Chapter 7 bankruptcy can be a lifesaver when you’re drowning in debt and see no way out, but the U.S. government takes the position that you might be able to pay at least a portion of your debts if you try. The Bankruptcy Abuse Prevention and Consumer Protection Act, passed in 2005, helps determine whether your situation really is hopeless or if you might be able to make a dent in what you owe.
This tricky question is addressed by something called the bankruptcy means test. If you pass, you can file for Chapter 7. If you don’t, your options are to file for Chapter 13 instead or not file for bankruptcy at all. How you answer these questions can help you determine whether you’re likely to pass the means test.
Is your income more than the median income for your state?
First, you may not even have to take the means test. The BAPCPA provides an escape hatch for debtors with lower incomes. If your current monthly income falls below the median income for your state, the legal presumption is that you probably cannot pay off any of your debts. You’re free to file for Chapter 7 protection on this basis alone.
You can easily look up your state’s median income online. These numbers can vary significantly from state to state and they’re based on your family size. Assuming you’re married with one child, you can earn up to $99,046 if you live in the District of Columbia, but only $50,614 if you live in Mississippi as of April 1, 2017.
Your “current monthly income” or CMI is based on what you earned the last six months. Total up your gross income for the last six months, that which was left over after you paid taxes and other mandatory deductions. Don’t count the current month. For example, if you’re doing this in June, you would count December of the previous year through May. Now divide this number by six. This is your CMI.
If your CMI is more than the median income in your state, you must take the means test unless you fall into an exempt category, such as that you’re on active duty with the National Guard and Reserve, or your debts are business-related, not personal. You can take an unofficial means test on various websites to get an idea of where you stand.
How much do disposable income do you have leftover?
The idea behind the means test is to determine how much disposable income you have left over each month after paying certain allowable living expenses. It’s this number that determines whether you qualify for Chapter 7 or must file Chapter 13 or forego bankruptcy instead. If you have enough disposable income, the BAPCPA says that this money must go to your creditors, so you can’t file for Chapter 7 bankruptcy and erase all your debts.
Your allowable expenses are set by law – or, more accurately, by the Internal Revenue Service. The IRS determines what individuals pay for things like housing and food in each metropolitan area and state, and many of the deductions you can make from your CMI to arrive at your disposable income are limited to these amounts. For example, you might been laboring under a $1,750-a-month rent payment, but if the IRS figure for housing says that most people in your area pay only $1,250, that’s all you can deduct from your CMI for housing.
This rule doesn’t apply to all expenses, however. In some cases, you can deduct what you actually pay, such as if you own your home rather than rent. Associated debt expenses for secured assets such as mortgages or auto loans are usually entered dollar-for-dollar.
Now do the math. As of 2017, if your disposable income is $117 a month or less, you’ve passed the means test. If it’s $195 a month or more, you’ve failed the means test and you cannot file for Chapter 7 protection. If your disposable income falls between these two extremes – maybe it’s $150 – you must next figure out how much disposable income this will produce over the next five years. If it’s enough to pay at least 25 percent of your unsecured debts totaling 7,700 or more, you’re not eligible for Chapter 7.
Are you married and will your spouse be filing for bankruptcy with you?
The next question concerns your marital status. If you’re single, or if you’re married but living in a separate household from your spouse, only your income counts toward your CMI. But if you’re married and living together, you must count both your incomes when calculating your CMI. This is the case whether you and your spouse are filing a joint bankruptcy petition or you’re filing on your own.
Including your spouse’s income might push your CMI over the median income figure for your state because the median income for a family of two is not necessarily double what it is for a single individual. For example, the number in Mississippi for one person is $37,051. The number for a family of two is $46,712, a difference of just $9,661. If your spouse earns $9,662 in Mississippi, you’d have to take the means test.
The means test does allow you to reduce your spouse’s income somewhat if she’s not filing for bankruptcy with you, however. It includes provisions for something called the “marital adjustment deduction” which lets you subtract her personal expenses from her income. Only the money left over after she meets these expenses is available to help sustain your household. Allowable marital adjustment deductions include things credit cards and auto loans in her sole name, unless the auto loan is secured by a vehicle that’s considered the family car. They include alimony or child support she might pay for a child who doesn’t live with you, as well as student loans, 401(k) loans and retirement contributions. Your disposable household income is what’s left over after you make these deductions.
Is your income likely to change in the next six months?
Do you expect that your income will decrease in upcoming months? If so, you might want to consider waiting a while to file for Chapter 7 if possible. This might drop your six-month CMI average below the state median so you don’t have to take the means test. If you do have to take the means test, it might reduce your disposable income. You might end up qualifying for Chapter 7 after all.