Bankruptcy Means Testing

Society used to harshly judge people who didn’t pay their bills. Robert Morris, a signer of the Declaration of Independence, spent three years in debtor’s prison in Philadelphia—and he was the financier of the American Revolution!

Today even celebrities like Lady Gaga, Mike Tyson and the billionaire President of the United States have declared bankruptcy, with no shame or jail time. There’s widespread acceptance of filing Chapter 7 personal bankruptcy to get out from under a mountain of debt and start fresh.

But before you wipe the slate clean, you are required by federal law to pass an income-analysis test called the bankruptcy means test that determines whether you’re eligible to file Chapter 7.

Your eligibility is based off information from one or two extensive federal forms, official form 122A-1 and possibly also official form 122A-2. On these forms you’ll report your income, debts, and expenses in great detail.

Congress required the means test beginning in 2005 when it toughened the bankruptcy laws with the passing of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). The idea was to stop flagrant abusers of the bankruptcy laws. Some high-living debtors were using Chapter 7 to bail out on lifestyles of the rich and shameless and leave society holding the bag.

Once you’ve proven to the court that you lack the “means”—another word for money or financial resources—to meet your obligations, you’ll pass the “means test” and may go ahead and file for Chapter 7 bankruptcy.

The means test makes filing for bankruptcy a little more difficult. But the good news is that most people pass the means test and get their Chapter 7 bankruptcy approved.

Be assured that you’ll have plenty of company in seeking debt relief through bankruptcy —469,464 Americans filed for non-business Chapter 7 bankruptcy in 2019, according to U.S. Bankruptcy Courts.

Bankruptcy Means Test Steps

The purpose of the bankruptcy means test is to determine whether you are hopelessly crushed by debt and can apply for a Chapter 7 fresh start. Or whether you have too much disposable incomes and don’t qualify to file for Chapter 7.

You’ll start the means test by filling out Official Form 122A-1. It’s a good idea to hire a bankruptcy lawyer to lead you through the forms and a complicated legal process that takes 6-8 months to complete. Bankruptcy law is a highly specialized field.

Your lawyer will ask you to gather as much documentation as possible of your income for the past six months to report on form 122A-1. Then you’ll compare your income to the median income for your household size in your state, according to the U.S. Census.

The most important question is simple: Is your median income less than your state’s median income? If it is, you pass the means test and can file for Chapter 7 bankruptcy.

If it isn’t, and your income exceeds the state’s median income, you can’t file for Chapter 7—at least not until you answer more questions on another form, Official Form 122A-2, which will show your expenses versus income.

A word of caution: You can fill out the forms and file for bankruptcy yourself, and save what might be several thousand dollars in legal fees. But unless you’re the kind of super-organized numbers nerd who loves to do their own taxes, there’s a good chance you’ll end up being “penny wise and pound foolish.”

Be careful trying to go it alone. A study of nearly 650,000 Chapter 7 cases filed from 2007 to 2016 concluded that more people tried filing without an attorney ( 7% up to 11%),but the results weren’t pretty.

Debtors without a lawyer were “nearly 10 times as likely to have their cases dismissed or their discharges denied than debtors with attorneys,” concluded Ed Flynn, an editor at the American Bankruptcy Institute.

Declaring personal bankruptcy is a serious step with great benefit but also grave consequences for your credit rating. Before you can file for Chapter 7, the law requires that you also speak with a credit counselor from a federally approved nonprofit credit counseling agency like InCharge Debt Solutions.

It’s a free session, lasting no more than an hour, that gives you an overview of your choices to eliminate debt, including bankruptcy and other government-approved methods.

If you decide on trying for bankruptcy, filing Chapter 7 is a complicated process that starts with the all-important means test. It’s part of your lawyer’s job to help you pass it.

If you don’t get the means test right it will doom your application for Chapter 7 and force you to try Chapter 13 bankruptcy instead.

Form 122A-1: Statement of Current Monthly Income

The purpose of form 122A-1 is to report your income level to the court and compare it to the median income in your home state. Based on your average monthly income, the court will determine if you qualify for Chapter 7 bankruptcy.

Your lawyer will guide you through calculating your income for the last six months from a variety of sources, including:

• Your employment income, based on pay stubs for six months
• Your spouse’s six-month employment income (if you’re filing for bankruptcy together)
• Income from spousal or child support
• Income from businesses you own
• Investment income, including dividends
• Unemployment income
• Retirement income
• Other income sources your lawyer identifies, such as a bank deposit or even a check or cash if you don’t have a bank account.

When you’ve finished adding up your total income for the past six months, divide the total by six to come up with your average monthly income. Then you’ll multiple your average monthly income by twelve to calculate your annual income.

Finally, you’ll compare your annual income to your state’s annual median family income for your household size, as determined by the U.S. Census.

The difference in state median incomes can be striking. For instance, the median income in Maryland in 2017, the latest available number, was $80,776. A Maryland resident could have a $78,000 annual income and still file for Chapter 7.

The median income in Arkansas is $45,869. An Arkansas resident’s annual income would have to be lower than that to qualify for Chapter 7 bankruptcy.

Form 122A-2: Means Test Calculation

The purpose of form 122A-2 is to calculate your disposable income by comparing your income and expenses. This is the second level “means test.” It determines in depth what your true “means” or financial resources are, and whether you have money to pay off debts.

This form shows how much money you have left over after basic needs, such as food, clothing, trips to the doctor and hospital, and rent or mortgage payments, are met.  The money left over is your disposable income that could be used to pay off debts.

Form 122A-2 asks you to report your annual income that you calculated in form 122A-2. Then directs you to list your expenses and obligations in great detail, including:

• Your expenses for food, clothing and health care versus IRS National Standards.
• Your expenses for housing rent, mortgage, utilities, and vehicles compared to IRS local standards for your household size and county.
• Your federal tax exemptions and dependents.
• Your amount paid for federal, state and local taxes, including income taxes, Medicare and Social Security taxes.
• Your court-ordered payments, including child support and alimony.
• Childcare expenses.
• Elementary school or secondary school expenses, including public or private schools.
• Expenses for caring for elderly, ill, or disabled members of your household.

Presumption of Abuse

This is the point on form 122A-2 where you learn if you pass the means test or not and can file for Chapter 7 or not.

If your calculations on the form show that you have too much disposable income after expenses and debts to qualify for Chapter 7 bankruptcy, this is called “presumption of abuse.”  (Remember, abuse of the bankruptcy laws by people with too much money prompted Congress to toughen the laws in 2005).

First the form directs you to calculate your monthly disposable income—what’s left over after your basic “allowable expenses.” Then you multiply that number by 60 months to come up with the amount you could pay toward debts for five years.

For instance, if you have a disposable income of $125 a month, your total disposable income for five years would be $7,500.  In that case, you’d be in luck!

Line 40 of the form gives you the answer you’ve been looking for. It asks if your five-year disposable income is less than $8,175?

If you can check the box indicating yes, then “there is no presumption of abuse.”  You are eligible to file for Chapter 7 bankruptcy, with an excellent chance of being approved by the courts.

If your five-year disposable income is more than $13,650, “there is presumption of abuse.” This means you have failed the means test. You have little chance of filing for Chapter 7 unless you can show extraordinary special circumstances.

If your disposal income is between $8,175 and $13,650, you have more work to do to prove that you should qualify.

Means Test Exemptions

Congratulations, you pass go and don’t have to take the means test.  That’s what happens if you meet one of three exemption requirements:

• If the debts you want to escape with Chapter 7 are primarily non-consumer (business) debts. The courts typically require your business debt to be more than 50% of the total debt, including such debts at money owed to business vendors and suppliers.
• If you are a disabled veteran who accumulated most of the debt while on active duty or performing a homeland defense activity.
• If you are a military reservist or a National Guard member called to active duty after September 11, 2001, you could qualify for an exemption from the means test requirement. Ask your attorney if any of these three apply to you.

After Completing Bankruptcy Means Testing

If you fail the Chapter 7 means test, Chapter 13 bankruptcy may be your best option. Often called the “wage earners bankruptcy,” it’s not exactly the do-over you were looking for. It doesn’t wipe the slate clean like Chapter 7, but allows you to get creditors off your back while you arrange a 3-5 year payment plan to fulfill your obligations.

You’ll be permitted you to keep some of your assets that a Chapter 7 filer might have to liquidate. Chapter 13 can work well for people with a good income and valuable assets who want to keep some of them, such as a primary residence.

Even if you’ve passed the Chapter 7 means test, filing for Chapter 7 bankruptcy may not be your best option. Bankruptcy is the nuclear option of resolving debt. It ruins your credit rating for 10 years.

This is when the hour-long session with a nonprofit credit card counselor, required by law before you can file for bankruptcy, comes in handy. You’ll explore less punishing alternatives to bankruptcy such as debt management programs, debt settlement, or a consolidation loan.

If you ultimately decide bankruptcy works for you, you must complete a session of pre-filing credit counseling. Then, after you’ve filed for bankruptcy, the law requires you to complete another short course with an accredited counselor in “Bankruptcy Debtor Education.”

This course includes lessons in money management, preparing a budget, and learning to save and set realistic financial goals. The idea is that equipped with new knowledge you won’t end up in bankruptcy again.