IS MY INCOME TOO HIGH TO FILE FOR CHAPTER 7 BANKRUPTCY?

Recently a couple came into my office who filed for Chapter 7 bankruptcy with another attorney.  They informed me that when they went to their 341 meeting of creditors, in addition to the court appointed Chapter 7 trustee, a gentleman sat down at the conference table and questioned them regarding their income and expenses. When he was finished, he informed the couple and their attorney that they had failed the ‘means test’ and as a result, did not qualify for Chapter 7 relief. He also warned them and their attorney that unless they voluntarily agreed to withdraw their case or convert it to one under Chapter 13, he would be making a motion to dismiss their case.  This man was an attorney from the United States Trustee’s Office.  One of their many jobs is to review Chapter 7 cases in order to see if debtors qualify to file for Chapter 7 based upon the debtors’ monthly income and expenses. I reviewed the couple’s monthly income and expenses and concluded that they were indeed ineligible to file under the formula provided for under the United States Bankruptcy Code called ‘the means test”.

THE MEANS TEST-ITS BACKGROUND AND PURPOSE

The ‘means test’ was enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) in 2005.  It established a specific arithmetic formula to determine whether or not prospective Chapter 7 debtors are eligible to file for Chapter 7 based upon their monthly income and expenses. Its purpose is to prevent individuals who have sufficient income to pay their bills either outside of bankruptcy or through a Chapter 13 bankruptcy plan from filing for Chapter 7, eliminating their debt and paying nothing. Essentially it attempts to prevent bankruptcy abuse. Prior to the enactment of BAPCPA, in order to dismiss a case for abuse, the U.S. trustee had to argue in objective terms that debtors have excess income in their monthly budget and thus have the ability to pay their creditors outside of Chapter 7 under a ‘totality of the circumstances’ test.  While this ‘totality of the circumstances’ test still exists today, and can be used by itself to dismiss a case for abuse, which I intend to write about in a future article, the U.S. Trustee’s Office will usually look first to the more objective ‘means test’ when examining a Chapter 7 debtors’ potential eligibility to file.

HOW DOES THE MEANS TEST WORK?

The ‘means test’ consists of a 2-part assessment which the debtors are required to prepare and file with the court as part of their bankruptcy petition.  If the debtors pass either part, the debtors are eligible to file.  The U.S. Trustee’s Office, the Chapter 7 trustee or any of the debtors’ creditors have the option of objecting to the results of the ‘means test’.  As a matter, of course, the U.S. Trustee’s Office will review all Chapter 7 petitions filed.  If they feel that there are potential errors in preparation of the means test that may make the debtors ineligible, either based upon the accuracy of the income included or the specific deductions taken by the debtors, they will likely investigate further.

The first part of the ‘means test’ is fairly straight forward.  The debtors’ gross household income from all sources (except income from social security) from the 6 months prior to filing is taken into account.  For instance, if the debtors are planning on filing in March, the sum of the income from September from the previous year through February from the current year will be used as household income. The debtors’ average monthly income from this 6-month period is then compared with the median monthly income in the state where the debtors reside for the same family size as the debtors.  If the debtors’ average monthly income is lower than this median amount, they pass the first part of the test, are eligible to file for Chapter 7 and are not required to prepare the second part of the ‘means test’.  If the debtors’ average income is higher than the median, the debtors must prepare the second part of the assessment to determine if they are eligible to file Chapter 7.

THE ‘MEANS TEST’ ARTIFICALLY DISCRIMINATES AGAINST POTENTIAL CHAPTER 7 DEBTORS FROM LONG ISLAND

The first part of the ‘means test’ is where potential debtors on Long Island and the rest of downstate New York proverbially ‘get the shaft’.  As the median income is based upon the median income from the entire state and not from the county from which the debtor resides, it includes income from upstate New York where incomes (and expenses) are substantially lower than those here on Long Island.  As a result, the median income for the entire state is artificially reduced.   For instance, the median monthly income figure used for a family of 4 in New York State at the time of writing this article is $7,571.00.  This amount must be used whether the debtors live in Manhattan’s Upper East Side, West Babylon or upstate Plattsburgh.  Comparatively, the median monthly income figure for a family of 4 in Connecticut, where income and living expenses are much more comparable with those on Long Island, is $9,333.00.  Unfortunately, because of this disparity, many Long Islanders who would automatically qualify to file Chapter 7 if the median income figures were based upon the county level rather than the state level, are forced to take the second part of the ‘means test’ and if they are unable to pass that part of the test, are ineligible to file at all.

CALCULATING THE SECOND PART OF THE ‘MEANS TEST’

The second part of the ‘means test’ is a much more complicated test than the first part.  The debtors must first start with the same average monthly income which was used as part of the first part of the ‘means test’.  The debtors are then allowed to subtract certain standard specified pre-determined expenses from their average monthly income based upon their family size and the county in which they reside.  The larger the family size, the higher these deductions will be and the more expensive the county is to live in, the higher these deductions will be.  These standard expense deductions are for ordinary living expenses such as clothing, food and utilities.  The debtors then get to subtract further deductions which are explicit to their particular circumstances. Some examples of these deductions are health insurance premium payments, child care expenses and taxes. If the remaining income left, after all allowable deductions are subtracted, is below a certain threshold, the debtors pass the second part of the ‘means test’ and are eligible to file for Chapter 7 bankruptcy.  If the balance is above this threshold, the debtors fail the second part of the ‘means test’ and are ineligible, at least at that time, to file for Chapter 7 bankruptcy.

WHAT ARE THE CHANCES THAT THERE WILL BE AN OBJECTION TO MY MEANS TEST CALCULATIONS?

While it is impossible to 100% predict whether or not the U.S. Trustee will object or even look into any specific debtors’ means test calculations, the likelihood of an investigation can be estimated based upon the debtors’ income, family size and whether or not the debtors had to take the second part of the ‘means test’.  If the debtors passed the first part of the means test as their income was calculated to be below the median, there is little chance that the trustee will investigate the calculations unless the pay stubs that are required to be filed along with the bankruptcy petition reveal substantially more income than what was shown in the ‘means test’ calculation. Even if the debtors were required to take the second test, if their income is not substantial, there is little incentive to look into the specific deductions which reduced the debtors’ income below the threshold enabling the debtor to file.  However, if the debtors’ have a fairly low family size, say of 4 and their average monthly income is high, say $12,000 per month, the U.S. Trustee’s Office knows that the standard expense deductions that are debtors are allowed to take would not put their remaining income anywhere near the threshold which the debtors would need to be below in order to be eligible to file Chapter 7.  As a result, in order to get their remaining income below this threshold, the debtors would have to take substantial deductions which are particular to their circumstances.  In this type of scenario, it is highly possible that the U.S. Trustee’s Office would request documentation of the debtor to determine both the validity and the accuracy of these deductions.

ALL PROSPECTIVE CHAPTER 7 DEBTORS SHOULD ASK THEIR ATTORNEYS ABOUT THE OUTCOME OF THEIR MEANS TEST CALCULATION AND THE LIKELIHOOD OF AN OBJECTION BASED UPON IT BEFORE THEY FILE

The last thing debtors want to hear after they file for Chapter 7 bankruptcy is that the U.S Trustee may be objecting to the very validity of their filing.  As such, all debtors should speak to their attorney regarding this issue before they file.  As the average monthly income used in the means test will likely change from month to month, the allowable standard deductions are consistently revised to account for inflation and inevitable changes in the debtors’ individual financial circumstances may vary the debtors’ other deductions, debtors who fail the ‘means test’ in one month may actually pass the next and vice-versa.  As a result, debtors who fail both parts of the ‘means test’ or who are on the borderline of failing, may want to consider waiting until their circumstances change before attempting to file for Chapter 7 bankruptcy.  Additionally, in a future article, I will write how careful pre-bankruptcy planning may enable debtors to pass the ‘means test’ who were unable to do so just a few short months earlier.