The Bankruptcy Means Test
It’s doubtful that anyone takes on debt with the goal to eventually seek bankruptcy. Yet from 2013 through 2017, an annual average of 898,621 adults found themselves in that very situation.
Whether it’s because of overextending yourself financially or changes in income, health or life circumstances, bankruptcy can quickly become your reality — even if you never intended to go down that road. If it happens to you, one of the first things a bankruptcy attorney will have you do is complete a means test to determine what kind of bankruptcy you can declare.
How the bankruptcy means test works
Bankruptcy refers to the process of eliminating your debts by discharging them or creating a debt repayment plan. There are two types of bankruptcy that individuals can file: Chapter 13 and Chapter 7.
In Chapter 13 bankruptcy, you reorganize your debts to create a three- to five-year installment payment plan. During that time, creditors cannot pursue collection. Chapter 13 allows a debtor to keep their assets and avoid foreclosure or repossession.
Chapter 7 bankruptcy, however, varies significantly from Chapter 13. “Chapter 7 is commonly referred to as a liquidation,” New York attorney Matthew Zimmelman said.
The way it works is that nonexempt assets, such as a vehicle, are sold to satisfy creditors. Other debts could be discharged, and no further payments need to be made. But before you can file Chapter 7, you have to prove that you cannot afford to make your current payments.
“You come in and show the court you can’t afford a meaningful payment plan, and you get a discharge for debts that are eligible,” Minnesota attorney Marie F. Martin said. This is where a means test comes in. With this test, you learn whether you are qualified to file Chapter 7 or if you must file Chapter 13.
The means test is designed to reduce the number of people who file Chapter 7 bankruptcy when they can actually afford to reorganize debts under Chapter 13.
“[The bankruptcy means test] came under BAPCPA, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” Martin said. “The goal of the means test in Chapter 7 is to determine whether it’s presumed under the law that the [debtor] is abusing the system.”
To that end, the means test measures your last six months of income against the median income of your state of residence, then helps you determine your disposable income. This helps the court decide whether there is a presumption of abuse if you file Chapter 7.
3 steps of the bankruptcy means test
1. Complete form 122A-1: Statement of Your Current Monthly Income
This form allows a debtor to calculate their monthly income from all sources, including alimony, retirement funds, unemployment and rental properties. At the end of the form, the debtor multiplies their monthly income by 12 to get their annual income and compares that to the median monthly income for a similar-sized family in their state.
If the debtor’s total income is below that number, the debtor is instructed to skip form 122A-2 (the means test calculation) because there is no presumption of abuse.
2. Complete form 122A-1Supp: Statement of Exemption from Presumption of Abuse Under § 707(b)(2)
Form 122A-1Supp lays out some additional situations that can allow an individual to avoid the means test. These include having debts incurred during active military duty or having performed a homeland defense activity for a certain period. This form is only submitted when the answers result in avoidance of the means test.
3. Complete form 122A-2: Means Test Calculation
This nine-page form allows debtors to outline their expenses based on the IRS-issued National and Local Standards for specific expenses, such as food, health care, clothing, utilities, and transportation. There are some expenses on the form, however, that are personalized. These include life insurance premiums, court-ordered payments, and child care costs.
In part three of the form, the total deductions are offset against the adjusted current monthly income to determine the debtor’s monthly disposable income. This is then multiplied by 60 to find their total disposable income over the next five years. That number creates the benchmark to determine whether there is a presumption of abuse.
If the form shows an aggregate five-year net income of more than $12,850, or 25 percent of their total unsecured debt (of $7,700 or more), then abuse is presumed. In part four of the form, there is space for a debtor to list any special circumstances they feel justify adjustments of income or expenses.
One of the most important lessons to take from this is that what a debtor views as their budget may not be what the bankruptcy court sees through the means test.
“[The means test] can put a debtor in a situation where they may not qualify, even if their budget shows that they have no disposable income,” Zimmelman said. “In certain categories, you just get allowances.
“Certain deductions are based on household size or on Census data,” he added. “It’s not dollar for dollar what your expenses are.”
What does it mean if you pass or fail the means test?
Passing the means test tells the court that you are not abusing the bankruptcy system. It shows that you cannot afford a restructuring, so Chapter 7 is an appropriate choice for you, based on your current situation.
If you fail the means test, it doesn’t mean that bankruptcy isn’t an option for you — just that Chapter 7 is likely off the table. You can still try to file it, marking the form’s box for the presumption of abuse and then listing out your special circumstances. But, according to Martin, you need to be prepared for more judicial involvement as the trustees look into your case.
“The [presumption of abuse] can be rebutted, or it can be upheld,” she said.
Retaking the means test
In some cases, it may be worth delaying bankruptcy after failing the means test.
“Because we’re looking at the last six full calendar months to see what was earned during that period, a debtor might have just received a bonus or had significant overtime,” Zimmelman said. “Now the income figures are skewed, and that could work against them.”
Because of the lengthy and confusing nature of the means test, both Zimmelman and Martin suggest bankruptcy filers work with an attorney. “Most [attorneys] do free consultations, so don’t hesitate to get that expertise,” Martin said.
Zimmelman agrees. “I always recommend consulting with an attorney who’s familiar with the means test to make sure you’re getting every deduction available,” he said. Neglecting to list an expense, he notes, can sometimes mean the difference between passing or failing the means test.