What is the “Means Test”?
The Means Test was a late addition to the Bankruptcy Code (also called BAPCPA) to apply to all bankruptcies filed after October 17, 2005.
Behind the “means test” or “income based test” was the understanding that some well to do Debtors were unfairly using bankruptcy to the detriment of unsecured creditors (mainly the credit card companies).
Before BAPCPA, Debtors who had high incomes and could afford to pay off at least some of their debt (credit cards) would incur huge balances on their credit cards, then file for bankruptcy and discharge all their credit cards.
The result of the test is that Debtors with above median income (this varies from state to state) cannot file a chapter-7 bankruptcy and can only avail themselves of a chapter 13-bankruptcy/payment plan.
Chapter 13 bankruptcy requires a court approved payment plan to pay back unsecured creditors over a five-year period. This is in contrast to a chapter 7 Bankruptcy where the Debtor’s unsecured creditors would usually be discharged with little or no payments going to these creditors.
Not surprisingly, most would be Debtors would rather do a chapter 7 with little or no payments to the unsecured creditors than make payments to those same creditors over the next five years.
In summary, any Debtor can file chapter 7 if they earn less that the median household income for their state. If a Debtor has above median income then a Chapter 13 Bankruptcy would be the only alternative available for debt relief. Unless… the Debtor can “beat” median requirement.
Exceptions to the Income Based Test
Under the assumption that a Chapter 7 bankruptcy is better than a Chapter 13. Beating the income dependent testing means finding a way for an above median Debtor to file a Chapter 7 Bankruptcy under the current provisions of the Bankruptcy Code.
To review, if a Debtor has above median income then they cannot file a chapter 7 bankruptcy and can, if they choose, file a Chapter 13 Bankruptcy.
If a debtor’s income is greater than the median income for her household size then the Means Test prohibits that Debtor from filing a Chapter 7 bankruptcy. However, the initial income calculation is only the first prong of the test.
Under the Bankruptcy Code the following are the exceptions to the means test:
Exception No. 1: The Bankruptcy Code allows the Debtor to subtract essential living expenses from their above median income.
When these expenses are subtracted, if the income that remains is below the Median Income threshold the Debtor to qualifies to file a Chapter 7.
Exception No. 2: For disabled Veterans (as defined by 38 U.S.C. §3741(1)) whose indebtedness occurred primarily during the time the Veteran was on active duty (as defined in 10 U.S.C. §101(d)(1)) or while performing a Homeland Defense activity (as defined in 32 U.S.C. §901(1)) the presumption of abuse does not arise. The means text does not apply to these Veterans or Homeland Defenders and they can always file Chapter 7.
Exception No. 3: For Reservists and National Guard Members; active duty or homeland defense activity. Members of a reserve Unit of the Armed Forces, and members of the National Guard who were called to active duty (as defined in 10 U.S.C. §101(d)(1)) after September 11, 2001, for a period of at least 90 days or who have performed homeland defense activity (as defined in 32 U.S.C. § 901(1)) for a period of at least 90 days are excluded from all forms of means testing during the time of active duty or homeland defense activity and for the 540 days afterwards (the “exclusion period”). The Means Test does not apply to these Reservists and National Guard and they can file Chapter 7 any time during the exclusion period.
Exception 4: If your debts are primarily non-consumer debts the Means Test does not apply to you. The Bankruptcy Code defined “Consumer Debt” as “… debt incurred primarily for a personal, family or household purposes.” The Ninth Circuit interprets the term “primarily” in § 707(b)(1) to mean that the your non-consumer debt is at least fifty-one percent of your total debt. In re Canales, 377 B.R. 658 (Bkrtcy.C.D. Cal., 2007).
In plain English, if more than half of your debt was from a failed business, past due income taxes, or in “some instances” student loans, then the means test does not apply to you. If, for example you have invested in multiple real estate properties and are now filing bankruptcy and total of the loans on your rental properties exceeds your personal debt by at least one percent, the means test does not apply to you. Here you can file a Chapter 7 even if your income is over the Median Income.
If you are contemplating bankruptcy and you are an above median debtor, choose an attorney that will spend time to help you determine if you can beat the means test and file a chapter 7.