Bankruptcy can be a helpful debt relief option when an individual is really struggling.
Finances and debt can be really stressful. Add a financial hardship, and now the burden could feel unbearable. You may now be considering the legal debt relief option of bankruptcy, but have run into the bankruptcy means test.
The purpose of this article is to simplify the bankruptcy means test information to make it understandable to you.
Here’s what we will cover:
- What is The Bankruptcy Means Test?
- Chapter 7 Qualification Using the Means Test
- How Does Part 1 Work?
- How Does Part 2 Work?
- What Is the Bankruptcy Means Test In Your State?
Let’s get started.
What is the Bankruptcy Means Test?
In short, the bankruptcy means test is a qualification test to see if you have the means to pay back some of your debt in a bankruptcy. Many people think of the means test as the qualification test for Chapter 7 bankruptcy.
Chapter 7 bankruptcy is a liquidation bankruptcy, meaning that the trustee may sell nonexempt property and distribute the funds to the creditors owed. Although it’s a liquidation bankruptcy, that does not mean that you will lose belongings, especially if you use bankruptcy exemptions.
Now, Chapter 7 and Chapter 13 bankruptcy are the most common types of bankruptcy, but many people choose Chapter 7 due to the fact that it’s lower cost and you can get out of debt in as little as 120 days. There are pros and cons to consider, but many people need some sort of relief when filing bankruptcy.
Let’s now cover Chapter 7 qualification using the means test.
Chapter 7 Qualification Using the Means Test
There are two parts of the Chapter 7 bankruptcy means test. Let’s cover the two parts.
- The first part uses your household income, your household size and compares it to allowable median household incomes in your state. If you pass using part 1, you may not have to take part 2 of the means test.
- If you do not pass using the first part of the means test, the second part may use your actual expenses to see whether you may qualify even if you are above the median guidelines for your state.
Let’s now go through each part of the means test.
How Does Part 1 Work?
The bankruptcy form for part 1 is complicated, so we will do our best to explain the test. Basically, the questions on this part are trying to understand your income and how it relates to the allowable income by the state.
How to Calculate Income
Income can be tricky. Now, W-2 income that is consistent and hasn’t changed can be easy, but let’s say you work hourly and your hours changed through the year. Let’s say there was a job change and now you are making more than you were previously. How do you calculate your income on an annual basis?
Let’s see how the bankruptcy form explains income:
Fill in the average monthly income that you received from all sources, derived during the 6 full months before you file this bankruptcy case. 11 U.S.C. § 101(10A). For example, if you are filing on September 15, the 6-month period would be March 1 through August 31. If the amount of your monthly income varied during the 6 months, add the income for all 6 months and divide the total by 6. Fill in the result. Do not include any income amount more than once. For example, if both spouses own the same rental property, put the income from that property in one column only. If you have nothing to report for any line, write $0 in the space.
Now, you could try taking a bankruptcy means test calculator online or a qualified bankruptcy attorney can help you parse through the specifics, but the goal here is to understand your average income for a 6 month period and then you can annualize that and compare it to the state median income below.
How to Compare Income to State Allowed Income
Once you understand your annualized income, you can now compare it to the state’s allowable income. You can find the most recent income limit for Chapter 7 on the US Government website.
Here’s an example of the most recent data at the time of this writing. Let’s cover an example.
- Household size of 4 in Texas with Household Income of $6,000 per month. You annualize that to $72,000 per year.
- You check the most recent income limit for that, and find that you have to be below $89,196 in Texas to qualify.
In this case, you may good chance to qualify for Chapter 7 bankruptcy as you already below the median household income for Texas.
How Does Part 2 Work?
In the example above, the individual makes $72,000 annually. Let’s say instead that the individual makes $95,000 annually, but has no disposable income.
Does that mean he would not qualify for Chapter 7 bankruptcy?
This is where part 2 of the means test comes into play when you use actual expenses. The official part 2 bankruptcy form is still super complex, so let’s break it down.
For example, there are instances that car payments, mortgages, child care, health insurance and potentially taxes may help you pass the means test by deducting actual expenses.
Let’s cover some of the expenses you may be able to deduct.
- Mandatory employment deductions. This can include retirement plans, union dues or even uniforms
- Income taxes
- Disability and health insurance premiums
- Childcare expenses
- Debt payments for your car and home that are secured
- Term life insurance premium
- Child support and alimony payments
- Potentially charitable contribution (limited)
There may be also special circumstances where you can deduct such items as food, clothing, personal care, housing and utility, transportation, etc., but you may have to provide proof of the expense, and you may not be grated those deductions.
In addition, the expenses may be limited to the number of people in your household. You can check the current national standards for potential maximum amounts for expenses.
How Does the Bankruptcy Means Test Work in Your State?
Each state is different, so it’s helpful to understand how it works specifically to your state. As such, I found different reputable articles you can find below that should have income limits for your state and provide state specific information about the bankruptcy means test when applicable.
Wrapping It All Up
Bankruptcy can be a helpful debt relief option when an individual is really struggling. The bankruptcy means test is complex and difficult to understand. Hopefully, this article has explained the means test in simple, understandable language to help you make the most informed decision.