Very little in bankruptcy causes more confusion and anxiety than the Chapter 7 means test. Many people assume that the means test will automatically force them into a Chapter 13 payment plan or prevent them from filing for bankruptcy at all. Although these assumptions are not true in most cases, the confusion is understandable. The means is unnecessarily complicated and not entirely rational. Yet, despite its complexity, a basic understanding of the test can maximize your chances of passing it or avoiding it altogether.
The Chapter 7 means test is a case study in unintended consequences. In theory, it requires people who can afford to pay at least part of their debts to enter into a Chapter 13 payment arrangement, rather than discharging their debts in Chapter 7. The driving force behind the enactment of the means test was the banking and credit card lobby, which sold the test to Congress in 2005 as a tool to prevent bankruptcy abuse. In practice, the means test does little to stop bankruptcy abuse. Instead, by setting arbitrary income caps and failing to take into account the debtor's actual ability to pay, it forces some struggling middle-income debtors into pointless or unworkable five-year Chapter 13 plans. Often these plans are exercises in futility, paying back unsecured creditors only a nominal amount.
Indeed, some debtors with significant disposable income should be in Chapter 13. For others, such as those who are seriously behind on a mortgage or auto loan, Chapter 13 offers the option to keep their home or car. However, for many people who would be better served by Chapter 7, the means test can be a trap. Therefore, it is essential to understand how the test impacts your options under the Bankruptcy Code.
It is generally not a good idea to tackle the highly complex means test without the advice of an experienced bankruptcy attorney. However, the best way to show how the means test works is to go through the process step-by-step with examples, as we have done below.
The first step in completing the means test is determining your "Current Monthly Income" or "CMI." CMI is not the same as your actual current income or what you are making right now. Instead, it is an average of your income over the six months before you file for bankruptcy.
To obtain your CMI, you must first add up all your gross income (your income before taxes and other deductions) for the six months prior to the month in which you will file for bankruptcy. Put another way, add up all of your gross income for the previous six months, and divide it by six. The resulting figure is your CMI.
Example: Let's consider Jane, who made $4000 per month from January through April. Jane lost her job and had no income in May and June. If she files for bankruptcy in July, her CMI will be based on the months from January through June, including the two months in which she had no income. An easy way to visualize this is through the use of a table:
To determine her CMI, Jane would add up all the income she made in the previous six months ($16,000) and divide it by six to give her a CMI of $2667. ($16,000 / 6 = $2667).
Quick Note. It is important to keep in mind that in calculating your CMI, you do not include the month that you file. For example, if you file in October, you would average your income for April through September. You would not include October.
Income for the means test is money you received from all sources, with some exceptions, which we will discuss below. You must list all income from wages, operating a business, pensions (except Social Security), investments, unemployment, other public benefits, private disability, assistance from family members or others (not loans), and income from any other source.
How should you list business income? If you have business income from a sole proprietorship, you can subtract your business expenses in the means test. If you own an incorporated business, you must include all income that you are entitled to as an owner, not just the salary that you receive from the business.
Social Security income is exempt from the means test. Social Security benefits, including SSI and SSD, do not count towards your the means test and should not be included in your means test calculations. You must still provide this information to your attorney, as it does count elsewhere in the bankruptcy schedules.
After calculating your CMI, you need to compare your income to the state median to see if you have to take the means test.
If your CMI is below the state median, you do not have to take take the means test. The Pennsylvania State median income figures are here.
Example: Bob and Mary are a husband, wife with two kids. They have a CMI of $6250 per month ($75,000 per year). If the Pennsylvania state median income for a family of four is $6390 per month ($109,316 per year), Bob and Mary's income falls below the median. Therefore, they could file under Chapter 7 (assuming they meet the other requirements) without taking the means test.
If your income is above the state median, you must take the means test, unless you fall under an exception.
Example: Bill and Ann, a couple with no minor children, have a CMI of $5000 per month ($60,000 per year). If the Pennsylvania State Median income for a family of two is $4424.25 per month ($53,091 per year), Bill and Ann are over the median and must take the means test if they wish to qualify for Chapter 7.
Some individuals may not need to take the means test, including debtors with primarily business debts, some servicemembers, and some veterans. For more information, see my post: "High Income Chapter 7: Passing the Threshold."
Because CMI is an average, the resulting figure may be significantly more or less than your actual current income. Thus, an unemployed debtor may still have a relatively high CMI if the job loss was very recent. For that reason, bankruptcy attorneys sometimes advise clients to wait to file until their 6-month average income has dropped.
Likewise, if you received little income for several of the previous six months but now have a steady salary, your CMI may be lower than your current income. You may need to file sooner than later because your CMI will go up every month.
As discussed above, if your income is over the state median, you must take the means test. The means test permits you to deduct certain standard expenses such as housing, food, clothing, medical care, transportation, etc. based upon IRS averages for your area. (As a Philadelphia bankruptcy lawyer with a practice covering Philadelphia, Montgomery, Delaware, Berks, Bucks, and other surrounding Pennsylvania counties, I can attest that the IRS housing and transportation allowances do reflect the actual cost of living in this region.)
In addition to the standard expenses, you can deduct some actual expenses, such as debt payments (primarily mortgage and auto loans), taxes, transportation expenses, healthcare, insurance, and charitable donations. Your income minus these allowable expenses is your "disposable income."
If, after taking the means test, your disposable income is below a certain cutoff amount, you can file under Chapter 7. The cutoff amount is typically below $200 per month, but we are using $120 for our examples).
Example: Bill and Ann take the means test. After allowable expenses, they have a disposable income of $100 per month, which falls below the $112 cutoff for Chapter 7. Therefore, they can file under Chapter 7.
If your disposable income is over the cutoff amount, you cannot file under Chapter 7. (You may still be able to file under Chapter 13, if you otherwise qualify.)
Example. Bob and Mary have a disposable income of $500, which is well above the $120 cutoff for Chapter 7. Therefore, they would be required to file under Chapter 13 if they want to file for bankruptcy.
I hope this article helps to clear up some of the mystery surrounding the means test. However, we have just touched the surface with our examples. In the rest of this series, our FAQs, and elsewhere on our website, we discuss avoiding the means test, passing the means test, and special circumstances that may allow you to file under Chapter 7, even if you fail the means test.