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How the Chapter 7 means test works

On Behalf of | Apr 4, 2022 | Firm News

Consumers in Escondido, California, who are overwhelmed with debt may choose Chapter 7 bankruptcy, which is a liquidation process. However, not just anyone can file Chapter 7, and filers must pass a means test.

Overview of the means test

In 2005, Congress passed the Bankruptcy Abuse and Consumer Protection Act to make it harder to qualify for Chapter 7 bankruptcy. Too many high earners had been abusing the system to get out of paying debt, which prompted the means test.

The means test determines eligibility by comparing the filer’s gross income, or wages before taxes, to the state median of the same-size household. If they exceed this figure, they proceed to step two, which calculates disposable income after deducting allowed expenses. If the amount exceeds the limit, the filer will need to explain the necessity of the expense to the court.

Expenses that filers can typically deduct are based on IRS standards, which include housing, food, clothing and health care. A consumer who has too much disposable income cannot file Chapter 7 and must convert to Chapter 13, which is a repayment plan.

Exemptions to the means test

The consumer may bypass the means test if they have more business debt than consumer debt, which is commonly at least 50%. A business debt is a debt taken with the intent to profit, but it commonly does not apply to sole proprietors.

Veterans or reservists who incurred debt on active homeland defense duty in the National Guard or Armed Forces are exempt. To qualify for the homeland defense exemption, the filer must have served 90 days and file no more than 540 days after service. A disabled veteran needs at least a 30% rating to receive a discharge because of a disability.

If a filer doesn’t pass the means test, they could try again after a circumstance that drops income. However, bankruptcy should be used as a last resort unless an individual sees no other way to pay the debt.