The most common bankruptcy filed is that of a Chapter 7, a liquidation for individuals or businesses which is designed to eliminate all debts. In exchange, your assets are liquidated, subject to certain exemptions, which allow you to retain certain assets. Secured debt is treated differently, as bankruptcy discharges debt, not liens, except in certain circumstances. A Chapter 13 is a reorganizing bankruptcy for individuals (wage earners) who wish to retain their assets and pay their debt, or a percentage thereof, over a 36- or 60-month period. Secured creditors are treated differently.
The Means Test is a tool used to determine the type of bankruptcy for which an individual is qualified. The Means Test was enacted by Congress in 2005 in order to determine a debtor’s ability to repay debts, prevent bankruptcy abuse, and reserve Chapter 7 bankruptcy for those who needed it most. It was included in the Code to prevent debtors with household income in excess of the median income of the state in which they reside from even filing a Chapter 7. The Means Test applies to those who have primarily consumer debt, rather than non-consumer debt.
There are exceptions to the household income limitations. Some of the exceptions include:
- If your non-consumer debt (business and investment debt) exceeds your consumer debt, the Means Test does not apply. Non-consumer debt includes tax debt, mortgages on investment properties, mortgages on business properties, and business debt. Consumer debt is debt which is voluntarily incurred and for the benefit of the debtor and/or his household, such as credit cards, goods and services, and entertainment.
- Social Security income is not counted within the computation of the Means Test household income.
- Monthly secured debt payments, such as car loans, residential mortgages, and home equity loans, can further reduce your income for purposes of the Means Test limitations, even on consumer debt.
Income tax liabilities which meet certain specific limitations may be discharged through a Chapter 7, which may permit you to avoid the Means Test with existing large non-consumer debts (i.e., taxes). Discharging some or all of your taxes that meet specific requirements of the Internal Revenue Code may be very beneficial. This is a complex area where one must look at the advantages and disadvantages of both the Bankruptcy Code and the Internal Revenue Code.
Should you exceed the median household income for the state in which you reside, and should none of the exceptions apply, you will be prohibited from filing a Chapter 7 and may file a Chapter 13 bankruptcy so long as you do not exceed the debt limitations thereof, or a Chapter 11 bankruptcy, which is usually very expensive and complex.
A Chapter 13 bankruptcy applies only to individuals, not businesses, and while the debtor must partially pay off some of the debt, it also offers several advantages. In a Chapter 13 bankruptcy, debtors may keep their property but must pay unsecured creditors an amount equal to the value of their non-exempt assets or their net disposable income, whichever is higher. Debtors work with a Trustee to set up a monthly Payment Plan to pay back unsecured debts. Co-signers to debt are not held responsible for repayment.
The limitations of the Means Test in a Chapter 13 are that if you were to exceed the Means Test income level, the Code limits you to “allowable” expenses in determining your Chapter 13 Plan. This would increase your disposable net (excess) income and cause your Plan payments to be higher than they would have been, but for the application of this limitation. Sometimes, it is possible to negotiate with the standing Chapter 13 Trustee with respect to the amount of permissible expenses.
Filing for bankruptcy is a complicated process with long-term consequences. While it is not required to consult with an attorney, it is in one’s best interests to speak with a qualified bankruptcy attorney who can help determine your qualifications and your best options.