Gross Income Is Used For Certain Parts of Bankruptcy Means Test
Determining which chapter of bankruptcy one is eligible to file has always been tricky.
But with the addition of the Means Test and other determining factors in 2005, bankruptcy eligibility became even more difficult to determine.
Not quite as complicated as college physics, but pretty hard.
A question recently posed to me was: “Do you use gross income or net income to determine if you can file bankruptcy?”
The answer is, both.
Which Bankruptcy Chapter?
The purpose for these tests is to determine who can file for Chapter 7 relief (which requires no payments to creditors as long as assets are all exempt), and who needs to file for Chapter 13 or Chapter 11 relief (and how much the payments would need to be in those chapters).
The Median Income Test Uses Gross Income
The first step is to determine if the income of the party to file the bankruptcy is above the median income level for that state, given the household size, and for the relevant period.
The median income is adjusted a couple times a year and is determined by the U.S. Census.
The Bankruptcy Code tells us that to determine the “current monthly income” of a debtor, we look at the GROSS household income from ALL sources RECEIVED in the six calendar months prior to the month in which the case is filed.
If that figure is below the median income for the location and household size of the particular debtor, then one hurdle has been cleared, but that doesn’t necessarily mean all is clear to file a Chapter 7 case (see below).
If that figure is above the median income, a means test must be done to determine whether a “presumption of abuse” arises, which means that absent special circumstances, relief under Chapter 7 may not be possible (but Chapter 13 or Chapter 11 might be feasible).
The Means Test
If you are ABOVE the median income, as defined above, for your area on the date your bankruptcy case is to be filed, then the next step is to do the calculations on the “Means Test”. This test uses a complex formula that takes the gross income for the 6 month period above, and then subtracts out only certain allowed IRS-budgeted expenses items, and ongoing secured debt obligations. A number is then reached and depending on what that number is, a “presumption of abuse” may or may not arise if a Chapter 7 case is filed.
This test is also used in Chapter 13 cases to determine how much the monthly payment is supposed to be (Disposable Monthly Income), although there are additional expenses allowed in Chapter 13 calculations, not allowed in Chapter 7..
Current Budget Test Uses Net Income
Regardless of whether your current monthly income as defined above is above or below the median income in your area, or whether your means test analysis shows a presumption of abuse or not, you must also look at your actual current budget, which is your monthly income as it stands today (or whenever you’re filing your bankruptcy case) minus your necessary living expenses (and business expenses if you’re operating a business or self-employed). Thus, it is your NET income.
If this figure shows a substantial surplus (and I’m not going to try to define “substantial” here, since it varies from court to court), and your debts are primarily “consumer” debts (used for household or personal items), then you likely will not be eligible for a Chapter 7 case, and will need to explore doing a repayment plan of some sort in either a Chapter 13 or Chapter 11 case.
If your debts are primarily NON-consumer, then the surplus in your budget is less of a factor in determining eligibility.
Some example of non-consumer debts: Taxes, business debts, portions of student loan debts used exclusively for education rather than food/rent, etc.)
Some examples of consumer debts: credit cards used for personal items, mortgage on your residence, etc.
But for those with primarily consumer debts, even if you’ve satisfied all the median income/means test issues, you can still draw objections to being in a Chapter 7 case if your budget shows too much of a surplus.
Confusing, Isn’t It?
The above was a mere dusting of this topic, designed to give a little guidance to those asking questions. But the bottom line here is that you need an experienced bankruptcy attorney to analyze all the relevant information to determine your eligibility, options, and risks and benefits of filing for bankruptcy.
Image courtesy of University of the Frasier Valley