What is the Bankruptcy Means test

The means test is an important component of the bankruptcy process. Its primary function is to determine whether an individual or household has sufficient financial means to repay their debts, specifically in the context of Chapter 7 bankruptcy.

Chapter 7 bankruptcy is a type of bankruptcy that allows individuals or businesses to discharge their eligible debts and obtain a fresh financial start. However, not everyone qualifies for Chapter 7 bankruptcy, as there are income limitations in place to prevent abuse of the system.

The means test helps determine eligibility for Chapter 7 bankruptcy by assessing the debtor’s income and comparing it to the median income in their state. Here’s a general overview of how the means test works:

1. Calculation of Current Monthly Income (CMI): The debtor’s average monthly income over the past six months is calculated. This includes income from all sources, such as employment, self-employment, rental income, and other forms of regular income.

2. Comparison to Median Income: The CMI is then compared to the median income for a household of the same size in the debtor’s state. The median income figures are regularly updated and provided by the U.S. Census Bureau and the Internal Revenue Service (IRS).

a. If the debtor’s income is below the median income, they automatically pass the means test and are eligible to file for Chapter 7 bankruptcy.

b. If the debtor’s income exceeds the median income, further calculations are required to determine eligibility.

3. Deductions and Allowances: If the debtor’s income is above the median, certain deductions and allowances are applied to determine disposable income. These deductions are designed to account for necessary living expenses and financial obligations.

Some allowable deductions may include rent or mortgage payments, utilities, food, clothing, transportation, health insurance, taxes, and other necessary expenses.

4. Calculation of Disposable Income: After deducting allowable expenses from the CMI, the remaining amount is considered disposable income.

5. Assessment of Ability to Repay: The disposable income is then assessed to determine whether it would be sufficient to repay a significant portion of the debtor’s unsecured debts over a specified period.

If the disposable income falls below a certain threshold, the debtor typically qualifies for Chapter 7 bankruptcy. If the disposable income is above the threshold, the debtor may be required to file for Chapter 13 bankruptcy instead. Chapter 13 involves a repayment plan to satisfy a portion of the debts over a three to five-year period.

In summary, the means test helps evaluate whether an individual or household’s income is low enough to qualify for Chapter 7 bankruptcy. It ensures that those with the means to repay their debts do not abuse the system and encourages them to pursue alternative bankruptcy options that involve partial repayment, such as Chapter 13.