In 2005, Congress amended the bankruptcy laws to require a “means test” before a person could file for liquidation under chapter 7. The means test measures a person’s “disposable income” that can be used to repay any debts.
If a person’s disposable income is too high, then a “presumption of abuse” applies meaning you cannot file for Chapter 7 but can still file for Chapter 13, which requires some repayment of debt.
There are some cases where a person does not have to take the means test prior to filing a chapter 7 petition. This includes:
- Disabled veterans whose debts accrued while engaged in homeland defense
- Members of the National Guard or armed forces reserves
- Those persons whose debts are primarily non-consumer (such as business debts).
Current Monthly Income vs. Median State Income
The means test begins by calculating the debtor’s “current monthly income.” Despite the name, this actually measures the average before-tax monthly income for the six months prior to seeking bankruptcy protection.
By way of example, let’s say John Smith has a job that pays $1,200 per month and he has no other sources of income (such as stock dividends or income from a rental property). Smith is also unmarried and lives alone in Massachusetts. This is important because the means test compares Smith’s current monthly income with the median income for his household size and state of residence.
The present median income for a one-person household in Massachusetts is $56,254 per year. This figure is determined by the U.S. Census Bureau and adjusted annually.
Since Smith’s estimated gross annual income is $14,400—$1,200 times 12 months—he is well under the state median and therefore eligible to file for chapter 7 bankruptcy.
Current Monthly Income vs. Disposable Income
But let’s say Smith’s salary is $60,000 per year, about $3,700 higher than the median. Can he still file for chapter 7?
The answer depends on the amount of deductions he can take from his income. These deductions subtract basic living expenses from Smith’s income and provide an estimate of his disposable income—that is, money he could use to pay off his creditors.
Some deductions are fixed by Internal Revenue Service rules. For instance, there is a single allowance for clothing, food, housekeeping and personal care based on income level and household size. Other deductions, like health insurance and education, are based on actual expenses.
After subtracting all permitted deductions from current monthly income, the result is multiplied by 60. This number is the debtor’s disposable income.
So if John Smith earns $5,000 per month and has $3,000 per month in qualifying deductions, his disposable income is [($5,000-$2,000) X 60] or $18,000.
This would put Smith well beyond the chapter 7 threshold in Massachusetts.
The law presumes a chapter 7 filing is an abuse of the system when disposable income either exceeds $11,725 or is sufficient to pay at least 25% of the person’s unsecured debts. (There is no presumption of abuse if disposable income is $7,025 or less, regardless if it exceeds the 25% repayment threshold.)
This is just a brief overview of the means test. It’s important to work with an experienced bankruptcy attorney before beginning the chapter 7 bankruptcy process, including the means test. Please contact Oberhauser Law if you have any questions.