The means test is a crucial step in the Chapter 7 bankruptcy process, designed to establish objective standards for determining eligibility for relief. For many people, overcoming the means test is the main challenge to qualify for Chapter 7. The means test consists of two parts: median income and disposable income. If you successfully pass the first part and your income falls below the median, you are exempt from the second part and can qualify for Chapter 7 Bankruptcy. But, failing both parts suggests a significant likelihood that you may not meet the requirements for Chapter 7, prompting consideration of Chapter 13 as an alternative.
Although its origins may suggest a deterrent for debtors, understanding the means test is essential for individuals seeking bankruptcy protection. In this blog post, we’ll delve into some of the basic parts of the means test, discussing its purpose, application, and how to navigate it successfully.
Understanding Why and How the Means Test Works
The means test, introduced into the Bankruptcy Code in 2005, specifically targets individuals with consumer debt. Consumer debt typically refers to debts incurred for personal, family, or household purposes. Common examples include credit cards, medical bills, personal loans, mortgages and car loans. By implementing the means test, the legal system aims to ensure a fair and equitable distribution of bankruptcy relief, taking into account the financial circumstances of those seeking debt discharge.
Defining Income
Income, in simple terms, refers to any money flowing into your household, which could come from various sources such as employment, business, or investments. However, the definition is not entirely straightforward, and exceptions do exist, which are elaborated further in our detailed discussion on what constitutes income on the means test.
Determine Your Household Income
The first question on Form 122 A-1 revolves around your marital status, specifically whether you are married, and if so, whether your spouse is filing jointly with you or if there is a legal separation. This information is crucial for calculating your household income, which is assessed based on both your and your spouse’s earnings.
It’s important to mention that even if your spouse is not participating in the bankruptcy filing with you, their income must still be accounted for on the means test under two conditions: you are legally married, and they reside with you (not legally separated).
The next step involves determining your annual income, which is computed over a six-month period, excluding the current month. Suppose you’re aiming to file for bankruptcy in December. In this case, you exclude December and look back six months. Therefore, the income calculation period spans from June to November (specifically from June 1 to November 30). Also, It doesn’t matter how many days are in a particular month, all months are treated equally.
Now, figure out your yearly income, based on this six-month period. It’s crucial to emphasize that income, in this context, refers to gross income only, not net income – so, don’t deduct taxes. Add up all the earnings from you and everyone in your household during those six months, regardless of the source. This includes income from side jobs, gigs like Uber or Instacart, investment income and bonuses. Include paystubs with dates falling within those six months; exclude those outside that timeframe. Divide the total for those six months by six to get a monthly amount, then multiply that by 12 to determine your household’s yearly income.
Median Income Comparison
Moving on to the next step of the means test, you’ll need to compare your yearly income with the median income for the same household size in your state. If your income is lower than the median, you can qualify for Chapter 7 without undergoing further means testing. If you are above the median income for your state you must take the part 2 of the means test, Form 122 A-2.
Each year, the IRS releases an annual list of median incomes based on household size for each State in the United States.
What is My Household Size?
In present day, figuring out your household size for a bankruptcy filing can be challenging due to the diverse living arrangements many households have. Typically, household size is based on the number of people living in your home. For example, a married couple with two kids would have a household size of four. If a mother also lives with them, it becomes five. Courts often use the “heads in beds” method, including everyone in the home in the calculation, along with their income for the Means Test.
From what I’ve seen, most complications arise when dealing with roommates contributing to expenses. If a roommate only chips in for costs, their income might not be necessary for the Means Test. Adult children living at home can also be challenging. If they’re over 18, self-supporting, and have a job, they might not be considered part of the household. However, if adding them to the household size helps you qualify for Chapter 7, their income might need to be included .
Handling part-time living situations, like a child with joint custody, can be another issue. Whether to count them might depend on tax claims and child support arrangements. I have had many cases like this and it’s always best to have clear explanations, solid supporting paperwork, and a well-defined strategy well before the proceedings begin.
The Means Test: Part Deux
The goal of the Second Part of the Means Test is to determine if you have any disposable monthly income, meaning funds left at the end of the month to repay your debts. To qualify for Chapter 7, you must show a negative disposable monthly income or an amount very close to zero after completing the means test.
The means test employs various approaches to examine your income, expenses, and the average costs for someone in a similar situation. Its aim is to assess whether you have the financial capacity to repay a portion of your debt. Here we will try to follow the form as closely as possible. If you don’t have it in front of you, here is Part 2.
The gross monthly income calculated we calculated above serves as the starting point for part 2. On a very simple level, all expenses from here on out (on a monthly basis) get deducted from your that gross income number. If you’re married, you are allowed to deduct payments your spouse makes for expenses not related to your household. This could include items such as alimony or child support from a previous marriage or even student loan payments.
IRS National Standards Section (Lines 6-15 of Means Test)
In the next step, you re-enter your household size, and the form uses the IRS National Expense Standards to calculate average expenses tailored to your specific county and household size. These standardized expenses are subtracted from your gross income, covering categories like food, clothing, housing, utilities, and out-of-pocket healthcare. Deductions for car payments, operating expenses, and public transportation are also allowed. It’s crucial to note that these standardized expenses may not align with your actual expenses. If your expenses are below the standards, you can claim the full standard amount. If they exceed the averages, claiming them requires a written justification, facing potential resistance from the US trustee’s office.
This section is where the complexity increases. Ensuring accurate inclusion of IRS standards is crucial, and consulting a bankruptcy attorney is advisable. I can’t tell you how many times I’ve seen people file a Chapter 7 bankruptcy, believing they grasp this section of the means test or pushing the boundaries a bit too much with the numbers. If you’re in this section, your case is already more complicated than 75% of all cased filed, and errors could permanently harm your future financial situation.
Actual Expenses Paid (Lines 16-32)
This section doesn’t use IRS National Standards but focuses on the amounts you’ve actually paid.
In my opinion, a crucial element in this section is income taxes, which is often the main reason people pass the means test. You are allowed to deduct the monthly amount you actually pay in Federal (Fed), State (IL), Social Security (FICA) and Medicare (Med) income taxes. Additionally, deductions are allowed for involuntary contributions tied to your employer, including 401k contributions, union dues, and uniform costs. Life insurance, court-ordered payments (spousal or child support, not wage garnishments), job-related continuing education, childcare, and unreimbursed business telephone services are also allowable expenses.
Deductions for Debt Payment (Line 33 of Means Test)
The way I see it, the second most critical factor for passing the means test often lies in Line 33, which allows deductions for debt payments. In this section, you can deduct the amounts you owe for secured debts, such as car or mortgage payments. If these payments are substantial, it can significantly impact your means test results.
It’s crucial to emphasize that the instructions explicitly state you can include “all amounts contractually due” in the 60 months post-bankruptcy filing. This means you needn’t be current or actively paying; you can still include them, providing flexibility for those with financial challenges and substantial secured debts.
How to Determine Disposable Income
Now to identify qualifying expenses you genuinely pay, return to the six-month range mentioned earlier, and total up the actual expenses paid in that period, and divide by 6 to determine the monthly average. This amount is then subtracted from your monthly gross income, yielding your monthly disposable income. To meet the means test goal, multiplying this number by 60 should result in a total less than $9,075. If you exceed this amount, your Chapter 7 bankruptcy could be presumed to be abusive, leading to resistance from both the US Trustee and your Chapter 7 trustee.
Means Test Disposable Income Example
Now I’ll break down an example: Suppose your monthly gross income is $6000.
Considering your household size, you have the following expenses:
- Food and Clothing Expenses (Line 6): $1350
- Out of Pocket Healthcare (Line 7): $150
- Housing Utilities and Insurance (Line 8): $750
- Mortgage or Rent (Line 9): $1500
- Income Taxes (Line 16): $1500
- Involuntary 401k Deductions: $250
Adding these up gives you $5500 in expenses against your $6000 gross income. This leaves you with $500 per month of disposable income. Over 60 months, this totals $30,000 ($500 x 60), which exceeds the $9075 required by the means test. Unfortunately, this means you haven’t passed the means test and don’t qualify for Chapter 7 bankruptcy.
These amounts align with standard means testing for a household size of 2 in Cook County Chicago in 2024. However, the example doesn’t include a vehicle deduction. If the $629 vehicle deduction were considered, this person would qualify for Chapter 7.
In general, the minimum monthly disposable income allowed to file Chapter 7 is around $150.
It is important to emphasize that the calculation above is a rough estimate. The actual means test form involves various other deductions affecting disposable income. These include lines 33-34 for secured debt repayments and cure amounts, line 36 allowing deduction of your estimated Chapter 13 plan payment and trustee fees, and line 41 assessing whether your disposable income can repay 25% of your total unsecured debt.
This form is among the most intricate in a Chapter 7 filing, and seeking guidance from an attorney is strongly recommended if uncertainties arise.
Skip the Means Test? Understanding Exemptions
In unique situations, you might be exempt from undergoing the means test entirely. To figure out if you qualify for an exemption from the means test in Chapter 7 bankruptcy, you can fill out the Statement of Exemption from Presumption of Abuse form. This form consists of two parts:
Part 1: Inquires about the nature of your debts. If your debts are predominantly business or tax-related (exceeding 50%)you may be exempt from the means test calculation. The classification of Student Loans as consumer debt is still uncertain, with a key consideration being the initial purpose behind incurring the debt. If the loan was taken for business reasons, you could potentially be exempt from the means test.
Part 2: Determines if you qualify under specific military service provisions:
- Disabled Veteran: If you’re a disabled veteran who incurred debts during active duty or homeland defense activities.
- Reservist or National Guard Member: If you’re a reservist or National Guard member called to active duty or homeland defense.
If you meet the criteria in Part 1 or Part 2 then you can use this to explain to the Court why you are exempt from taking the means test. However, it’s important to note that this exemption only applies to means test Part 2. Despite the exemption, you are still required to provide information about your income. Ensure you submit all necessary details to the Court as part of the bankruptcy filing process.
Looking at the Bigger Picture
Well, can you pass the means test? If yes, that’s great news. However, the analysis doesn’t end there. This article talks about if you can pass the means test, but from my perspective the bigger question is if you should file for Chapter 7 bankruptcy. Yes its true, Chapter 7 bankruptcy gives you a fresh start without repaying anything, but there are other important things to consider. These include:
- Asset Protection
- Preferential Payments
- Large Purchases Before Filing
- Fraudulent Conveyances
- Overall Bankruptcy Goals
- Bankruptcy Timing
- Dischargeability of Specific Debt Types
- Prior Bankruptcy Filings
- Previous Discharges
You can click each topic for more insights, and stay tuned I’ll try to give additional content in the future.
Also, I made a simple flowchart to help you choose the best bankruptcy chapter.
Final Thoughts
It’s worth noting that having a presumption of abuse doesn’t necessarily disqualify you from Chapter 7. However, rebutting this presumption is challenging, and filing bankruptcy without a strong argument for Chapter 7 qualification may lead to sanctions or the denial of conversion to Chapter 13. Given the gravity of these decisions, it’s crucial not to take excessive risks when your financial well-being is at stake.
