Chapter 7 bankruptcy accounts for approximately 70% of filings. It’s a popular choice for individuals trying to escape overwhelming debt because it offers a clean slate–all but a few debts are typically discharged. But many people would want to take advantage of a “free ticket” out of debt, so Chapter 7 bankruptcy has strict eligibility requirements.
In this blog post, we’ll dive into the Chapter 7 means test, which you must pass to qualify for this type of bankruptcy. Integrity Law Group has been helping individuals and businesses in Seattle navigate bankruptcy for over 16 years. If you’re considering filing for Chapter 7, we’re here to offer experienced guidance and legal counsel so you can get a fresh start.
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An Overview of Chapter 7 Bankruptcy
When you file for Chapter 7 bankruptcy, the court issues an automatic stay that protects you from creditors. It prevents them from certain collection actions like wage garnishment or repossession. The next step is the liquidation of assets. A trustee will be assigned to your case, and they will take charge of liquidating your non-exempt assets to pay off your debts as much as possible. Once all non-exempt assets are liquidated and paid to creditors, your remaining debts should be discharged. Some types of debts, like child support, cannot be discharged.
Pros and Cons of Chapter 7 Bankruptcy
The most obvious advantage of Chapter 7 bankruptcy is that in the end, most of your debts are discharged, letting you start fresh. But the most obvious disadvantage is that your non-exempt assets must be liquidated, first.
However, the good news is that most people who qualify through the Chapter 7 means test do not have many non-exempt assets. In fact, as many as 96% of Chapter 7 bankruptcies are “no-asset” cases, where the filer does not have sufficient equity to be liquidated. That means that most people can get the advantage of discharged debt without the disadvantage of asset liquidation.
However, bankruptcy should always be a last resort, as there are other major drawbacks. It will stay on your credit report for several years, making it difficult to get any sort of loan or credit.
The Chapter 7 Means Test
You must pass the Chapter 7 means test to qualify for this type of bankruptcy. The idea of the means test is that only those without sufficient income or equity to repay their debts can have those debts discharged. If you have enough income to pay off your debts and just need more time to do so, you will need to file for Chapter 13 bankruptcy instead.
The first step of the Chapter 7 means test is determining your current monthly income. This is your gross income over the last six calendar months. It includes not just wages but alimony, income from business or rental property, unemployment income, pension, and Social Security income. Once you have your current monthly income, you’ll compare it to the median income determined by the Office of the United States Trustee (UST).
Median Income in Chapter 7 Means Test
You’ll compare your income to the current median income provided by the UST for your state and household size. If your income is less than that number, you automatically pass the means test and qualify for Chapter 7 bankruptcy. If your income is above the median, the test becomes more complicated, and it’s time to calculate your disposable income.
Disposable Income in the Chapter 7 Means Test
You can still pass the Chapter 7 means test if your overall monthly income is higher than the median, but your disposable income is not. There are four categories of expenses you can deduct from your monthly income to calculate your disposable income.
- National standard expenses from the IRS. The IRS sets a standard for things like food, housing, and transportation. You can’t deduct your actual expenses for these things, but you can deduct the IRS’ standard amounts.
- Payments to secured or priority creditors. The payments for your house mortgage or car loan payments may be deductible. You can also deduct the expenses of priority debts that wouldn’t be discharged after a Chapter 7 bankruptcy, like tax debts.
- Actual expenses. If you can prove reasonable, necessary expenses in addition to the IRS standards, you may be able to deduct these.
- Administrative expenses. Since the alternative to Chapter 7 is a Chapter 13 bankruptcy, you can actually deduct the expenses you’d have if you were to file for Chapter 13 instead.
After these deductions, you can calculate your disposable monthly income. If that amount is not enough to pay at least 25% of your priority unsecured debts in the next five years, you’re still eligible for Chapter 7 bankruptcy.
Learn More About Chapter 7 Bankruptcy Today
Sounds complicated, doesn’t it? It is. Even though Chapter 7 bankruptcy is considered the simplest option, it’s still far from easy to navigate. The Chapter 7 means test alone can be complex and confusing, even before the rest of the paperwork and bankruptcy process. It’s not uncommon for people to fail the means test due to small errors or misunderstandings, therefore disqualifying themselves from their deserved chance at a fresh start.
You don’t have to figure out Chapter 7 bankruptcy or the means test alone. The Integrity Law Group team can help you through a successful Chapter 7 bankruptcy, or we can guide you through Chapter 13 if you don’t pass the means test. Contact us today to speak with an experienced bankruptcy lawyer who will evaluate your situation and offer personalized advice.