The Means Test and Eligibility to File for Chapter 7 Bankruptcy
Many people want to file for Chapter 7 bankruptcy because, if all goes well, it results in a bankruptcy discharge that removes their personal liability to repay consumer debts. However, Chapter 7 bankruptcy is limited to those people who are truly experiencing severe hardship and cannot pay off their debts.
The “means test” is considered an objective standard that is used to determine whether an individual is experiencing enough hardship to be eligible for Chapter 7 bankruptcy. The purpose of the formula is to keep debtors who have high incomes from filing for Chapter 7 bankruptcy when they have the ability to pay off all or most of their debts.
While you need not be indigent to file, the means test ensures that only those with limited disposable income are able to file under Chapter 7. However, there are exceptions. Disabled veterans who incurred more than half their debt while on active duty or while providing homeland defense do not have to pass the means test in order to file for Chapter 7 bankruptcy, as long as their disability ratings are at least 30%. Similarly, if most of your debt arose from operating a business, rather than consumer activities like buying objects for personal use or receiving medical care, you do not need to pass the means test to file.
Not everyone who passes the means test should file for Chapter 7 bankruptcy. Some people have only a few debts, and they might be better served trying to negotiate with a couple of creditors to restructure their payments, rather than filing for bankruptcy and affecting their credit scores.
How Does the Means Test Work?
The first step of the means test is to determine whether your income is greater than or less than the median income in your state for a household of a comparable size. Every state has a different median income for different household sizes. Those who earn less than the median income are immediately eligible. You do not need to take any further steps and can file under Chapter 7.
However, if your income is greater than the median, you will need to take further steps. You will need to subtract certain allowed monthly expenses from your income to determine your “disposable income.” Each county has a different allowed amount for various types of expenses, such as housing, taxes, and childcare.
You can earn a high income and still pass the means test if you have substantial expenses like a hefty mortgage, multiple car payments, taxes, childcare, health care, or care of an elderly or disabled person. However, if your disposable income is more than a certain sum, you will not be able to file. There are online calculators that can help you make this determination.
Again, simply passing the means test is not a reliable indication that you should file for Chapter 7 bankruptcy because in some cases you may be able to negotiate an arrangement that suits you better. Filing for Chapter 7 bankruptcy, also known as liquidation bankruptcy, can result in the loss of property and can adversely affect your credit score, making it difficult to qualify for loans or buy a home in the near future. In some cases, filing for Chapter 13 bankruptcy may be more appropriate, especially if you have multiple mortgages and want to keep your home, or have car payments that are more than what your car is worth. There are tools available under Chapter 13 that are not available under Chapter 7, which will allow you to better protect your assets.