- The means test assesses your ability to repay debts to determine eligibility for Chapter 7 bankruptcy.
- You automatically pass the means test if your household income is under your state's median income.
- Those who don't pass the means test can still file Chapter 13 bankruptcy.
Chapter 7 bankruptcy is commonly called a "clean slate" bankruptcy because it can wipe away a filer's dischargeable debts. While providing a major benefit to the borrower, Chapter 7 bankruptcy can be a burden to creditors. Courts impose strict requirements to ensure that debtors filing for Chapter 7 cannot repay their debts and aren't taking advantage of bankruptcy protections.
To determine whether or not a debtor, the person filing for bankruptcy, can afford to pay off their debts, bankruptcy courts use a formula called a means test to determine whether debtors qualify for Chapter 7 bankruptcy. Read on to see how the means test is calculated and what happens if you fail the means test.
Understanding the Chapter 7 means test
A means test evaluates someone's finances to determine if they qualify for assistance. Means tests are also used in government assistance programs like Temporary Assistance for Needy Families or Medicaid. Applied to bankruptcy proceedings, the means test determines if you're eligible for Chapter 7 bankruptcy.
Under Chapter 7 bankruptcy, a borrower liquidates non-exempt assets like luxury items, houses, and collections. The proceeds are divided among a borrower's lenders. Once this process is complete, the borrower is no longer responsible for all dischargeable debts, such as credit card debt, medical bills, and personal loans.
While some debts cannot be discharged, like taxes, student loan payments, and child support, Chapter 7 still provides a huge benefit as borrowers won't have to pay back a large portion of their debts. However, if you make too much money and the bankruptcy court thinks you can pay off your debts over time, you might not be able to file for Chapter 7 bankruptcy.
What is the purpose of the means test?
This is where the means test comes into play. "The idea is to prevent wealthy individuals from skipping out on legitimate debts," says Derek Jacques, a consumer bankruptcy attorney with The Mitten Law Firm.
If you don't pass the means test, that doesn't mean you can't file for bankruptcy. Individual debtors who don't pass the Chapter 7 means test typically file for Chapter 13 bankruptcy, another bankruptcy often called the "wage earner's plan." Under this plan, debtors create a payment plan outlining how they'll repay their debts.
A Chapter 13 bankruptcy comes with more downsides compared to Chapter 7. For one, proceedings are far longer. A Chapter 13 bankruptcy can take three to five years compared to four to six months for a Chapter 7 bankruptcy. If you hire a bankruptcy attorney, your legal fees will also be higher.
It's worth noting that it takes longer to recover from a Chapter 7 bankruptcy than a Chapter 13 bankruptcy. Chapter 7 filings fall off your credit report after 10 years compared to seven years for a Chapter 13 bankruptcy.
Step-by-step guide to the means test calculation
Damon Duncan, a bankruptcy attorney and board-certified specialist in consumer bankruptcy at Duncan Law, explains that the means test "is like a quiz that looks at your income and expenses to see if you have enough money to pay back some of your debts. If you make too much money, you might not pass the test."
The income evaluated by the means test varies from state to state. That's because the median cost of living and earnings differ nationwide. "What's considered too much income in one area might be different in another," Duncan says. The bankruptcy court also has some discretion to consider individual household needs.
The means test consists of two stages:
Stage 1: state median income comparison
Courts compare the debtor's average income over the last six months to the median income in your state for a family of a similar size. "If your income is lower, you pass the test," Duncan says. The United States Trustee determines the median income for each state. The information is updated several times a year.
For example, let's say a family of four makes $119,000. If this family filed for bankruptcy in California, where the median income for a four-person household is $123,451, they'd pass the means test and file for Chapter 7 bankruptcy. However, the same family living in Michigan, where the median income is $109,931, would move to the second step of the means test.
Stage 2: Expenses and income
If your income is higher than the median income in your state, you still might pass the means test. If that happens, "there's a more detailed calculation involving your expenses and income," Duncan says.
These calculations include "extra housing costs, special education expenses, and other circumstances to be considered as reasons the median income would not be reasonable for this family," says Jonathan Carson, CEO of bankruptcy services firm Stretto.
According to bankruptcy attorney Ronald LeVine, some families have to shoulder extra costs for medical bills or support for elderly family members. These costs can vary greatly. Bankruptcy courts can take the individual needs of each household into account when determining whether or not a debtor can proceed with filing for Chapter 7 bankruptcy, even if they have a higher household income.
Key factors in the Means test (income, expenses, etc.)
Key factors in the means test will be your income, all expenses, and disposable income, if any. The bankruptcy court will want all of this information in writing, and it will be important to keep the court informed of any changes.
If a debtor gets a new job after filing for Chapter 7 bankruptcy, Salerno says several variables impact what happens next. "It's possible that with a significant change in income, the case could change from a Chapter 7 to a Chapter 13."
However, Carson says that a new job, even with a higher salary, is unlikely to impact Chapter 7 bankruptcy proceedings. "Since the means test is looking back at the last six months before filing, a new job would not normally factor into what happens in an individual's Chapter 7 bankruptcy," he says.
Matthew Salerno, a bankruptcy law professor at Case Western Reserve School of Law, says debtors should be careful when providing information "because mistakes, like missing or conflicting information, could result in dismissal of a Chapter 7 bankruptcy." Withholding information is considered fraud.
Salerno emphasizes that it's important to be truthful and accurate with the bankruptcy court throughout the proceedings. If a debtor's financial circumstances change at any point during bankruptcy proceedings, Salerno recommends that they discuss the situation with their bankruptcy attorney so they can determine whether to update previously filed forms or notify the case trustee or the bankruptcy court.
Although filing for Chapter 7 bankruptcy may seem simple, Salerno cautions that all bankruptcy proceedings are complex. "Deciding whether to file for bankruptcy and what type of bankruptcy to file are serious considerations. Successfully completing a Chapter 7 bankruptcy can provide much-needed debt relief, but the Chapter 7 bankruptcy can remain on a credit report for up to 10 years," he says.
How to pass the means test with a high income
You'll likely have to file Chapter 13 bankruptcy if you have a high income. You must stay honest when you report your income and expenses. Falsifying or misreporting any information can result in the courts dismissing your case.
What happens if you pass or fail the means test?
If you pass the Chapter 7 means test, then you can proceed with the process of filing Chapter 7 bankruptcy. If you fail the means test, you can still file bankruptcy, but it will most likely be Chapter 13 bankruptcy under what is called the "wage earner's plan."
The Chapter 13 wage earner's plan gives people with regular income the option of repaying some or all of their debts over a set period of time with court supervision.
Frequently asked questions about the Chapter 7 means test
All of your expenses are considered in the means test. It is important to provide an accurate picture of your financial situation and show the court why Chapter 7 is the right option for you.
Passing the Chapter 7 means test shouldn't be hard if your income is under the state median. If you make more than the state median, difficulty passing the means test will depend on the state you file in.
If you don't pass the means test, that doesn't mean you can't file for bankruptcy. You still have the option of filing for Chapter 13 bankruptcy under what is often called the "wage earner's plan." With this plan, debtors create a payment plan outlining how they will repay their debts.
