Most individual debtors filing for bankruptcy relief are required to complete either Official Bankruptcy Form 22A or 22C (Statement of Current Monthly Income and calculations). Bankruptcy Form 22A is the form chapter 7 debtors will complete for “means testing” purposes; Form 22C is the form chapter 13 debtors will complete.
What is the “Means Test”?
Under the old bankruptcy law, almost any resident of the United States could file a Chapter 7 bankruptcy. The new bankruptcy law includes a formula test, called the means test, to determine who may (and who may not) be eligible to file Chapter 7 bankruptcy. The means test applies to people whose debts are primarily consumer debts (such as credit cards, car debt, or mortgages). Many people are forced into bankruptcy because of a failed business or a large business related judgment. Debtors with primarily business debts are exempt from the means test and may file Chapter 7 bankruptcy regardless of their income and expenses.
The means test formula is designed to evaluate whether the debtor has the financial means to pay back a substantial part of his/her debts in a repayment plan through Chapter 13 bankruptcy. The means test formula considers measures of income and allowable expenses. If, according to the results of the formula, you have sufficient net monthly income to repay debts you then are not eligible for Chapter 7 bankruptcy, but you may be eligible for relief in Chapter 13 bankruptcy.
Here is a summary of the means test and its most important terms and definitions.
How does the “Means Test” Work?
The means test evaluates your income in comparison to the official median income for households in Massachusetts as reported by the Bureau of Census in the most recent reporting year. The median income base increases with the size of your household.
First, the means test evaluates whether your current monthly income (from all sources) is greater or less than the applicable median income. Current Monthly Income (CMI) has a special meaning in the new bankruptcy law. CMI is defined as the average monthly gross income received during the six full months just prior to your filing bankruptcy. CMI includes gross income from all sources including income of a non-filing spouse, regular gifts or assistance from family members, and gross income from a wholly-owned business. (Business expenses are deducted elsewhere in the means test calculations.) On the other hand, social security income is excluded from the definition of CMI.
The median income will increase as to the final number of members of each household. The incomes change periodically as gathered by the government, and may go either up or down, based on statistical information gathered by the Census Bureau.
If your CMI exceeds Massachusetts’s median income, then the means test applies a more complicated expense formula to arrive at your eligibility for Chapter 7 bankruptcy. The formula starts with your CMI and then deducts several categories of allowed expenses to calculate your “net monthly income” which is presumed to be available to pay general unsecured creditors. The means test deducts the following expense categories from “current monthly income” to arrive at your “disposable income.”
Standard Living Expenses.
You can deduct an amount of “standard living expenses” established and published by the IRS as guidance for its agents negotiating consensual payment of overdue taxes. Debtors may claim documented living expenses up to 5 percent above the IRS standard if such expenses are “reasonably necessary.”
Housing Expenses.
The IRS publishes “local standards” of transportation and housing expenses. The local housing allowance is different for each county in Massachusetts and further varies depending on your household size. The housing allowance includes estimated cost of home ownership and operating expenses such as utilities and taxes. If you are buying a home and have a mortgage, you are also allowed to deduct from your CMI the amount of mortgage payments due during the ensuing five years. However, if you are paying a mortgage, the local housing allowance will be reduced by the amount of its assumed ownership expense so that your mortgage payments are not counted twice in the means test formula. Renters are limited to the IRS local standard allowance.
Transportation Expenses.
Transportation expenses are comprised of two separate expense categories related to vehicle ownership: “operating expenses” and “ownership expenses.” Operating expenses are standard published expenses which vary according to the number of cars owned and your location. Your deductible ownership expense is computed as the higher of (1) the IRS national standard ownership allowance based on the number of family cars; or (2) your actual car payments during the ensuing five years after filing divided by 60. (Debtors who purchase expensive cars with large car payments increase their ability to pass the means test eligibility for Chapter 7. If your car is owned free and clear you deduct the standard ownership and operating expenses.)
Other Expenses.
Debtors may also deduct from their CMI actual expense for categories the IRS specifies as “other necessary expenses.” These expenses include, but are not limited to, items such as:
- child care;
- tax withholding
- medical and dental expenses including medical insurance for debtor’s family (debtor’s without health insurance may buy insurance before filing to help pass the Chapter 7 means test);
- term life premiums;
- energy costs;
- private school tuition up to $125 per month per child;
- alimony, child support, and other court order payments;
- care of elderly or disable dependents;
- health savings accounts;
- internet and phone service (including cellular phones);
- actual expenses for food and clothing up to 5 percent above the IRS allowance.
Secured Debt Payments.
Payments due secured creditors, such as scheduled home mortgages and car loans during the five years after the bankruptcy filing date. This amount also includes required payments to creditors secured by personal property such as appliances or furniture.
Priority Debts.
Required debts such as taxes or domestic support obligations.
Education Debts.
Reasonable and necessary private school educational expenses up to $1,500 per child per year.
Debtors are allowed to deduct the greater of either the IRS local housing allowance or the total of actual mortgage payments plus allowed home maintenance expenses, such as utilities. For cars, you can deduct either secured debt payments or the IRS car allowance, whichever is greater.
As stated above, eligibility for Chapter 7 bankruptcy under the new bankruptcy law requires a detailed computer analysis with software designed for means test calculations.
Failing the means test means there is a “presumption of abuse” and you cannot file a Chapter 7 bankruptcy, but you may be able to overcome that presumption if special circumstances call for an adjustment to your income or expenses. Some examples of possible “special circumstances” are job loss or pay cut, a serious medical condition, or unusually high child care expenses. To establish that your financial situation is a special circumstance that warrants a waiver of the means test formula, you will have to show that your expenses incurred are reasonable and that you have no reasonable alternative. Judges are given discretion to determine if special circumstances allow filing a Chapter 7 bankruptcy by a debtor who cannot pass the means test formula.