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The Bankruptcy Means Test: What Is It And How Does It Work?

Forbes 8/2/2022 Mark Henricks - Forbes Advisor
The Bankruptcy Means Test: What Is It And How Does It Work? © Getty The Bankruptcy Means Test: What Is It And How Does It Work?

Bankruptcy offers a way for struggling borrowers to shed some or all of their debts and start fresh. But before debtors can get to that point, they must clear several hurdles"starting with the bankruptcy means test.

Means Test Basics

The means test is a formula that determines whether a borrower can seek protection from creditors under Chapter 7 of the bankruptcy code.

Chapter 7 bankruptcy, also known as liquidation bankruptcy, lets a borrower keep some exempt property"such as a car"while everything else is supposed to be sold to pay off unsecured debts. After going through the process, which takes four to six months, the filer may emerge with fewer assets but a slate wiped clean of most types of debt including credit card balances, personal loans and unpaid medical bills.

There's a different means test under Chapter 13, the other type of individual bankruptcy. Chapter 13 is called reorganization bankruptcy because the debtor must make payments on unsecured debts for three to five years. Most bankruptcy filers pick Chapter 7. But if they can't pass the means test, Chapter 13 is the only option.

Bankruptcy Means Test: Some Background

The bankruptcy means test came to life under the Bankruptcy Abuse Prevention and Consumer Protection Act, a sweeping overhaul of the personal bankruptcy process that was signed into law in 2005. The means test was created to prevent people from filing for Chapter 7 when they could afford to repay debts.

The means test is required for individual bankruptcy filers who primarily have consumer debt. If you're seeking bankruptcy protection mostly because of tax debt, business debt, investments, mortgages or damages awarded in a lawsuit, you can proceed right to Chapter 7. The same goes if you're a disabled veteran.

Fully 94% of people who take the means test pass it, according to a report from the U.S. Trustee Program, the federal entity that oversees bankruptcies. The report shows the trustees even allow some debtors they identify as 'abusive' to go ahead and file under Chapter 7. In that sense, the means test is not all that mean.

How the Bankruptcy Means Test Works

The means test can be quite confusing because Congress left many aspects of it open to interpretation.

At its simplest, the means test consists of two steps. The first checks the filer's income; the second is more complicated and involves reviewing the debtor's income and expenses.

Step One: Comparing Income to the Median

You begin the means test by completing Form 122A-1, the 'Chapter 7 Statement of Your Current Monthly Income.' The form is available as a download from the United States Courts website.

After entering your marital status, you fill in details about the average monthly income you received during the previous six months, including:

  • Wages, salary, tips, bonuses, overtime pay and commissions before payroll deductions
  • Alimony
  • Any funds regularly received for expenses, such as child support or rent payments from roommates
  • Self-employment income, after taxes and expenses
  • Investment income, like dividends, interest and royalties
  • Unemployment benefits
  • Pension benefits

Filers do not need to supply information about Social Security benefits they receive or any government payments for a military disability.

Once you've tallied your typical monthly income, multiply by 12 to get an annual income figure. Then, compare that to the median income in your state, which you can find at the Means Testing portal on the Justice Department's website. Locate the box labeled 'Data Required for Completing the 122A Forms and the 122C Forms,' select the current date range and click 'Go.'

You'll land on a page with a link labeled 'Median Family Income Based on State/Territory and Family Size.' At that link, you'll find a table showing median incomes for households of various sizes within each state and four U.S. territories.

If your income is less than the relevant median, you have passed the means test and can seek Chapter 7 bankruptcy. If not, you can either give up and elect for a Chapter 13 filing, or you can move on to the second step.

Step Two: Means Test Calculation

The second part of the Chapter 7 means test uses Form 122A-2, the 'Chapter 7 Means Test Calculation.' You determine your eligible expenses, then subtract them from your average monthly income from step one. If the result indicates you would be unable to pay off at least 25% of your unsecured debts over five years, you can file for Chapter 7.

While it may sound straightforward, part two of the test has limitations. 'Eligible expenses' include rent, groceries and medical costs, but other costs are considered disposable"meaning the bankruptcy system believes you could take that money and use it to pay off debts instead.

But there's room for interpretation on both expenses and income, so the second phase of the means test is arguably outside the skill set of just about any nonexpert. For this reason, even fans of DIY legal solutions advocate talking to an experienced bankruptcy attorney before attempting step two.

Of course, involving a lawyer hikes the price considerably. However, other approaches, such as free online means test calculators, aren't likely to work as well. And the risks are significant.

You could wind up filing for Chapter 7 incorrectly, leading the court to convert your case to a Chapter 13 filing. Or you may conclude that you're not able to file under Chapter 7, even though you qualify.

Bottom Line

The bankruptcy means test separates people who can legally afford to pay their debts from those who can't. Filers who pass the first part of the test can head straight to Chapter 7 and work on wiping away debts through the bankruptcy process. Some filers will need to complete the second, more complicated part of the test to qualify for liquidation bankruptcy. Those who fail it altogether will need to file under Chapter 13 or find an alternative route.

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