Explaining the Means Test for Chapter 7 Discharge Eligibility

Bankruptcy courts use what is called the “means test” to determine if a debtor is eligible for a full discharge of allowable debts under Chapter 7 of the Bankruptcy Code. In 2005, by statutory amendments, the means test was mandated as a method of combating bankruptcy abuse.

A means test evaluation is not always necessary. Generally, if the debtor’s gross monthly income (“GMI”) is below the median GMI for the debtor’s family size in the geographical region where the debtor lives, then a means test is not required. For example, currently, the median GMI for a two-person family in San Diego is about $6,400. As such, a San Diego debtor with a GMI of $5,000 for a two-person family would not need to satisfy the means test.

When a means test is necessary, an evaluation is made of the debtor’s income compared to living expenses and debt payments. If the first two categories are about equal, then there is no excess income to make debt payments. Under those circumstances, a full discharge of allowable debts is more likely. By contrast, if the debtor has significant income above and beyond monthly living expenses, then that excess income is available for debt payments. A full discharge may not be allowed by the bankruptcy court under those circumstances and the debtor may need to file under Chapter 13.

A bankruptcy is initiated by the filing of a Bankruptcy Petition. When a means test evaluation is necessary, certain forms must be filed with the Petition providing information about the debtor’s income, living expenses and debt payments. With respect to income, most sources of income must be included. However, some exclusions are allowed like social security disability benefits. Income calculations are based on the income received during the six months prior to the date of the bankruptcy filing. Note that the means test evaluation takes into account any recent changes in circumstance with respect to income and/or expenses. Thus, if the debtor has recently lost his or her job, then that will be taken into account.

With respect to the debtor’s living expenses, the courts follow guidelines published by the Internal Revenue Service (“IRS”) for allowable expense categories and for how much is considered “reasonable” for those expenses based on where the debtor lives. Use of the IRS guidelines prevents a debtor from claiming an extravagant level of expenses and also accounts for differences in regional costs of living. For example, food expenses are higher in San Diego than in small-town Nebraska.

As a means test hypothetical, assume that a San Diego debtor has gross monthly income of $4,000, rent of $1,900 and other gross monthly living expenses totaling $2,100. Assume also that the debtor has $1,000 in monthly debt servicing for unsecured consumer debts like credit cards. As can be seen, in this hypothetical, the debtor’s income and living expenses are both $4,000. As such, there is little or no excess income to make debt payments. In this hypothetical, assuming a means test is necessary, the debtor is likely to pass and likely to be eligible for a full discharge of allowable debts under Chapter 7.

Debtors who fail the means test are still eligible to file for protection under the Bankruptcy Code. However, as noted, such debtors must seek debt relief through Chapter 13 which facilitates debt adjustment rather than debt discharge.

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