Crucial Question: What Is the “Means Test” in a Chapter 7 Bankruptcy?

To qualify for filing a Chapter 7 case, you must pass the “means test.” It is usually quite easy to pass.

 

What’s the Point of the “Means Test”?

A consumer Chapter 7 “straight bankruptcy” case “discharges” (legally writes off) many or sometimes all of your debts, and does so in a matter of only 3 or 4 months. A Chapter 13 “adjustment of debts” case, in contrast, requires you to pay as much as you are reasonably able to pay to your creditors over a 3 to 5 year period. That usually means that all of your creditors get paid at least a portion of what you owed them (although not always).

For a long time bankruptcy law has encouraged people to file under Chapter 13 instead of Chapter 7, presumably to induce at least a partial payment of debts. In a total re-write of the bankruptcy laws in the late 1970s, that encouragement mostly took the form of “carrots,” significant advantages for filing under Chapter 13. But in the last major set of bankruptcy amendments, in 2005, that encouragement instead shifted mostly to “sticks,” methods of preventing certain people from filing under Chapter 7.

The “means test” is one such method. Its intent is to prevent you from filing a regular Chapter 7 case if you have the “means” to pay a meaningful amount to your creditors.

Usually a Simple Test, but with Convoluting Possibilities

The fact is that most people who need and want to file a Chapter 7 case are able to pass the “means test.” And most of those people do so quite quickly and easily.

There are a number of steps to the “means test.” But you can pass it on the first step, and then you’re done, you don’t have to go through the other steps. Or if you don’t pass it on the first step but do so on the second, again you’re done and don’t have to go any further.

The first step is relatively straightforward. Beyond that, the “means test” gets maddeningly complicated—it’s perhaps one of the most detailed, difficult to apply set of rules in consumer bankruptcy law.

Fortunately, the vast majority of people who file a Chapter 7 case pass the “means test” with its first step, the “median income” step.

The “Median Income” Step of the “Means Test”

The idea behind this first step is that if your income is low enough, the system doesn’t need to get into how much money you have beyond your living expenses to pay your creditors. If your income is low enough the assumption is that you are using most of your income just to get by, and you get a free pass—you pass the “means test” without having to compare your income to your expenses.

How low does your income need to be to pass the “means test” at this first step?

It cannot be more than the median income amount for your state and family size.

Median income is the amount at which half of the population has a lower income while half of the population has a higher income. The median income amounts for each state and family size are updated periodically, with the most recent change at this writing having been effective November 1, 2014. Tables of these median income amounts are published and available.

“Income” for the “Means Test”

Before you jump to see if your own income is no more than your applicable median income amount, you need to understand that “income” here does not mean what you think it does.

For purposes of the “means test,” first, consider only whatever money you received during precisely the SIX FULL calendar months before your Chapter 7 case will be filed. So if you are filing a Chapter 7 case on any dater from December 1 through 31, you look at money you received from June 1 through November 30 of that year.

Second, we’ve purposely said “money” instead of “income” here simply because for purposes of the “means test” you include virtually all money you received during the applicable six-month period from virtually all sources. It’s not just employment income, or money that’s taxable and shows up on your income tax return. (However, exclude funds received from any kind of Social Security benefits).

Once you have the total 6-month “income” amount, multiply it by 2 to get the annualized amount of “income.” Then compare that amount to the one for your state and family size in the published table.

Timing of Filing Affects “Income” Amount

Notice that the combination of this expansive definition of “income” with this six-month look-back period means that your “income” can change month to month, especially if you occasionally get money in irregular amounts or with irregular timing. Examples include inconsistent child support, an annual or quarterly bonus from work, or any kind of lump sum distribution like a disability settlement or from a vehicle accident.   Either an unusual payment or a gap in money that you were usually receiving can artificially inflate or deflate your “income” for the “means test,” either pushing you temporarily above your applicable median income or below it. Even a moderate amount of money—because the impact is doubled when annualized—can effect whether you pass this step of the “means test.”

The Rest of the “Means Test”

The second step of the “means test”—the one you have to get into if your “income” is more than the applicable median income amount—involves a comparison of your income and expenses to come up with your “disposable income.” Sounds easy enough but it’s infinitely more convoluted than it sounds because your “allowed” expenses are in some instances what you actually spend, for other expenses what you are allowed under national standards, and for other expenses based on regional or local standards. Then the resulting “disposable income” amount is put through a multi-part formula comparing it to the amount of your debts to determine whether you have sufficient means to be required to file a Chapter 13 case instead of a Chapter 7 one.

Many people who have income beyond their applicable median income amount pass the “means test” because their “disposable income” is low enough. But no question: it’s nice to avoid all that if you’re simply under the median income.

Beyond the second “disposable income” step, if after all this you still haven’t passed the “means test,” there is one more possible way to pass, by showing “special circumstances.” This is a step that you will very unlikely need to take, and is beyond the scope of this blog post.