In particular, the goal was to push more filers into Chapter 13 bankruptcy as opposed to Chapter 7 bankruptcy.
The main difference, of course, is the five-year repayment plan that’s required in virtually all Chapter 13 cases, while most Chapter 7 filers eliminate the majority of their debts in as little as four months.
In order to reach the goal of more Chapter 13 cases, one of the most significant changes in the Bankruptcy Abuse Prevention and Consumer Protection Act was the Means Test.
The test established, for the first time, an income requirement of sorts for Chapter 7 cases. Consumers who didn’t meet the income requirement would have no recourse but to file for a Chapter 13 repayment plan.
Targeting Higher Income Filers with the Means Test
There are two different ways to qualify for a Chapter 7 bankruptcy under the revised bankruptcy provisions. If your income is at or below the average median income for a family your size in your state, you qualify for to file a Chapter 7 case.
If you made more during the last full calendar year, there is a “presumption of abuse” according to the language of the federal tax law. However, you have the chance to rebut that presumption that you are abusing the Chapter 7 income guidelines.
That’s where the Means Test comes into play. In effect, the Means Test gives a consumer the chance to show they don’t have enough discretionary income, after all income and expenses are considered, to make any significant payments to creditors.
“Income” is not Really Income Under the Means Test
Critics of the Means Test say it is overly complex, benefitting perhaps, only bankruptcy attorneys, since it’s very difficult for a layman to correctly fill out the forms required for the Means Test. Critics also point to the arbitrary calculation required as part of the test.
For example, a debtor’s current or projected income isn’t part of the Means Test. Instead, the test requires paycheck stubs and other information covering the six months prior to the bankruptcy filing. An average monthly income from that period of time is used.
The expenses under the Means Test also don’t involve a consumer’s actual expenses. Instead, many of the expenses are based on IRS standards that vary slightly in different parts of the country. So, instead of a test that subtracts expenses from income to see how much discretionary income is left, the Means Test doesn’t include current income and doesn’t take into account actual expenses.
The Means Test and Bad Faith
Even if a debtor qualifies for a Chapter 7 case because the result of the Means Test shows insufficient discretionary income to pay out in a Chapter 13 plan, that Chapter 7 status is still not guaranteed. Trustees have the power, and in fact have been given the mandate, to look for any instances of bad faith that would disqualify a debtor from a Chapter 7 case.
Case law is still refining exactly what bad faith means. So far, bad faith has been defined as a situation in which the “totality of the circumstances” points to a rotten debtor. For example, courts have upheld cases in which income deductions for college expenses for kids were thrown out, creating more money to be paid to creditors.
In other cases, judges have decided that debtors in extravagant homes – and what often are exorbitant monthly payments – should instead be required to reduce those monthly living expenses so that some of the money that had been going to a mortgage for a huge house instead is paid to creditors in a Chapter 13 plan.
Has the Means Test Worked?
A five-year analysis of bankruptcy statistics suggests that the goals of the Means Test and the reorganization of federal bankruptcy laws have not been met. Initially, it seemed that the revision of the law would be successful.
In the first year, personal bankruptcies dropped by more than 50 percent, dropped to under 900,000 filers, compared to nearly 2,000,000 filers in 2005. However, the number of bankruptcy cases steadily increased and the number of Chapter 7 filings jumped as well.
By 2010, bankruptcy filings were estimated to come close to 2,000,000 for the year. While Chapter 7 filings dropped to about 50 percent of total individual filings in 2006, that figure was expected to reach 70 percent in 2010.
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