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New Bankruptcy Laws and The Means Test
In 2005 everything about bankruptcy changed, a new test called the "Means Test" was introduced which has left most people nothing short of confused. The means test is used by the courts to determine eligibility for Chapter 7 or Chapter 13 bankruptcy. The Internal Revenue Service is responsible for calculating this system which allows them to determine who can and who can not file Chapter 7.
What the Changes in Law Mean
Prior to the introduction of the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005," the most common reason for someone to file under Chapter 13 was to avoid the loss of equity in their home or other property. And while equity protection will continue to be a big reason for people to choose Chapter 13 over Chapter 7, the new rules will force many people to file under Chapter 13 even if they have no equity, because the means test takes into account the debtor's income level.
How the Means Test Works
Using the Means Test, the court takes the debtor’s average income for the 6 months prior to filing and compares it to the median income for that state. Whatever the median annual income is for your state, if your income is below that then you can use Chapter 7 as an option but if it is not then things get a little trickier. The next step in the calculation takes income, less living expenses (excluding payments on the debts included in the bankruptcy), and multiplies that figure times 60. This represents the amount of income available over a 5-year period for repayment of the debt obligations.
If the income available for debt repayment over that 5-year period is $10,000 or more, then Chapter 13 will be required. In other words, anyone earning above the state median, and with at least $166.67 per month of available income, will automatically be denied Chapter 7. So for example, if the court determines that you have $200 per month income above living expenses, $200 times 60 is $12,000. Since $12,000 is above $10,000, you're stuck with Chapter 13.
What happens if you are above the median income but do NOT have at least $166.67 per month to pay toward your debts? Then the final part of the means test is applied. If the available income is less than $100 per month, then Chapter 7 again becomes an option. If the available income is between $100 and $166.66, then it is measured against the debt as a percentage, with 25% being the benchmark.
In other words, let's say your income is above the median, your debt is $50,000, and you only have $125 of available monthly income. We take $125 times 60 months (5 years), which equals $7,500 total. Since $7,500 is less than 25% of your $50,000 debt, Chapter 7 is still a possible option for you. If your debt was only $25,000, then your $7,500 of available income would exceed 25% of your debt and you would be required to file under Chapter 13.
- If you need help with filing bankruptcy, click here for a Free Case Review with a Bankruptcy Lawyer near you. The content of this website is provided for informational purposes only, and nothing here should be taken as legal advice.