The Meaning of a Bankruptcy “Means Test”

What the means test means for your ability to file.

means test

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 created a firestorm in the world of bankruptcy law because it created the “means test.” Many people worried that the means test would make filing for bankruptcy next to impossible.

Now obviously it’s still possible to file for bankruptcy—roughly 1½ million people successfully file each year. But it has set some new standards for filing and it makes it more imperative than ever for you to have your ducks in a proper row before you file.

What does a “means test” really mean for me?

With the means test, an independent trustee (i.e. one chosen by the court, and not you or the banks) analyzes your finances to determine if (and how) you qualify for bankruptcy.

For Chapter 7 filings, you are generally either qualified or you’re not – it’s fairly cut and dry. For Chapter 13, the means test results can be a major factor in determining the schedule the court assigns for the repayment of your debts.

The means test has a few parts to it and each stage has the potential to completely derail your bankruptcy judgment if you aren’t prepared.

Means test, part 1: Median income assessment

At the first stage the trustee conducts a preliminary assessment of your income, looking at the past 6 months of income earned. This part is often the biggest problem for most people when it comes to their finances. Basically, the trustee compares your income to the median income for your state (set each year by the publication of the United States Trustee).

Pop Quiz

What’s the proper name for the median income in your state?

a) State income level

b) Federal income level

c) Federal poverty line

d) State distress line

Reveal Answer

The intention of this step is to keep the ultra rich from filing for bankruptcy simply because they have lived beyond their means. In reality, it’s caused a few problems for those outside the richest income bracket, too.

c) Federal poverty line (FPL)

Return to question

What’s the issue with median income?

High income earners have a legitimate reason to be concerned about their bankruptcy filing. This law almost makes the assumption that because you earn a good wage, you must necessarily have good finances unless you’re being irresponsible.

While this should for the most part be true, it’s not always the case. Extraordinary circumstances can cause even high income earners to have problems that are out of their control.

Fact: High unemployment in your state can make it
harder to file for bankruptcy.

Additionally, even if you don’t earn a high income, you may still find yourself above the median income. Let’s say you live in a state with rampant unemployment problems caused by the recession. You may not be well-off, but you’re better off than the many unemployed residents in your state.

If you do earn an income higher than the median income of your state, don’t panic – you can still file for bankruptcy. You are still permitted to file for bankruptcy. In some cases, the judge will convert a Chapter 7 bankruptcy filing to Chapter 13. In other cases, if you can prove extenuating circumstances, the judge will allow your case to continue.

Means test, part 2: Financial history

In the second part of the means test the trustee reviews your financial history to determine if there are any indications of potential bankruptcy abuse. Your creditors also have the opportunity to review the case and debts to submit evidence if they believe you may be abusing the system.

This sounds scary, but it’s actually not as bad as it sounds. Most people in distress aren’t taking actions that would be considered abuse, although you do have to be careful that you don’t spend too much on credit or take out multiple payday loans for large amounts just before you file.

Here are some examples things they look for:

  • If you bought more than $500 of “luxury goods” within 90 days of filing
  • If you took out more than $750 in cash advances or payday loans within 90 days of filing
  • Maxing out your credit cards just prior to filing
  • Applying for new lines of credit either just before or after you file

If any account activity is flagged during the review, those debts may be ruled non-dischargeable so you’d be obligated to pay them back. In extreme cases where they find multiple instances of fraud, your case might be converted to a Chapter 13 bankruptcy or your case could be rejected completely.

Pop Quiz

What’s an example of a debt that can’t be discharged even if it’s a legitimately owed debt?

a) Your mortgage

b) Back taxes

c) Private student loan

d) Any credit card that’s current with your payments

Reveal Answer

Most debt that originates from a government agency (tax debt, student loans, court judgments, etc.) can’t be discharged through bankruptcy

b) Back taxes

Return to question

What do I do if I fail the means test?

It’s stressful to think your case will get thrown out, but again it’s not really as gut-wrenching as it sounds. For the most part, people who are legitimately struggling won’t have to do any extra work to prove they’re in a bad situation –that’s going to be obvious by the numbers.

If you’re a high income earner, just talk to your attorney and get you defense in order. If you think something in your credit history is going to be an issue, have your case ready for that, too. It’s better to be too prepared than not prepared enough.

If you do “fail” the means test and you’re filing a Chapter 7 bankruptcy, it may be converted to a Chapter 13. In any case, you have the opportunity to present your defense and prove your case, so you can actually “fail” the means test and still successfully file for bankruptcy.