Chapter 7 Bankruptcy and the Means Test

When the Bankruptcy Code is changed in 2005, the idea that this would force people to file under Chapter 13, which requires a plan to repay as much of your debt as possible, instead of using Chapter 7 to get a “fresh start” by discharging most debts and allowing you to keep most (if not all) of your possessions was a commonly held belief. The new law did have a bias against Chapter 7 bankruptcies, but the reality is that most people still can file under the chapter that gives them their best options.

The means test, which can be used to force you pursue a Chapter 13 bankruptcy, has “safe harbors” that protects the average filer’s choice of which bankruptcy to pursue. For this reason, you need some understanding of this test and when the safe harbor based on income will allow you to consider a range of possibilities, including those under the Bankruptcy Code if necessary, to handle your financial struggles.

Due to the formula involved, we will take a greatly simplified journey through the means test. Its starting point is “current monthly income,” which actually looks at the average income from the previous six months to find a monthly average. Also, the focus is on income from all sources used to pay household expenses of the debtor and the debtor’s dependents on a regular basis during this period. The bankruptcy law provides for various deductions from the total and also excludes some sources of funds from being counted. The most prominent of these would be any benefit received under the Social Security Act. However, not everything paid under this Act is not counted necessarily – for example, the Advisory Committee on Bankruptcy Rules did not include Unemployment Compensation as being excluded. Also, we will see some other sources that are omitted due to the use of data regarding income from the Census Bureau.

“Current monthly income” must be calculated, after which it is multiplied by 12 to turn it into a yearly amount. The new total then can be compared to the median income in your state; the median income is the amount at which half of the households fall below it while the other half will be above it. As mentioned previously, the source of this data is the Census Bureau. For this reason, we have to be aware of various items that it leaves out of its income calculations, including Food Stamps, public-housing benefits, and lump-sum inheritances, so that the comparison is based on the same information. Meanwhile, in addition to income, your household size is important for establishing the median income level, as reported by the Census Bureau, that you would use for the means test. Unfortunately, this is another case in which the bankruptcy law does not provide clear guidance, which has made the definition of the size of any particular household an issue of contention at times.

However, despite the problems with ambiguity with the additions to the bankruptcy law in 2005, the means test eventually does produce an income figure to be compared to the median income borrowed from the Census Bureau. As of May 1, 2014, in Pennsylvania, the median income for a one-person household has been $47,809 while, for a household of two, this rises to $56,690. It continues to increase as the household size increases. The issue now becomes what all of this means to you.

Essentially, it means that the means test will be meaningless to you as long as your household income falls below the median level for a household of the same size in Pennsylvania (or the level for whatever state you live in). You would be in one of the safe harbors that Congress built into the means test. In turn, this means that the “presumption of abuse” (which focuses on a debtor’s ability to repay creditors) does not apply to you so that, if you decide to file for bankruptcy, you should be able to choose the chapter that would be most beneficial in meeting your goals for filing.

Most people who pursue a bankruptcy tend to be under the median income figure that applies to them, which means that the means test that can seem so intimidating due to its complexities actually has no effect on them. For those above the median income, the test will have implications, which can be explored at another time. What matters here is that you generally will not have to worry about the means test with its presumption of abuse preventing you from considering all of your options, including a possible Chapter 7 bankruptcy as a last resort, as you begin rebuilding your financial world.