his monthly Chapter 13 plan payment should be. Chapter 13 debtors typically claim lots of allowable living expenses to show a low disposable income. A low disposable income results in a low Chapter 13 plan payment. Bankruptcy trustees review the debtor’s claimed expenses to ensure that the expenses are both allowable and reasonable in amount.