Chapter 7 Means Test Considerations

An overview of strategic considerations for the “wealthy” applicant

Among other strategic issues for determining if clients qualify for Chapter 7 relief, the month in which clients receive semi-annual or annual bonuses or performance merit pay often becomes a consideration in the decision as to the appropriate month for which the case must be filed in order to pass the means test. One significant aspect of the means test is that individuals who owe primarily business debts identified as more than 50% of total scheduled debt that was not incurred for personal, family or household purposes are eligible for Chapter 7 relief.  In analyzing whether their debt is consumer debt or business debt, the purpose of the debt is analyzed at the time the debt was incurred.  Home mortgage debt does not typically qualify as consumer debt.  Nonetheless, most tax debts based upon the better reasoned case law are typically not consumer debts.  Individuals whose gross income from all sources exceeds the median income of the state very often are still eligible to file Chapter 7 and pass the means test based upon inclusion of allowable deductions.  Examples of some expenses that can be deducted in the means test analysis include standard living expenses, transportation costs, education expenses, and charitable contributions.  After the means test formula results in a finding that the debtor’s income is greater than the state median income, other portions of the test apply which evaluate whether the debtor has enough income to pay at least 25% of unsecured non-priority (tax and other categories) of debt or the amount of $10,950, whichever is less.

Fortunately for bankruptcy practitioners, the software programs that are utilized to prepare Chapter 7 and Chapter 13 bankruptcy petitions are continually updated with the current allowable expenses and state and local standards for applicable deductions in applying the means test.  Individuals very often in initial telephone conference, after disclosure of a partial amount of information, quickly ask whether they are eligible for Chapter 7.  Any experienced bankruptcy practitioner cannot respond accurately to this question without first meeting with the client, reviewing a detailed worksheet indicating all income during the six month period preceding the projected date of filing, and reviewing the debtor’s full schedule of expenses.  Application of the means test can result in anomalous results.  In my personal experience, individuals who do not own real estate and whose monthly income is slightly in excess of the state median income often have difficulty qualifying to file a Chapter 7 case.  On the other hand, high income individuals whose base income is well in excess of the state median income for their family size and who have two and three mortgages against their home and other secured debt payments somehow mathematically qualify for Chapter 7 relief.

I recall an instance in a joint filing of a married couple where the means test was barely satisfied.  In this particular case, the husband was the sole wage earner, but the wife had been unemployed for a fairly lengthy period of time.  A few days before the scheduled appointment for my clients to sign their Chapter 7 petition, the wife contacted me to cheerfully advise me that she had recently obtained a job and would be starting immediately.  I looked at the petition and realized that her income, which would be for the second half of the month, would render my clients ineligible for Chapter 7 relief.  I made a prompt phone call to my client and advised her that unfortunately, she would have to defer taking her job for two weeks, or come in with her husband immediately, sign the bankruptcy petition, and pay the remainder of the outstanding retainer; otherwise they would have to file for Chapter 13.  It is hard to envision that, when the means test was passed into current law, this type of planning would be a necessary part of competent bankruptcy planning and legal advice to clients, but unfortunately it is a fact of life.  In other instances, high wage earners who were receiving fairly substantial severance payments whether by lump sum or overtime have had to wait several months so that the means test can be passed by including several months of no income and/or limited receipt of unemployment compensation to proceed with a Chapter 7 case.  While it may come as a surprise to many clients, unemployment compensation is not a benefit under the Social Security Act and must be included in calculation of their current monthly income.  Social Security payments however, are not included.

In the advent of the internet age, very often potential clients have done a considerable amount of research on the internet before contacting me. Many have entered their financial information into a website calculator and have used this information to conclude that they do or do not qualify under the means test for relief under Chapter 7.  However, in more than one instance, after retaining me to proceed with a bankruptcy case, whether Chapter 7 or Chapter 13, I determine that the conclusion that they reached through use of some of these website tests was incorrect.  The facts and circumstances that are present when an individual considers taking a significant step by looking at insolvency options vary so widely, that it is often difficult to make a final determination on means test issues up until the time that nearly every entry is made into the bankruptcy software that runs the calculations.

The great recession beginning even prior to the market crash in October of 2008 has significantly affected the citizens of New Jersey and is far from over.  Many of the clients I am consulting with presently have struggled with multiple years of underemployment and periods of unemployment, while facing increasing costs to raise their families and meet property tax and other expense burdens shared by New Jersey citizens.  Many individuals considering bankruptcy at the present time are higher income earners that never would have thought they would be saddled by large personal and tax debt.  They often are very concerned about maintenance of their credit rating that may or may not be already tarnished by late payments, credit card debt, missed mortgage payments, and/or one or two lawsuits that have been filed against them.  While higher earning individuals have the ability to better service debt, paying default interest rates and monthly minimum payments on their credit card debt in excess of 25% is a detriment to their ability to meet current expenses and plan for retirement.  In these instances, considering Chapter 7 or Chapter 13 bankruptcy to discharge debt should not be ruled out as an option.  The means test for a Chapter 7 must be thoroughly and completely analyzed prior to taking such a significant personal action to address their financial issues.  While the means test states that the median income for a family of 4 in New Jersey is $103,786, this article should at least highlight that that number is not the end of the analysis for anyone contemplating a bankruptcy filing, but rather the start of an informed inquiry into whether bankruptcy is an appropriate option.

Introduction to the Chapter 7 Means Test