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Guest Blog: Can I File Bankruptcy? Passing the Means Test

8/29/2012

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If you are buried in debt, tired of all the debt collector phone calls, and don’t see any way out, you may be considering bankruptcy. But can you file? In 2005, the bankruptcy laws underwent sweeping changes in an effort to curtail what lawmakers perceived as abusive bankruptcies by high income earners who had the ability to repay their debts. The changes created the bankruptcy “Means Test,” which you must pass in order to file bankruptcy. For straight bankruptcy under Chapter 7, you must pass the test in order to file. For repayment bankruptcy under Chapter 13, the test determines how much of your unsecured debt (credit card debt, medical bills, and the like) you have to repay to your creditors.

The Means Test compares your household income to the median income (in your state) for a household of your size. If you are married, your household income includes your spouse’s income, unless you are physically separated. If your household income is below or equal to the median, you pass. If your household income is above the median, then you have to take the second part of the test, which involves an 8-page formula that starts with your income and applies certain allowable expenses based on IRS standards to see if you have any leftover disposable cash in your budget. If you do, then you may be required to file a Chapter 13 repayment bankruptcy and repay your debts to the extent you are able.

If your income is above median, you can still pass the Means Test if you have a large mortgage payment, car payment, or other expense that is allowed as an additional deduction. But the higher your income goes, the more difficult it will be to pass. For above-median income earners, the only way to know for sure if you pass is to have an attorney review your income information and documentation and apply the 8-page formula.

The median income for Means Test purposes is based on your average income over the six months prior to filing bankruptcy. For example, if you file in July, the Means Test period will be January 1st through June 30th. In some cases, it may be advantageous to time your bankruptcy filing so that the Means Test works in you favor. For example, if you were recently laid off, waiting a few months before you file can lower your average income, making it more likely that you will pass.

There is an important exception to the Means Test. If the majority of your debt is business related, the test does not apply. Exercise caution in utilizing this exception if you are an above-median income earner, since good faith is always a consideration in bankruptcy cases. A bankruptcy trustee could always make a bad faith objection and ask that the Court apply your current income if your current income and expenses leave you with disposable cash left over in your monthly budget.

Article courtesy of Mark Aalam. Mark Aalam is a bankruptcy attorney and owner of Bankruptcy Legal Center in San Diego, California.
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