When it gets impossible to pay debts, consumers in Escondido, California, might choose to file Chapter 7 bankruptcy. Chapter 7 helps relieve debt by selling nonexempt assets to pay creditors. However, Chapter 7 bankruptcy requires a debtor to pass a means test before they file.
Reason for the means test
The Chapter 7 means test compares a debtor’s average monthly disposable income to the median in the state for a similar sized household. Congress enacted the means test under the Bankruptcy Abuse and Prevention Act of 2005 to prevent abuse of Chapter 7. Before this law, almost anyone could use Chapter 7 to wipe out debts, including debts they could have paid.
The new law wanted to encourage filers, especially high-earners, to choose Chapter 13 as a debt repayment plan. It doesn’t mean that consumers need zero disposable income to qualify, but their income can’t be enough to pay creditors.
How the means test works
The means test can be a one- or two-part test. If the debtor’s income falls below the median, then they pass the test with no further requirements. Otherwise, they proceed to the next step, which calculates their expenses to figure disposable income.
Debts who have a low disposable income commonly qualify, but higher incomes may still qualify with allowable expenses. The IRS sets the standard for allowable expenses, which may include food, clothing, medical, mortgages and vehicle payments. If a consumer fails the test, they can retake it in a few months since it is based on six months of income. This means the debtor’s situation could change so that they meet the income threshold for Chapter 7.
While bankruptcy doesn’t erase all debts, it still provides relief from unsecured debts. Since bankruptcy can impact credit for several years, a consumer should carefully consider their options.