The Bankruptcy Means Test – (and how to pass it if you need to)
What is the means test and why do you care?
The means test is supposed to determine whether you can file a chapter 7 or must file a chapter 13. And, if you do file a chapter 13, how much you will have to pay to your unsecured creditors.
“Supposed to determine.” But does it?
Answer: (caution…legalese on the way…) it depends.
If (big IF) you just approach the means test mechanically (the way most attorneys seem to), then it does just that.
But, if your attorney is experienced, the attorney may know ways to manipulate the means test–legally (of course)– so that you pass the test and may be eligible for a chapter 7 or a chapter 13 that actually pays back NOTHING to unsecured creditors.
Means Test Basics
The first thing to understand is when the test applies and when it doesn’t.
The first step is to look at the current income for your family size. This means you can disregard 99% of all the websites you will find that discuss the means test. Almost none of them update their figures. You can go here: http://www.justice.gov/ust/eo/bapcpa/meanstesting.htm to see the current figures for your state.
By the way, figuring out your family size may be more tricky than one would think! What about the children of divorced parents? What if you have shared parenting? (Warning, more legalese on the way…) It depends.
Although bankruptcy law is federal the application can vary from one state to another and even vary within the state. In Cincinnati and Dayton Ohio, for example, either parent can claim the children. So if the divorced parents each file bankruptcy, they can both claim the children for means test purposes.
What if your income is below the median for your family size?
Stop! Go no further. You are done. No means test for you. You should qualify for a chapter 7.
What if your income is above the median?
Then you keep going into the sometimes fantasy world of the means test.
By the way, this is where I see a lot of attorneys taking “short-cuts” in their analysis of your situation, and it is a very bad thing to do.
I do a number of second opinion consultations where people tell me, “I saw an attorney who said that because my income was above median, I had to file chapter 13.”
Nothing could be further from the truth, I tell them. Either the attorney was lazy, didn’t know any better, or just wanted to put you into a chapter 13 so he could earn a higher fee than you would pay for a chapter 7. Now, that sounds harsh, but I have been around a long time, and I call it as I see it. All of these things do happen.
The reality is this: all that happens when your income is above median is that you have to keep going and do a long math question to determine if you “pass” or “fail” the means test.
If you “pass” the means test then you possibly are going to be able to file a chapter 7.
“Possibly?” you ask.
Just because you pass the means test does not mean that you automatically qualify for a Chapter 7.
Sometimes you can pass the means test and fail another test, which is more of a subjective kind of “ability to pay debts” test. In other words, it really does depend on whether or not you can actually afford to pay back some of your debt in an amount that would be meaningful, not just 1% in most cases, based upon a livable budget and your actual income.
Also, in a chapter 13, you don’t pass or fail the means test. The formula is different and the results are used for a different purpose.
The means test in Chapter 13 is used to determine how much you would be required to pay back to all of your unsecured creditors. But again, the result of this calculation is sometimes unrealistic or flat-out incorrect.
And, the courts know and understand this, so, different courts use different approaches to achieve a result that does make sense. For example, the means test uses the average of your six-month income prior to filing your bankruptcy case. It may be that your income during that period could be much different than your actual income now or the income that you expect to earn in the future.
When this happens, the results of a means test calculation will be totally meaningless. In these cases, the court will look to your expected income and use a more common sense approach to determine how much your creditors will be paid. Suppose you are filing bankruptcy because you can no longer work in your previous capacity; this would be very important to you.
Means test magic- ways to “pass” the means test if you “fail”
Like many things in the law, there are opportunities to improve the results that you will get. For example, when you are getting ready to do your taxes there are certain things that you can do, all of which are completely legal, to reduce the amount of tax that you owe.
Similarly, if you are getting ready to file a bankruptcy case, there are things that you can do, all completely legal, to manipulate the outcome of the means test so that you can qualify for Chapter 7 or, if you are going to file a Chapter 13, that you pay as little as you possibly can to all of your unsecured creditors.
Unsecured creditors complain about this but the fact is that the bankruptcy system is designed to provide a fresh start to consumers who need it. The law allows certain things to be done which will improve the results for consumer. I believe that it is absolutely mandatory for an attorney to advise his client about the ways to improve the results.
For example, in a Chapter 7, there are certain deductions that you can take that actually help you pass the means test. One such deduction is the payment that you make on your automobile. Therefore, if you’ve been scrimping and saving and making do with a free and clear car that is held together with duct tape and glue– its paid for and you really can’t afford a new one because you are trying to pay other bills–you will essentially be penalized because you don’t have a car payment. What some people do is replace that car prior to filing a bankruptcy.
With the car replaced, you have a car payment which is a deduction on the means test. Magic! Now you have a safe car and PASS the means test. The deduction means that there is less money available to pay unsecured creditors–sometimes nothing.
Creditors complain that the consumer is getting a car paid for at the expense of the amount of money that would be available to pay them. This is true, in a way, but why should the unsecured creditors benefit from a consumer who is scrimping and saving and often trying to make do with an automobile that clearly needs to be replaced and is sometimes actually unsafe to drive?
Similarly, in a chapter 13 setting, we may have a situation where we have enough income to pay back something to the unsecured creditors but again we have a car that desperately needs to be sent to the junkyard. In these cases, the consumer legitimately needs to replace the car.
Once the car is replaced, the excess income that would have been available to pay the unsecured creditors is now being used to pay for the car. Also, in a Chapter 13, the interest rate gets changed from a typically high rate to about 4.75% in most cases.
Consequently, it is very common for people contemplating filing Chapter 13 to replace one or even two automobiles prior to filing. The “left over” money that is paid to the unsecured creditors is significantly reduced by these deductions! All of this is allowed by law and actually is beneficial and necessary for the consumer to get to and from work so he can successfully complete the Chapter 13 plan.
Why do YOU want to know about the means test?
Most folks I speak with are interested in the means test because they want to qualify for Chapter 7 and avoid chapter 13. The presumption here is that a Chapter 7 is somehow better than a Chapter 13.
While the notion that “paying nothing is better than paying something” has a superficial attraction, I can tell you from 30 years’ experience that a Chapter 7 is not always the best answer to someone’s financial problems.
Even people who qualify for Chapter 7 are sometimes much better off filing a Chapter 13. This is because there are so many things that can be done in a Chapter 13 that are simply impossible in a Chapter 7.
The most common example of this would be the individual who qualifies for Chapter 7 and wants to keep his $20,000 car. The car payment is $526 per month because the interest rate is 24.99%. The car has been financed for six years and so the consumer is going to end up paying $17,910 in interest for this car.
I can take the same car and pay it off in a Chapter 13 in five years at 375.00 dollars per month. The savings here is $15,402. Wouldn’t the consumer be better off filing a Chapter 13? Is a savings of $15,402 a good idea? You tell me. Is chapter 7 really always better?
Means test “Gotchas”
How the the “substantial abuse” test prevents Chapter 7 even if you “pass” the means test (or even if it doesn’t apply).
The means test is full of ridiculous results and unexpected problems. I’ve personally, through extensive pre-bankruptcy filing, filed an individual who made over $100,000 a year in a chapter 7, and it was approved with no problems whatsoever.
I’ve also seen people who pass the means test – folks with very limited income – be forced to file a Chapter 13 bankruptcy by the United States Trustee’s Office even though the amount paid to creditors was less than five cents on the dollar.
Strange, but true.
Even if you pass the means test, there is another test, called the “substantial abuse test,” 11 USC sections 707 (b)(3) that permits the United States Trustee’s Office to disapprove your chapter 7 even though you pass the means test.
“I pass the means test but can’t file chapter 7. Why?”
The theory here is that, all things considered, even if you pass the means test, you really do have enough income left over after you pay your normal living expenses to provide a meaningful payment to your creditors. There are many ways this kind of situation arises with the result being that you cannot file Chapter 7 and must file Chapter 13.
Really–the only way anyone can be confident that they are going to be choosing the best of all possible debt relief options is to seek the assistance of a seasoned and experienced bankruptcy attorney. This is not an area where you want to try to be your own attorney.
What to do if you need to file and can’t get around the means test?
This is kind of a trick question, actually.
In the tens of thousands of cases are filed, I find that it is really not necessary to get around or avoid or evade the means test. The result that you want–a financial recovery–is possible with both chapter 7 and Chapter 13. People who qualify for Chapter 7 are often better off filing a Chapter 13. And, people who are in 13 often pay back nothing to their unsecured creditors. In addition, there are many benefits of being in a Chapter 13 that simply aren’t available in a Chapter 7.
Depending on your personal situation, you may not even need to do the means test.
And, if you are required to do the means test now, there may be changes that you can make or things that are happening in your life that might mean that you won’t have to do the means test if you wait a month or two before you file.
In other cases, if you have to do the means test, there are changes that you can make that will allow you to pass the test. Finally, in situations where you have to do the means test and you cannot file a Chapter 7, there are things that you can do in a Chapter 13 that will result in very little, if any, additional money being paid to your unsecured creditors. Plus, we often replace cars that are eating us up with costly repairs to keep them running and really do need to be replaced.
Again, I hate to sound like a lawyer, but what’s best for you really does depend on what you need, which is sometimes different from what you think you need. There is no one-size-fits-all analysis that can be done, and there is no universal goal of trying to avoid or pass the means test that will result in the best solution to your problems. Chapter 7 is not the “holy grail” of debt relief, and it is not the best answer to every situation.
You really do need an experienced attorney and counselor to go over your personal situation: your needs and your goals. That’s the way to get the best result.
So, don’t sweat the means test. It’s not really the problem that people think it is.
Let your attorney figure out the best solution and explain to you why it will get the best results for you. You may be surprised how much better off you are with the advice of experienced counsel.