After staring at your financial records for hours on end, you are finally prepared to face the truth. Your considerable financial debts have not been assuaged by the budgeting acrobatics you have attempted to employ during the past few months. The burden of debt still looms, just as dark and oppressive as ever. You are forced to make the difficult but inevitable decision to file for bankruptcy. Unfortunately, complication isn't eased. Declaring Chapter 7 or Chapter 13 Bankruptcy involves an intimidating pile of paperwork, and if your income is above the median for the state, you must also complete a rather bothersome thing called a means test, which can cause a host of problems for bankruptcy filers.
What is a Means Test?
In 2005, the U.S. government made some pretty substantial alterations to bankruptcy laws. One of the biggest changes was the addition of a means test that applies to those filing for bankruptcy and who make more than the state median income. It can determine whether you are eligible for Chapter 7 Bankruptcy and will affect a Chapter 13 Bankruptcy plan (such as a 3 versus 5 year plan). The rationale behind the change was that the means test would prevent debtors with a relatively high income in relation to their accumulated debt from filing for Chapter 7 Bankruptcy. The means test is not applicable if the debts incurred are not consumer debts. Proponents of the means test believe that it prevents unscrupulous wealthy individuals from completely erasing their debts, while critics decry the fact that consumers must pass a means test while companies do not.
Issues with the Means Test
There are a few issues with how the means test is applied during bankruptcy proceedings. These include:
- How is the household size counted? When filing for bankruptcy your case is decided based on your income relative to your household size to show if you can feasibly repay creditors under certain plans. However, there are several competing tests for how households are counted. One way is to go by the number of people listed on your tax return while another is to look at the actual economic inter-dependencies.
- What are acceptable deductions?The actual household expenses of a non-filing spouse, taxes, various forms of insurance (health, life and disability), secured payments for real estate or vehicles, charitable contributions, child/spousal support, and required deductions from ones pay like union dues.
- What are amounts that are included in income?Any sources of money other than social security payments may qualify as income. The means test requires an average of six months of actual income. Therefore, timing becomes an important factor for those trying to file in terms of income earned in the last six months. It is important not to file for bankruptcy after receiving an unusual amount of income such as a performance bonus or tax refund.
- What if I don't qualify?If you do not qualify due to the means test you can wait until your income is lower or increase deductions and file alternatively under Chapter 13. Here the means test does not prevent a filing but only requires a higher percentage of debt being paid if you have a higher income.
Ways around the Means Test
As is the case for a lot of federal legislation, it was implemented with good intentions, but can sometimes prove ineffective and unfair. Although there is really no way to avoid taking the means test, there are certain exceptions that may affect your eligibility determination.
One example of an exception would be if you received a sizeable bonus within the past few months. If the bonus was a large sum that affects your average income, then you can argue that you are highly unlikely to receive another bonus of that nature in the future and thus should be able to exclude it from the calculation.
Another example is if you have substantial, recurring medical costs. For instance, if you suffer from a chronic condition that requires several hundred dollars of medical expenses every single month, then you may be able to factor those medical costs into your means test.
Your results on the means test may also be negatively affected by simple errors in the documentation. Common mistakes include:
- Incorrect household size - in general you should count everyone in the house who is part of the same economic unit (renters would therefore be excluded)
- Claiming child support that isn't received - child support only counts as income if it is actually received and it only counts as an expense if you pay it
- Erroneous deductions - make sure you list all of the available deductions and don't take out deductions that aren't allowed such as college expenses or 401(k) loan repayments
Perhaps the most effective way to ensure that your bankruptcy documentation is correct, and takes advantage of all the possible financial exceptions, is to enlist the services of a qualified bankruptcy lawyer. An attorney specializing in bankruptcy law will be able to provide you with expert legal counseling which will significantly reduce the stress of filing a claim. Most importantly, they will help you understand and navigate the means test to ensure your claim has a positive outcome.
Written by Ronald D. Weiss, a Long Island Bankruptcy, foreclosure and modification lawyer who since 1988 has represented individuals and businesses in the greater Long Island and New York areas undergoing financial hardship.