Many people with high incomes that are considering Chapter 7 Bankruptcy presume that they are ineligible because they cannot qualify under the financial means test. The means test was a significant reform included in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).
Prior to enactment of this means test, judges were granted discretion in evaluating whether to let a debtor proceed with a Chapter 7 liquidation bankruptcy or force the debtor to pay into a Chapter 13 payment plan. When Congress adopted the means test, the discretion of judges was replaced with a mathematical calculation to determine a debtor’s 7 bankruptcy eligibility.
The means test is essentially a two part test:
If a debtor’s income is less than the median income for the state, the debtor qualifies for Chapter 7 bankruptcy without any further analysis under Bankruptcy Code Section 707(b)(2).
If the debtor’s income exceeds the median state income, the debtor’s income for the six (6) months prior to filing bankruptcy will be considered after certain allowable deductions to determine if the debtor has sufficient disposable income to pay back a reasonable portion of his or her unsecured debts.
The Chapter 7 means test can be difficult to understand so we have provided a step by step example below that illustrates how a family of four with relatively high income can qualify for Chapter 7 Bankruptcy. Our example will include a married couple with two children. The husband will be the sole breadwinner and make $100,000 per year as a pharmaceutical sales representative. The family lives in Brighton Beach, Brooklyn and owns a home and two vehicles. The mortgage on their home is $3000 per month and the payment on each vehicle is $650. Because the family is overextended, they are also one month behind on the mortgage and car payments.
Step 1 Comparing Income to the State Median
The state median income for New York is $6794. We will assume that the sales representative’s income is standard each month so he makes $8333 per month. Because the family income exceeds the state median income for a family of four, we must analyze their income and expenses to determine if they have enough disposable income after paying certain allowable expenses, secured debts, priority unsecured debts and arrearages on secured debts to have a reasonable amount left to pay toward unsecured non-priority debts.
Priority debts are things like alimony, child support, taxes and court imposed penalties. While we assumed for purposes of this example that the salesperson’s income remained constant, this is not necessarily an accurate assumption so sometimes waiting to file bankruptcy until a debtor has more low income months can make a difference.
Step 2 Determining Allowable Expenses
The IRS standards provide allowable deductions for certain types of living expenses including clothing, food, utilities, out of pocket health insurance, transportation, utilities and more. We have provided the allowable monthly deductions for King County given the scenario described above:
Clothing Food and Household Supplies: $1450
Out of Pocket Health Care ($60 X 4): $240 (assumes all family members under age 65)
Vehicle Operation Expenses (2 cars): $684
Car Ownership Costs ($650 per vehicle): $1300
Mortgage Payment: $3000
These expenses represent your total allowable expenses under IRS standards. It is important to note that we used the actual car payment on each vehicle ($650 per vehicle) and the actual mortgage payment of $3000. While we could have used the IRS standard for these two expenses, we are allowed to choose the actual amount of the secured monthly obligation or the IRS standard.
Because the IRS standard for mortgage and utilities was only $2291, we used the actual mortgage payment of $3000 because it was greater. Similarly, the vehicle ownership costs under the IRS standard would have only amounted to $496 per vehicle so we elected to deduct the actual car note payment of $650 per month per vehicle. Technically, our use of the actual payment owed makes these deductions for secured debt obligations rather than IRS approved expenses.
We are also permitted to deduct some additional expenses including arrearages of one month on both cars and the residence. This amounts to another $4300 ($3000 for the mortgage and $650 per vehicle) that must be divided by sixty (60) months which is the period over which the arrearages would be made if we were forced to participate in a Chapter 13 payment plan. This would result in another $72 deduction per month (i.e. $4300/60). Additionally tax obligations and priority debts (like child support and alimony) may be deducted so we will assume these amounts total $700 per month.
We are end up with the following summary:
Total Income $8333
Car Payments $1300
Clothing & Food $1450
Out of Pocket Health $240
Vehicle Operation $684
Car/Mortgage Arrearage $72
Priority Unsecured (Child Support)/Taxes $700
Non Mortgage Utilities $818
Total Disposable Income: $69
This total disposable income number is the critical calculation because you will be allowed to file a Chapter 7 unless you have at least $7025 ($117 per month) in disposable income left to pay to non-priority unsecured debtors over a 5 year Chapter 13 repayment plan. Because this family has only $69 per month in disposable income after paying allowable IRS expenses, secured creditors and priority unsecured creditors, they would qualify for Chapter 7 under the means test.
It is important to notice the impact of higher secured debts (i.e. car payments and mortgage). If this family had to use only the IRS allowable housing deduction and car ownership deduction, the family would not have qualified for Chapter 7 under the means test. However, their ability to count the entire amount of any secured debts (and priority unsecured debts) assisted the family in qualifying for Chapter 7.