The information contained herein is not legal advice. In order to determine whether you qualify for chapter 7 bankruptcy or what expenses you may legally claim in a chapter 7 bankruptcy proceeding, you should retain an attorney.
Chapter 7 Bankruptcy: The Means Test And Median Income Test
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 or "BABCPA" instituted a median income test and a means test to determine whether you qualify for a chapter 7 bankruptcy discharge. The purpose of the median income and means tests was to limit the use of chapter 7 bankruptcy to those who truly cannot pay their debts and deserve a "fresh start."
The median income test is a threshold test in which your gross income is compared against the average gross income of similar sized households in your state. If you pass the median income test, then you do not need to complete the means test.
The means test is calculated by deducting designated monthly expenses from your "current monthly income" or CMI (your average gross income over the six calendar months before you file for bankruptcy) to arrive at your "disposable monthly income" or DMI. The higher your disposable monthly income, the more likely you will not be allowed a chapter 7 bankruptcy discharge. In doing this calculation you are entitled to take the higher of your actual expenses or a standard deduction based on your location. Often times the standard deductions are higher than your actual expenses and you may be able to "pass" the means test because of the higher deductions.
Even if you pass both the means test and the median income test, you can still be denied a discharged under a test call the totality of the circumstances, which looks at all your actual current income and actual current expenses. If your actual current income is significantly higher than your actual expenses, you may be denied a discharge.
What Can Be Done About The Chapter 7 Means Test?
Often time people come to me for a chapter 7 bankruptcy discharge that are just over the means test by a few dollars to a few hundred dollars. The natural question that arises is "are their legal ways to increase your expenses that will allow you to qualify for chapter 7 bankruptcy and avoid the oppressive chapter 13 bankruptcy process?"
The general answer is yes but first an important disclaimer. THE FBI INVESTIGATES BANKRUPTCY FRAUD AND YOU CAN BE IMPRISONED OR SIGNIFICANTLY FINED IF YOU ATTEMTP TO COMMIT FRAUD ON THE BANKRUPTCY COURT. I make this disclaimer because two things you do not want to do are 1) incur expenses solely to obtain a chapter 7 bankruptcy discharge or 2) incur expenses just to get a chapter 7 bankruptcy discharge with the intention of cancelling them right after discharge.
First, you have to understand what expenses legitimately can be included in your expenses for means test purposes. Generally, you can deduct expenses that are specified under the "National Standards and Local Standards" and your actual monthly expenses under the "Other Necessary Expenses" issued by the IRS. The National Standards and Local Standards are just that-Standards-and there is limited flexibility in the amount you can claim for any particular group of expenses.
Other Necessary Expenses are expenses such as child care, term life insurance, health savings account, disability insurance, and health insurance. These deductions are in addition to the National Standards and Local Standards deduction and are at actual cost.
Adjustments to Other Necessary Expenses are an area of the means test that can legitimately be adjusted to improve your odds of passing the means test and, therefore, obtaining your chapter 7 bankruptcy discharge. The key to remember is that all expenses need to reasonably be for the health and welfare of you and your family.
For example: let's take a married couple in Texas with 2 minor children ages 12 and 15 with combined income of $80,000 and who currently fail the means test by $200.00. Let's in addition assume they have no life insurance, which is far too common these days, and they have a home mortgage of $250,000. I would argue (and pretty much every insurance agent on the planet would agree) that it would be very reasonable for each of these parents to carry at least $500,000 of term life insurance and disability insurance replacing 2/3rds of their income in the event of long term disability. Assuming the parents are in their early to mid 30s and in reasonable health, they would be looking at $50 per month in life insurance premiums each on 30 year term and probably $80 each per month on a mid grade disability policy. It would be very difficult for someone to argue that expenditures such as these are not reasonably necessary for the health and welfare of their family.
Another area of the means test with some flexibility is in regard to vehicle operating expenses and vehicle ownership/lease expenses. The means test allows a deduction for vehicle expenses for up to two vehicles operated and an additional expense deduction if there is a lease or car payment on one or more of the vehicles.[1] If your car does not have a car payment, you still may be entitled to an additional operation deduction if your car is an older vehicle by age or mileage. There is no hard fast rule in regard to how old or how many miles but most districts allowing such a deduction require the car to have more than 75,000 or 100,000 miles or be 6 years old or older. Check with your local United States Trustee to be certain.
The way these vehicle deductions can help your means test relates to whether you can reasonably increase your car expenses. For example, in the same example above, let's assume the couple both work but only have one car. Most courts (and Trustees) are ok with you claiming expenses on up to two cars as long as there are two licensed drivers in the house. The family would easily pass the means test if they added one vehicle to the household with a modest car payment because they would get an ownership deduction of $496 per month plus an additional operation expense deduction.
A key to remember and a note of caution is that Bankruptcy Courts are equity courts looking to grant chapter 7 bankruptcy discharges to debtors deserving of a "fresh start." If the United States Trustee's office gets the feeling that you are toying with the system to fabricate a chapter 7 discharge, you will likely have problems. A good example is taking on a luxury debt which pushes you into a chapter 7 bankruptcy.
For example, assume you are $1000 short of passing the means test but only have one car in a two driver household. You run out and by a new Lexus with an $800 car payment that combined with the additional operating expense qualifies you for a chapter 7 bankruptcy discharge. Moreover, this purchase was done in the 3 months prior to filing bankruptcy. The first question in the United State's Trustee's mind, the Court's mind, and your creditors' minds is going to be "did he really need a Lexus in light of the fact that he is drowning in debt?"
The bottom line is that there is flexibility in the means test but whatever you do that increases your expenses on the means test and puts chapter 7 bankruptcy in grasp needs to be reasonably necessary for the health and welfare of you and your family.
Written By Ron Smeberg, Esq. who practices chapter 7, 11, and 13 bankruptcy in San Antonio, Texas.
[1] Some courts allow the second ownership/lease expense regardless as to where there is a lease or lien on the car; however, because I am in Texas, I will assume the ownership/lease expenses is only available if there is a lease or lien on the car.
