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Bankruptcy by Example: Pass the “Means Test” the Easy Way

Most people filing Chapter 7 “straight bankruptcy” easily pass the “means test” by having income no greater than the “median.” Do you?

The Chapter 7 “Presumption of Abuse”

“Abuse” is not a pretty word, one which has picked up a particularly bad sound to it. But in the bankruptcy context it has a very special meaning as used in the phrase “presumption of abuse.” The idea is that only people who truly need a Chapter 7 “straight bankruptcy” should be allowed to do one. Otherwise they should either not be filing bankruptcy at all or else should be in a Chapter 13 case. Under Chapter 13 a person generally has to pay all they can to their creditors during a three-to-five-year period. So if a person files a Chapter 7 case and has too much “disposable income,” the case is “presumed to be an abuse of Chapter 7.” That person may be required to change their case into a Chapter 13 one, or in unusual situations could be forced out of bankruptcy altogether.

The “Means Test”

The “means test” for qualifying whether you can be in a Chapter 7 case has an easy part and some other potentially quite complicated parts. But if you pass the easy part, then you pass the whole “means test” without having to get into the complicated parts.

The easy part is an income test. It has its own twists and turns but simply put you pass if your income is no higher than a certain threshold. That threshold is the “median income” for your size family in your state. If your income is no higher income than your “median income,” you pass the “means test” without going through the other steps of the test

To give you just an idea about the next part of the “means test”—the one you have to mess with if your income is larger than your “median income”—it goes back to the “presumption of abuse” we mentioned at the beginning of this blog post. If you are above “median income,” you have to go through the next step of calculating the amount of your “disposable income.” This requires you and your attorney to go through an astonishingly complicated income and expenses calculation. Your expenses are calculated in part on what you actually spend, in part on national standards on how much expenses are allowed, and in part on local standards. And the resulting “disposable income” amount is then put through a formula comparing it to the amount of your debts to determine whether that puts you in a “presumption of abuse.” No question: it’s nice to avoid all that if your income is simply no more than the applicable “median income.”

“Income” for Purposes of the “Means Test”

The easy income side of the “means test” is much more straightforward than the rest of the test, but it has its own peculiarities. It looks only at money you received during precisely the SIX FULL calendar months before your Chapter 7 case is filed. Almost all money you received during this six-month period from virtually all sources is counted, not just income from employment or taxable income. (Money in the form of any Social Security benefits is excluded, though). Once you have the total 6-month “income” amount, multiply it by 2 to get the annualized amount of “income.”

This odd way of defining income has an important practical result. It means that during that six-calendar-month period any irregular amount of money you receive, or any gap in money that you usually receive, can artificially inflate or deflate your “income” for the “means test.” An unusual extra amount of money could push you above your applicable “median income” amount applicable to you, or a gap in usual income can pull you below your “median income” amount. As a result, purposely delaying or hurrying the filing of your case can result in you passing or not passing the “means test.”

Here’s how this works in practice.

The Example

Heather is divorced, with custody of a teenage son. She has worked at the same employment for the last several years, paid on a salary. During the last year she has been paid $3,500 per month in gross income, and is paid on the 1st and 15th of the month.

She received court-ordered child support of $600 per month from her ex-husband very irregularly during 2012 and 2013 because he had a period of unemployment, so he fell $5,400 behind. But after Heather got frustrated with this and turned the problem over to the state support enforcement agency in late 2013, it found and garnished his savings account so that Heather received $4,500 on February 20, 2014. And she has been receiving the regular $600 support payment on the 1st day of every month starting in March.

Notwithstanding this chunk of money, Heather is by now far behind on many debts. She has just been sued by a collection agency, and is expecting her wages to be garnished any day. So she is considering filing bankruptcy. She hopes to get a fresh financial start through Chapter 7, in part because her son is doing well in high school and she really wants to help pay for college.

Applying the Income Side of the Means Test

The current “median income” for a two-person family in Oregon is $56,382 (for cases filed starting May 1, 2014, likely to be adjusted later in the year). She was hoping to file her Chapter 7 case during August 2014 to stop the collection lawsuit and its anticipated wage garnishment. If she files anytime from August 1 through 31, 2014, the 6-month full calendar month period for calculating her income for the means test is February 1 through July 31, 2013. During that period she received:

12 bimonthly paychecks of $1,750 each = $21,000

+ 6 monthly support payments (May 1-August 1, 2014) of $600 each = $3,600

+ 1 support arrearage payment (on March 1) = $4,500

= Total 6-month income for means test purposes = $29,100

Multiplying $29,100 by 2 results in an annualized income of $58,200, above her applicable $56,382 “median income.”

Being above the “median income” means that Heather does not pass this easy income part of the “means test.” .She and her attorney would need to complete the expenses side of the test to find out whether her “disposable income” would be high enough to make her case “presumed to be an abuse of Chapter 7.” If so, she would likely not be able to proceed through Chapter 7 to get a fresh financial start.

However, if she would be able to delay filing her Chapter 7 case only slightly, until September 1, 2014 (likely by having her attorney prevent the collection lawsuit from turning into a judgment), then the 6-month income period shifts later by one month, to the period from March 1 through August 31, 2014. Then the large support arrearage payment received on February 20, 2014 would no longer be part of the income calculation. So now her 6-month “income” would be calculated:

12 bimonthly paychecks of $1,750 each = $21,000

+ 6 monthly support payments (March 1-September 1) of $600 each = $3,600

= Total 6-month income for means test purposes = $24,600

Multiplying $24,600 by 2 results in an annualized “income” of $49,200, which is now below the applicable $56,382 “median income.”

Now that her “income” is below “median income,” she passes the easy income part of the “means test.” Her case would not be “presumed to be an abuse of Chapter 7” so she would qualify to file a Chapter 7 “straight bankruptcy.” Unless there was some unusual challenge made to her case, she would very likely have a successful Chapter 7 case, and the fresh financial start she is seeking.