For many, the subject of bankruptcy is shrouded in mystery, myth and misinformation. Examples include: People who file for bankruptcy are irresponsible. Bankruptcy forever ruins your credit. Bankruptcy absolves the debtor of all debt. None of those assertions are categorically true. And here is one more: You have to qualify for bankruptcy in order to file.
That statement is far too black and white. Qualification has more to do with the type of bankruptcy that is filed than it does your individual eligibility. The bankruptcy means test helps to determine which type of bankruptcy you qualify for.
What is the bankruptcy means test?
Prior to the passing of the Bankruptcy Protection Act in 2005, bankruptcy courts were given considerable latitude in determining who was eligible. Standards were lenient, inconsistent and, as a result, unfair. Since the passing of this law, a debtor must pass the means test in order to qualify for Chapter 7 bankruptcy.
This type of bankruptcy is a liquidation procedure in which a debtor's nonexempt assets are sold in order to pay their creditors. The means test for Chapter 7 bankruptcy has two checks:
- The debtor's average monthly income for the six months preceding filing for bankruptcy must be less than or equal to the median income of the state. Sources of income include wages, business income, interest and dividends, rental income, child support, unemployment, retirement income and tax refunds.
- If the debtor's income for the six months preceding filing is more than the median income of the state, the second part of the test determines eligibility. If the debtor's disposable income is enough to pay some of the debt under Chapter 13 bankruptcy, then the debtor does not qualify for Chapter 7. Chapter 13 bankruptcy places the debtor in a five-year repayment plan, where all priority and secured debts must be repaid.
Even if a debtor does not pass the bankruptcy means test, it is still possible to file for Chapter 7 bankruptcy. Special circumstances must be presented, with documentation, for a court to allow Chapter 7 bankruptcy. Special circumstances could be recent unemployment, very high rent or a serious medical condition. If sufficient proof is not presented to demonstrate special circumstances, the case will most likely be dismissed or converted to Chapter 13.
There are those who do not need to pass the means test in order to qualify for Chapter 7 bankruptcy. Disabled veterans who incurred debt while on active duty are exempt as long as the disability is at least 30 percent and at least half of the debt was incurred while on duty. Also, if most of the debt came from a business, the debtor may file for Chapter 7 bankruptcy without passing the means test.