Qualifying for Chapter 7 – The Means Test

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005  (BAPCPA) was enacted by Congress in part to prevent high income earners who have disposable income and can afford to repay some or all of their debt from filing a Chapter 7 bankruptcy and avoid paying anything to creditors. Post 2005, all debtors who file for Chapter 7 must file a form that is a statement of current monthly income and expenses, which is used by the court to determine if disposable income is available to repay creditors.

A common myth on the internet is that if you are a high-income earner you can never file for chapter 7. High-income earners can qualify for chapter 7 if their allowable expenses show that little or no disposable income is available to repay creditors and granting a discharge (the forgiveness of debt) under chapter 7 would not be an abuse of the bankruptcy code.

So how does a debtor qualify to file chapter 7?

The formula first considers the income earned by the debtor in the previous six months; the income is annualized, which means the snapshot of the previous six months is used to “predict” what the annual income would be of the debtor; then that annual income is compared to the median family income for a similar household living in the same county as the debtor. If the income is below the median family income than the debtor automatically qualifies to file for chapter 7. However, if the income is above the median family income the formula continues and looks to the debtors expenses.

Not all expenses are allowed under the means test; helpful expenses to a high-income earners are expenses like federal tax withholdings, mandatory retirement contributions, court ordered support payments, health care expenses to name a few. A simple way to understand what is allowable and not allowable is this example; bankruptcy is not designed to be a lifestyle police, we are all allowed to make our own life choices, but bankruptcy is designed to prevent abuse. Therefore, a family that chooses to send their children to private school and has a tuition payment of $1000.00 a month, which is a very real expense that must be accounted for in their budget, will not get “credit” for the $1000.00 monthly expense in the means test because there is an alternative available, public school, when analyzing whether or not it would be abusive to allow a debtor to avoid paying all of his or her creditors.

The formula, based upon the allowable expenses, calculates the disposable income available monthly and then multiplies it by 60 to predict the available disposable income that could be given to creditors during a 60 month chapter 13 plan; if the disposable income is below $12,850 then the debtor qualifies for chapter 7.

Qualifying for chapter 7 has a lot of nuances and debtors should consult with an attorney before filing bankruptcy to make sure that they understand all available options in order to make the best decision to solve their financial issues.

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