6 Months Income
The first step in deciding whether to file bankruptcy is to evaluate your income over the last six months. This six-month income test is called the "means test" or median income test. In order to qualify for Chapter 7 bankruptcy, your gross income in the six months prior to filing your bankruptcy case must not exceed the median income for your family size. For example, in the state of Washington, the median income for a family size of one is currently (April, 2009) $50,656.00. The median income is calculated based on your last six months multiplied by two. Thus, if a single person has made less than $25,000 over the last six months, he or she qualifies under the median income or means test to file for Chapter 7 bankruptcy. If one makes more than the median income, he or she may also qualify for Chapter 7 under the means test under certain circumstances where he or she is making mortgage payments, car payments and other expenses that may result in income less than the median.
Current Monthly Income and Expenses
After calculating 6 months gross income, the next step is to evaluate current monthly income and expenses. The best way to calculate current monthly income is to review several recent pay stubs. When calculating current monthly income, it is important to exclude deductions for garnishments, 401k loan repayment and other pre and post-tax deductions that will not be utilized by the bankruptcy court when evaluating current monthly income. Current monthly income must be calculated for both spouses, as applicable. After calculating current monthly income, the next step is to calculate current monthly expenses. These expenses include rent/mortgage payment, car payment, food, gas, home maintenance, clothing, etc. Do not include credit card expenses, past medical bills or any other debt that will be eliminated or restructured in your bankruptcy case. Also, if you are facing foreclosure, do not calculate the mortgage payment.
In both Chapter 7 and Chapter 13, you are required to disclose all assets you own at the time your bankruptcy case is filed. It is important to disclose all assets to your lawyer prior to filing your bankruptcy case. If assets are not disclosed, you risk losing the asset in your bankruptcy case even if you could have exempted the asset. In bankruptcy, certain assets are exempt under both Washington and Federal law. For example, the homestead exemption under Washington law currently exempts $125,000 of equity in a primary residence. This means that the bankruptcy trustee in Chapter 7 cannot sell your primary residence if your equity (home value less mortgages) is less than $125,000. Assets such as automobile accident claims must be disclosed whether you have received a settlement or not. Same with inheritances. If your assets are exempt then you may be able to file Chapter 7 without losing any assets. If your assets are not exempt then a Chapter 13 may be appropriate.
Identify and calculate debt
The next step is to identify and calculate the type and amount of your debt. I ask clients to calculate all credit card, medical and other general unsecured debt in one column; mortgage, auto and other secured debt in a separate column and taxes and other debts owed to the government in a third column. If the amount of the general unsecured debt (credit cards, etc) exceed the client's yearly income, then Chapter 7 bankruptcy may be an appropriate solution. If monthly mortgage, auto and other secured debt exceeds the client's monthly income, then Chapter 7 or Chapter 13 bankruptcy may be an appropriate solution to eliminate or restructure such secured debt. On the other hand, if a client has significant tax or other unsecured "priority" debt, then Chapter 7 may not be a viable option unless the debt was incurred and assessed more than three years prior to the bankruptcy filing. A Chapter 13 may be a more appropriate venue to restructure tax debt under these circumstances.
The last step is to evaluate your financial affairs over the last year. In Chapter 7, a number of financial dealings can cause complications in your Chapter 7 case. For example, if you repaid a family member over $600 in the year before filing, the trustee in your Chapter 7 case has the option of filing a lawsuit against your family member to recover the payment(s) in order to distribute the payment(s) to all creditors. Another financial dealing that can cause problems in Chapter 7 is the transfer of an asset to a family member in the years leading up to your bankruptcy case. For example, if you transfer a home or real estate to a family member in the year leading up to your bankruptcy case and there is equity in the property, the trustee in your Chapter 7 case can sue the family member to undo the transaction. Then, the trustee is able to sell the real estate and distribute proceeds to your creditors. Be sure to disclose all financial dealings to your lawyer.