Filing for personal bankruptcy can be overwhelming. If you are in financial crisis and considering bankruptcy as an option for moving forward, you might be confused by the options for filing and what steps they need to take to file. This article will help you start thinking those things through.
Should You Choose Chapter 7 or Chapter 13 Bankruptcy?
One of the preliminary determinations you will need to make is whether to file Chapter 7 or Chapter 13. In order to make this decision, you need to know if you qualify for Chapter 7 bankruptcy. To do this, you need to understand the steps to the Chapter 7 "means test" and determine whether you meet the eligibility requirements.
Chapter 7 bankruptcy is often called a liquidation bankruptcy because it eliminates most of the debtor's debts in the bankruptcy discharge after liquidating many of the debtor's assets, other than a family home and car, to try to pay off as many creditors as possible. Chapter 13 bankruptcy, in contrast, operates more like a financial restructuring, in which the debtor renegotiates payment terms with creditors and repays creditors over a period of three to five years while keeping most assets.
How the Chapter 7 Bankruptcy Means Test Started
Chapter 7 might seem like a more appealing option to many, since it has the power to simply eliminate a debtor's obligations. However, since Chapter 7 is such a powerful tool, Congress was concerned that only those who absolutely could not pay their debts had the option of filing Chapter 7 bankruptcy. Spurred on by lobbyists from credit card companies who supplied anecdotal evidence of consumers recklessly racking up debt and then simply walking away from those obligations in Chapter 7 bankruptcy, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, in which they established the Chapter 7 means test to limit Chapter 7 filings to those who fell within certain income guidelines.
Steps of the Chapter 7 Means Test
The means test may seem like a challenge for those looking to file for Chapter 7 bankruptcy protection. But many people still qualify for Chapter 7 bankruptcy after they go through all of the steps to the test.
Step One - Determine the State's Median Income
The first step to the means test is to look at the debtor's home state median income as determined by the U.S. Census Bureau. Then the debtor takes his or her income for the previous six months and doubles it. If that figure is less than or equal to the state's median income, the debtor passes the means test at the first step and need not go any further to determine whether he or she can file for Chapter 7 bankruptcy.
Step Two - Deduct Expenses
If a debtor has earned more than the state's median income, he or she may still be eligible to file for Chapter 7 bankruptcy after deducting certain expenses from his or her income to determine the debtor's disposable income. The I.R.S. allows debtors to subtract payments for:
- Food and clothing expenses
- Out-of-pocket health care expenses
- Housing and utilities and other non-mortgage expenses
- Mortgage or rent expenses
- Vehicle payments and maintenance expenses
- Public transportation expenses
- Tax payments
- Life insurance payments
- Involuntary deductions from wages for employment, such as union dues and uniform costs
- Court-ordered payments, such as child or spousal support
- Education payments for employment or a child with special needs
- Telecommunications services expenses
- Expenses for protecting the family against violence
- Payments for education of children under age 18
- Home energy expenses
- Charitable expenses
- Future payments on secured debt
After all of the deductions from income, what remains is the amount the government considers the debtor's disposable income. Then the debtor multiplies that amount by 60 to see what his or her disposable income will be for the next five years. If the amount is less than $6,000, the debtor may file for Chapter 7 bankruptcy. If the amount is larger than $10,000, the debtor may not file Chapter 7 bankruptcy and must file Chapter13 if he or she still wishes to file bankruptcy.
Step Three - Compare Income to Unsecured Debt
If the debtor's disposable income falls between $6,000 and $10,000, there is one final step to the means test. The debtor compares his or her disposable income to the amount of his or her non-priority unsecured debt, such as bank credit cards, store credit cards or personal loans not backed by collateral, to determine whether it is feasible to make anything more than token payments to his or her creditors.
If the amount of disposable income is less than 25 percent of the amount of unsecured debt, the court presumes that the debtor is not going to be able to repay the debt in the foreseeable future and the debtor may file Chapter 7. If the amount of disposable income is greater than 25 percent of the debtor's unsecured debts, the court presumes that the debtor does not need Chapter 7 bankruptcy protection and would be able to afford a repayment plan under Chapter 13 bankruptcy.
Making a Decision about Bankruptcy
Financial troubles may seem insurmountable and the idea of filing for bankruptcy might seem to be daunting or out-of-reach. It's true that the Chapter 7 bankruptcy means test has tightened the requirements for those who can file. But many people still qualify for this powerful form of debt relief. If you are struggling financially and feel like you are out of options, do not hesitate to contact an experienced bankruptcy attorney who can discuss your situation with you and advise you of your options.