Income vs. Debt Eligibility Thresholds for Chapter 7 Bankruptcy

Chapter 7 bankruptcy offers debt relief to individuals struggling with overwhelming financial obligations by liquidating non-exempt assets to pay off creditors. However, not everyone qualifies for Chapter 7 relief due to the eligibility criteria set by the Bankruptcy Code, most notably the means test. Contact the Los Angeles Chapter 7 Bankruptcy Attorneys at Wadhwani & Shanfeld to discuss the critical balance between income, expenses, and debt that determines Chapter 7 eligibility, focusing on the means test, household size, and other factors that influence whether a debtor qualifies for a discharge.

The Chapter 7 Means Test

The means test is designed to prevent higher-income individuals from filing for Chapter 7 bankruptcy. It assesses whether a debtor has enough disposable income to repay their debts through a Chapter 13 repayment plan instead. The test compares a debtor’s income to the median income in their state for a household of similar size. If the debtor’s income is below the state median, they typically qualify for Chapter 7. However, if their income exceeds this threshold, the means test evaluates whether the debtor can pay a portion of their debts.

Median Income Standards: The U.S. Census Bureau provides updated median income figures by state. These figures are crucial in determining initial Chapter 7 eligibility. For example, as of 2024, a household of four in California has a higher median income threshold compared to a similar household in a lower-cost state like Mississippi. Thus, where the debtor resides significantly affects the eligibility calculation.

The Second Step of the Means Test

If a debtor’s income exceeds the median threshold, they must complete the second step of the means test. This step involves calculating the debtor’s disposable income after accounting for specific allowed expenses. The calculation focuses on necessary living expenses, including rent or mortgage payments, utilities, transportation, and healthcare costs, among others. The difference between the debtor’s income and these allowable expenses is their disposable income, which determines whether they can repay some portion of their debt under Chapter 13 instead of filing under Chapter 7.

Allowable Expenses: Allowable expenses under the means test are based on Internal Revenue Service (IRS) guidelines, which provide standardized expense amounts for various categories. Debtors cannot use their actual living expenses unless those expenses fall below the allowed amounts. If a debtor’s disposable income after allowable expenses exceeds a certain amount, they may not qualify for Chapter 7.

Income Considerations in the Means Test

Income plays a pivotal role in determining Chapter 7 eligibility, and the means test accounts for all sources of income received in the six months preceding the bankruptcy filing. This includes wages, salaries, tips, bonuses, rental income, retirement benefits, unemployment compensation, and even household contributions from other individuals.

Seasonal Workers and Irregular Income: For debtors with irregular or fluctuating income, such as freelancers, gig workers, or seasonal employees, calculating income for the means test can be complicated. Since the test averages income over the past six months, a period of high earnings may skew the results, even if the debtor’s current financial situation is precarious. In such cases, debtors may need to provide detailed documentation and consider timing their bankruptcy filing to reflect their ongoing financial situation more accurately.

The Role of Household Size

Household size is another essential factor in the means test calculation. The larger the household, the higher the allowable income threshold for Chapter 7 eligibility. For instance, a single individual filing for Chapter 7 will have a lower median income threshold than a family of four. It’s important to note that household size includes dependents, children, and others who live with the debtor and rely on their financial support.

Non-Filing Spouses and Household Contributions: In cases where a married debtor files for bankruptcy individually, the means test still considers the non-filing spouse’s income. This is known as the “marital adjustment,” and it accounts for the fact that both spouses’ incomes contribute to household expenses. However, the test only considers the non-filing spouse’s income to the extent that it supports household expenses. Debtors can adjust for contributions from non-filing spouses to ensure that the means test accurately reflects their financial situation.

Balancing Debt and Expenses

The balance between income and debt is another crucial factor in Chapter 7 eligibility. If a debtor has substantial debt but also high living expenses, the means test may show that they lack the disposable income to pay their creditors, making them eligible for Chapter 7.

High Debt Burden: Even individuals with higher-than-average incomes may still qualify for Chapter 7 if they carry an overwhelming amount of debt. For example, someone with substantial medical bills or credit card debt may find that, after allowable expenses, they lack sufficient disposable income to repay these obligations under a Chapter 13 plan.

Non-Dischargeable Debts: Certain types of debt, such as student loans, child support, and recent tax obligations, are typically non-dischargeable in Chapter 7 bankruptcy. While these debts won’t be eliminated, their presence can still affect a debtor’s overall financial situation. Individuals burdened by non-dischargeable debts may find it more challenging to pass the means test due to the ongoing financial obligations associated with these debts.

What Happens if You Don’t Pass the Means Test?

If a debtor does not pass the means test, they are generally ineligible for Chapter 7 bankruptcy. However, they may still pursue debt relief through Chapter 13. Chapter 13 allows debtors to repay a portion of their debts over a three- to five-year period based on their disposable income. While this does not provide the immediate relief that Chapter 7 offers, it can still provide a structured way to manage and eventually eliminate debts.

Filing Under Chapter 13: For debtors who do not qualify for Chapter 7, Chapter 13 may be the next best option. Chapter 13 allows individuals to retain their property while they make regular payments under a court-approved repayment plan. In contrast to Chapter 7, where debts are discharged quickly after the liquidation of assets, Chapter 13 involves a longer-term commitment but offers greater protection for non-exempt property.

Contact Wadhwani & Shanfeld

Determining whether you qualify for Chapter 7 bankruptcy requires a careful examination of your income, debt, and allowable expenses. While the means test is designed to ensure that Chapter 7 is reserved for those who genuinely cannot afford to pay their debts, navigating the eligibility thresholds can be complex, especially for individuals with irregular income or significant financial obligations. If you are considering filing for bankruptcy and need help assessing your eligibility, consulting with an experienced bankruptcy attorney can be crucial. An attorney can help you understand the intricacies of the means test, evaluate your financial situation, and guide you toward the best debt relief options available.

For more information on Chapter 7 eligibility and how to file, contact Wadhwani & Shanfeld. Our experienced bankruptcy attorneys can help you determine whether Chapter 7 is the right path for you and assist you in achieving the financial relief you need.

Sources:

uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics

experian.com/blogs/ask-experian/what-is-bankruptcy-means-test/