How does the bankruptcy means test work?

WHAT is the means test in bankruptcy? It’s a method for calculating what your household income is to determine if you qualify for Chapter 7 or Chapter 13 of the bankruptcy code.

By household income, we mean the combined income of husband and wife, if the debtor is married, unless they are separated.

The means test is a relatively new concept introduced in the new bankruptcy code of 2005. Before that new bankruptcy law took effect, there was no such thing as a means test. Before 2005, the general rule was if the household income were less than the monthly necessary expenses, a debtor would probably qualify for Chapter 7.

Under the means test, debtor’s average income for the last six months, if less than the median income for the household for the state, would prima facie qualify debtor for Chapter 7, without any presumption of abuse arising. Each state has a different median income. For example, in California, the median income for a single person is about $48,000 a year. So, if you are single and make less than $48,000 a year, then you would automatically qualify for Chapter 7.

However, this does not mean that single persons making more than $48,000 would be disqualified from Chapter 7. This is so because the means test provides for amounts that may be deducted from gross income given the cost of living in the state.

Hence, a single person making $70,000 a year with a mortgage payment and a car payment would probably still qualify for Chapter 7.

What happens if one’s income is so high that the means test is breached? A presumption of abuse is marked in your means test and the U.S. Trustee (UST) would have their say about the presumption of abuse matter. The UST position would be: show me documentary evidence why you qualify for Chapter 7.

It is possible to overcome the presumption of abuse and still get a Chapter 7 discharge even if your income is a lot more than the state median income if you can prove to the satisfaction of the UST that you do indeed qualify for Chapter 7.

If you are short on your documentation, the UST will file a motion to dismiss your Chapter 7 case based on the abuse of bankruptcy law. This gives you a chance to argue why you are eligible for Chapter 7 discharge despite the objection of the UST before the bankruptcy judge in charge of your case. I would say that it’s difficult to convince the judge if the UST has filed its motion to dismiss unless you have good and complete documentation to support your case for getting a Chapter 7 discharge.

For instance, you give $500 a month to your favorite charity. With this deduction, you pass the means test for Chapter 7, but the UST files its motion to dismiss as they object to your claim of a charitable deduction. You argue that you do indeed give $125 in cash to your church every week, with a grand total of $500 a month. Without this deduction, your disposable income is $500 a month, dislodging you from Chapter 7 and tracking you into Chapter 13 instead.

The UST asks for proof that you actually give $500 a month to your church. Since you donate in cash, there is no documentary proof of your weekly donation. You submit a picture of your hand putting $125 of cash into the cash box of the church every Sunday for one month. The UST pretty much says that they don’t believe your picture evidence. The UST says that your income tax returns for 2017 do not claim any charitable donation. You argue that your CPA was drunk when he prepared your tax returns.

Will the bankruptcy judge side with you or the UST? I think the odds are against you. The UST and federal judges are well qualified in what they do.

If you can’t pass the means test for Chapter 7, no matter how hard you try, you should really consider filing Chapter 13 instead. Chapter 13 lets you reorganize your financial resources in such a way that you pay possibly only a small portion of what you owe. For example, you owe $50,000 of credit cards. In Chapter 7, you don’t have to pay the $50,000; the discharge order just wipes them out. In Chapter 13, you might have to pay $200 a month for 60 months, or $12,000. If you complete all 60 payments of $200 each, the court will discharge or wipe out $38,000 of your credit cards.

I have a senior client who couldn’t file a Chapter 7 because she had sold her house to her brother in law for $120,000 below market price. I advised her against Chapter 7 unless she wanted to risk losing her house. She did this because when her husband died two years ago, she could not afford to make the mortgage payments anymore. Her brother-in-law allowed her to stay in her house, which now belonged to him, for as long as she wanted, without rent. This was a verbal agreement. The client was 74 years old. The arrangement worked for her because even if she just rented a room, she would have to pay at least $500 a month. So, if she lived another 20 years, living in her house rent-free would be like getting back $120,000 over 20 years.

Even if she passed the means test with flying colors since her only income now was social security of $1,300, there was a big chance that the Chapter 7 trustee would invalidate the sale of the house to the brother in law since it was sold below market price only two years ago. If this happened, it would be a big disaster because she would lose the roof over her head immediately and she would have nowhere to go.

The court confirmed her Chapter 13 plan recently where she paid only $152/month for 60 months. If she completes her Chapter 13 plan payment, the court will discharge $53,000 of her $60,000 credit cards. In other words, her Chapter 13 plan approved by the court will discharge 90 percent of her credit cards if she pays 10 percent of those cards over five years. There is no interest accruing during the five years because, with Chapter 13, credit cards cannot charge interest. All payments go to the reduction of principal.

People have different kinds of financial hardship, but they all benefit from total elimination of debt in Chapter 7 or partial elimination of debt in Chapter 13. Either way, they end up with no debt eventually. I can say with certainty that 100% of my clients are better off with no debt after a bankruptcy discharge. They all become productive again and are much happier living their lives debt-free.

Most, if not all, have rebuilt their credit after only a couple of years.

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DISCLAIMER: NONE OF THE FOREGOING IS CONSIDERED LEGAL ADVICE. EACH CASE IS DIFFERENT.

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Lawrence Bautista Yang specializes in Bankruptcy, Business, Real Estate and Civil Litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 20274 Carrey Road, Walnut, CA 91789 or 1000 S. Fremont Ave., Mailstop 58, Building A-10 South, Suite 10042, Alhambra, CA 91803.

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