There is a lot of misinformation out there as to who can and who cannot file a Chapter 7 bankruptcy. Some people will lead you to believe that since the passage of the new bankruptcy laws in 2005, only individuals with extremely low incomes can file a Chapter 7. This is another bankruptcy myth that needs to be dispelled.
First off, what is a Chapter 7 bankruptcy?
A Chapter 7 bankruptcy is designed to eliminate a debtor’s dischargeable debt. Some debt may not be dischargeable such as student loans, domestic support obligations, and certain taxes, but unsecured debt, including credit cards, medicals bills, club memberships, and deficiency balances, is typically dischargeable.
A Chapter 7 is often referred to as a liquidation bankruptcy due to the fact that a Chapter 7 bankruptcy trustee is appointed in order to gather and sell the debtor’s nonexempt assets and to use the proceeds of such assets to pay the debtor’s creditors in accordance with the provisions of the Bankruptcy Code. In order to protect their assets, debtors are permitted to apply Federal or State exemptions, and as a result, most Chapter 7 Debtors do not have give up any of their property. Still, it should be realized that the filing of a petition under Chapter 7 could result in the loss of property, but an experienced bankruptcy attorney should be able to inform you whether you will have to give up any property prior to you making your decision to file.
Now, who qualifies to file a Chapter 7 bankrupty?
Since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) went into effect on October 17, 2005, debtors must qualify to file a Chapter 7 proceeding, or it must be determined whether they have a capacity for debt repayment and must file a Chapter 13 bankruptcy.
What is median income?
Contrary to popular belief, many debtors qualify for Chapter 7 bankruptcy relief even if their income is above the median income amount as established for the state in which they live. The Office of the U.S. Trustee in the U.S. Department of Justice publishes the median income amounts here (please note that this links you to the applicable median incomes for cases filed on or after March 15, 2011 through the date of this post – median incomes are updated frequently). The number of people in a debtor’s household is taken into consideration in determining the applicable median income.
The debtor’s current monthly income
The income measured by the Bankruptcy Court in order to evaluate whether a debtor qualifies to file a Chapter 7 is not just any old income that the debtor chooses to disclose. A debtor must disclose all household income for the six months prior to the month in which he or she files bankruptcy proceeding. Income includes wages, rental income, business income, investment income, unemployment compensation, worker’s compensation, and contributions from family or friends. The total amount of income for that six-month period amount is divided by six to come up with the debtor’s current monthly income.
If the debtor’s annualized current monthly income is below the established median income, only Parts I, II and III of Form 22A, or the “means test”, must be filled out, and the debtor qualifies to file a Chapter 7. Please note, however, there are some circumstances under which a debtor may not be entitled to filing a Chapter 7 even when his or her income is less than the median income. I will leave that for another post.
The means test for a debtor with above-median income
If the debtor’s income is above the applicable median income, the remainder of the means test must be completed. The remainder of the means test consists of entries whereby the debtor’s current monthly income can be reduced by a set of certain allowed deductions specified by the Internal Revenue Service’s Collection Financial Standards, as well as some of the debtor’s actual expenses. After the deductions are applied, the amount of the debtor’s leftover current monthly income, if any, becomes known as the debtor’s monthly disposable income.
The debtor’s “monthly disposable income”
Many debtors, after going through the completion of the means test, will end up with a negative monthly disposable income. What does this mean? Well, even though that debtor’s income was above-median, he or she will qualify to file a Chapter 7. If the debtor has a positive monthly disposable income but it is equal to or less than $166.66, the debtor may still qualify to file a Chapter 7 proceeding.
Amazingly, some bankruptcy attorneys still do not know how to fill out a means test. I have seen several cases within the last year where a debtor’s bankruptcy attorney had put the debtor into a Chapter 13 bankruptcy case solely because the debtor’s income was above median. These debtors qualified for filing Chapter 7 proceedings and had no reason to be in Chapter 13 proceedings. The means test is not an easy form to fill out because it has many nuances and ambiguities. Several of the line items on the means test actually are being litigated in Bankruptcy Courts across the country in an effort to determine the Congressional intent behind some of the amended statutes under BAPCPA.
The bottomline is – to determine whether a debtor with above-median income qualifies to file a Chapter 7, he or she needs to go to an experienced bankruptcy attorney. If a debtor goes to a nonattorney bankruptcy preparer, an inexperienced attorney, or an attorney who is just out to make more money off of him or her by collecting higher attorney fees, he or she may end up in Chapter 13 case unnecessarily. Chapter 13 bankruptcies usually have much higher attorney fees and the debtor ends up paying his or her creditors some amount of money over a 3 to 5 year period.
There are several reasons why a debtor who qualifies to file a Chapter 7 may want to file a Chapter 13 (which I will address in another post), but if one of those reasons are not applicable, a debtor will save money, time and headaches by filing a Chapter 7. Do yourself a favor, and find an experienced and ethical bankruptcy attorney.