The Chapter 7 Means Test
You have to pass the means test to qualify for a Chapter 7 case. It’s often an easy test to pass but one with some crucial twists and turns.
The Purpose of the “Means Test”
You need to qualify to file a Chapter 7 “straight bankruptcy” case. The “means test” is the main step in qualifying. Its purpose is to not let you file a Chapter 7 case if you have the “means” to pay a meaningful amount to your creditors. If you do, then usually you would instead have to go through a Chapter 13 “adjustment of debts” case.
A consumer Chapter 7 case generally “discharges” (legally writes off) all or most of your debts. And it does so in a process that usually takes only 3 or 4 months.
In contrast a Chapter 13 case requires you to pay as much as you can reasonably pay to your creditors over a 3 to 5 year period. That usually means that under Chapter 13 your creditors get paid at least a portion of what you owe them. Often that portion is small, and sometimes most of your creditors actually get nothing. But the point is that Chapter 7 is SO much faster and easier. IF it’s the right option for you, you want to be able to qualify. And that means passing the means test.
Usually Easy, but Watch Out for the Twists and Turns
The reality is that most people who want to file under Chapter 7 can pass the means test. And most of those who pass do so quite easily.
Here’s why. There are a number of steps to the means test. But if you pass it on the first easiest step, then you’re done. You don’t have to go through the other more complicated steps.
This first step—the “median income” step—is relatively straightforward. But it has its own oddities—its twists and turns.
The “Median Income” Step
The idea behind this first step is that if your income is low enough, you have no money for creditors. You don’t have the “means” to pay a meaningful amount to the creditors.
If your income is low enough you pass the means test simply on the basis of your income. You don’t have to compare your income to your expenses to see if you have enough left over to pay to your creditors. (That’s the second step of the means test, if you don’t pass at this median income step.)
How low does your income need to be to pass the means test at this first step?
It can’t be more than the current median income amount for your state and your family size.
Median income is somewhat like the average income but not quite. It is the income amount at which half the people of the population have a lower income while half of the people has a higher income. The median income amounts for each state and family size are updated usually two or three times a year. The most recent update as of this writing was effective as of May 1, 2017. Tables of these median income amounts are published and made available.
“Income” Isn’t What You Think
“Income” has a very special and specific meaning here. To see if your income fits within your applicable median income amount, you need to know this meaning of “income.”
First, consider only money you received during precisely the SIX FULL calendar months before the filing of your bankruptcy case. For example, assume you are filing a Chapter 7 case on any day in the month of July. Then, you only count money you’d received from January 1 through June 30 of that year.
Second, we purposely said “money” instead of “income” here. That’s because 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. Include essentially all sources of funds, except those received through any kind of Social Security benefit.
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 Often Changes Your “Income”
With this particular definition of “income,” whether you are above or below median income can change by the month. That’s especially true if you occasionally get money in irregular amounts and/or with irregular timing. Examples would be 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.
An unusual payment can artificially inflate your “income” for the means test. A gap in usual payments can deflate your “income.” These can either push you temporarily above your applicable median income or below it. Because the impact is doubled (when you annualize the 6-months of income), even a moderate change can effect whether you pass this step of the means test.
The Rest of the “Means Test”
If your income is more than your applicable median income, you go to the second step of the means test. This involves a comparison of your income and allowed expenses to come up with your “disposable income.” The twist and turn here is in calculating your allowed expenses. We’ll get into that in our next blog post.