Updated: Jan 13, 2022
The principal provision of this Congressional enactment was the addition of a “means test” designed to prevent higher income earners from filing Chapter 7 bankruptcy. The “means test” is term that is often heard today in the context of social security reform. Essentially a “means test” is designed as a pre-qualifier or test to determine the right to certain benefits. In the context of social security reform, if a person is old enough to obtain social security benefits but has sufficient financial means to comfortably retire, then that person will not be able to receive social security benefits from the government upon retirement. In the context of a Chapter 7 bankruptcy, the “means test” acts in the same way as that proposed in the current dialogue surrounding social security reform. The bankruptcy “means test” determines whether an individual’s monthly income is too high qualify for a Chapter 7 bankruptcy. In applying the “means test”, the bankruptcy court looks at the debtor’s average income for the 6 months prior to filing and compare it to the median income for that state. It then deducts specific monthly expenses from your current average income to arrive at monthly net disposable income. The higher your net disposable income, the more likely you won’t be allowed to use Chapter 7 bankruptcy. Median income levels vary by state, county, metropolitan area and household size. Each metropolitan area has different allowed amounts for categories of expenses: basic necessities, housing, and transportation and the like. The Chapter 7 “means test” doesn’t require that you be penniless in order to be eligible to file a Chapter 7 bankruptcy. You can earn significant monthly income and still qualify for Chapter 7 bankruptcy if you have a lot of expenses, such as a high mortgage payment. High income earners who fail the means test, however, may not use Chapter 7 bankruptcy to wipe out their debts altogether. They can use one of the other bankruptcy chapters, Chapter 13 or Chapter 11, to repay a portion of their debts. But they cannot use Chapter 7 to wipe out all their debts. There are two very important exceptions to the requirement that a Chapter 7 filer pass the “means test”. The first is Social Security income, which is not to be considered in the “means test” calculation. The second exception and more important in the context of the current economic downturn, is that non–consumer or business debtors are not required to even take the “means test.” This means that a self–employed business person whose debts are primarily business related debts can make $100,000.00 or more per month and still file a Chapter 7 bankruptcy. Where this second exception gets a little tricky is defining what is a consumer versus business debt. Typically consumer debts are incurred for personal, family or household purposes. Such things as credit cards, personal loans, medical bills and residential real estate loans are considered consumer debts. Non–consumer debts are those that are incurred for a profit motive. Business related credit cards, business loans, business vehicles, business creditors, vendors and the like. As with most things in the law there is a gray area. One such area is non–owner occupied real estate. Clearly, a real estate investor who as a regular course of business buys, sells and rents real estate would have his non – owner occupied real estate debts characterized as business not consumer debt. But what of the “flipper” who ran up real estate debts before the recent decline in the real estate market? There are many, many individuals out there with more than one piece of real estate. If you are one of those individuals, chances are that you will be able to discharge all that debt in a Chapter 7 bankruptcy, regardless of your current monthly income and regardless of whether or not you can pass the “means test.” If you are suffering under the weight of negative equity, you should consult with an experienced bankruptcy attorney in your area to see if you qualify for a Chapter 7 bankruptcy.