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A means test is required for bankruptcy applicants who earn more than the median income for their communities. Means testing aims to ensure that bankruptcy applicants make full or partial repayment to their creditors if they can afford to do so.
Applicants who cannot afford repayment installments are considered eligible for Chapter 7 bankruptcy, which discharges most debts altogether but may require forfeiture of significant assets. Individuals who can afford to make some payments to creditors are eligible for Chapter 13 bankruptcy, and means testing helps set the amount and term length of the payments they'll make to help reimburse their creditors.
Note that means testing also may be applicable to Chapter 11 (reorganization) bankruptcy or Chapter 12 bankruptcy, which is similar to Chapter 13 but applies only to farmers and fishermen. Let's focus on Chapters 7 and 13, the bankruptcy options most often used by individuals and couples. Here's what you need to know.
How Does Bankruptcy Means Testing Work?
A bankruptcy test is a component of the federal bankruptcy process that evaluates your ability to afford basic necessities such as food, clothing, transportation and health care in the community where you live. To do so, it compares your monthly income and expenses with the amount a typical household your size spends on those items.
When submitting a means test, you must look up those median costs for your community and insert them in the means-testing worksheet, along with information about your actual expenses. Information on median income and expenses for your community are available online from federal government agencies.
If means testing is required as part of your bankruptcy filing, completed forms must be submitted to the court within 14 days of opening your case. Including these forms with your bankruptcy filing is acceptable and may be advisable in many cases. If you plan to file Chapter 7 and your means test determines you are ineligible, for instance, you might be better off filing Chapter 13 instead. Consult with your bankruptcy attorney about the timing of your means-testing submissions.
Here's how the paperwork requirements shake out for Chapter 7 and Chapter 13 bankruptcy filings:
All Chapter 7 filers must complete Form 122A-1, a statement of monthly income that reflects all sources of income for you (and your spouse if you file jointly) for the six months preceding your bankruptcy filing. Per instructions for the worksheet, you add up all income for the six-month period and divide by six to provide a monthly average.
If that average is less than your state's median income for a household of your size—a number you must look up online or get from your bankruptcy court or attorney—your Chapter 7 case can proceed.
If your income exceeds the median for your community, you are under a presumption of abuse and must refute it for Chapter 7 to continue.
You may do so by completing one of two additional forms:
- Form 122A-1Supp: This form asks about the nature of your debts and potential exemptions due to military service. If the bulk of your debts are not "consumer debts," defined as "incurred by an individual primarily for a personal, family, or household purpose," there may be no presumption of abuse. If you are a disabled veteran, National Guard member or reservist called to active duty presumption of abuse may not stand. (Some filers with military exemptions may be required to resubmit means testing forms when their active duty ends.)
- Form 122A-2: If you are not exempted using Form 122A-1Supp, you must complete Form 122A-2 to determine whether your income is sufficient to offer creditors repayment under a Chapter 13 repayment plan. Form 122A-2 requires you to detail the expenses for a household your size using statistical costs of necessities including food, clothing and transportation, using statistics compiled by federal agencies. Final calculations on this form may determine that you are ineligible for Chapter 7 bankruptcy and must instead file for protection under Chapter 13.
If you file for Chapter 13 bankruptcy, you must complete Form 122C-1. You use this form to characterize the average monthly income you (and your spouse, if filing jointly) earned in the six months preceding your bankruptcy filing. You must provide amounts of income from sources including salary and wages, unemployment benefits, pension and other retirement benefits as well as investments. You'll then compare your income to the median for a household your size in your community, using federal government data you look up.
If your income is equal to or less than the median income for your community, you do not need to fill out any additional forms, and the length of time during which you must make repayments to creditors (known as the commitment period) is set at three years.
If your income exceeds the median for your community, you must fill out Form 122C-B. This form determines how much income you have in excess of what's needed to pay for everyday necessities that can be used to repay your creditors. It also determines the amount of the monthly payment you may be expected to pay over a five-year commitment period.
What Information Is Needed for a Bankruptcy Means Test?
To complete the means test forms required for a bankruptcy petition, you must gather the necessary forms and the following information:
- The sources, amounts and frequency of your income for the six months preceding your bankruptcy filing.
- A detailed list of monthly living expenses, including food, clothing, shelter, utilities, taxes, transportation and health care (insurance, medications and the like).
- Information on median income and living expenses for your community in the time period leading up to your bankruptcy filing
Median income and cost data is compiled by federal agencies, including the IRS, U.S. Census Bureau and Bureau of Labor Statistics, but fortunately you don't need to fetch them all individually. The U.S. Department of Justice provides a handy means testing webpage that guides you to all the necessary resources. Once you select a date range appropriate to your bankruptcy filing, you're shown a page that links to appropriate information at the relevant government agencies.
Alternatives to Bankruptcy
If you're overwhelmed with debt, bankruptcy can bring a kind of relief, but it is best considered a last resort. Chapter 7 can mean the loss of your home and other assets, and bankruptcy has severe drawbacks for your credit. A Chapter 13 bankruptcy appears on your credit report for seven years from the filing date, while Chapter 7 stays on your credit report for 10 years. Both hurt credit scores as long as they remain, and while their score impact lessens over time, some lenders refuse to consider applicants with bankruptcy on their credit reports, regardless of credit scores.
For these reasons, it's wise to consider the following bankruptcy alternatives.
Seek help from a certified nonprofit credit counseling agency. These nonprofits can review your household cash flow and help you set up a budget and get back on your feet. If your situation requires more than smart planning, credit counselors may still be able to help you work out a program with your creditors. The solution may lower your payments and can resolve your debt problems within a few years via a debt management plan (more on that below).
If you anticipate future difficulty paying your bills and your credit is fair to good or better, debt consolidation could help stave off bankruptcy. Taking out a personal loan, borrowing against your home equity or transferring balances from current credit card accounts to a new card with a 0% introductory APR can provide relief compounding interest charges and rising interest rates. Debt consolidation has few downsides for your credit scores, as long as you avoid running up new balances on the accounts you pay off using a loan or balance transfer card.
Debt Management Plan
A debt management plan (DMP) is a repayment program organized through a certified credit counseling agency. After determining how much you can afford to put toward monthly debt repayment, the counseling agency presents your creditors with a plan to resolve your debts within three to five years. Creditors may or may not accept this argument and are under no legal obligation to enter into a DMP.
Furthermore, Certain types of debt, such as federal student loans and unpaid alimony or child support, cannot be negotiated as part of a DMP. While typically less damaging than bankruptcy, DMPs still have the potential to harm your credit, and if you fail to keep up with your DMP payments, you could still be forced into bankruptcy.
Debt Settlement or Debt Relief
Debt settlement companies (often marketed as debt relief providers) are for-profit companies that claim they can lower your debt burden dramatically by negotiating with creditors on your behalf. These companies typically tell you to stop making your monthly debt payments and instead to make regular deposits in a special savings account they'll use the balance of to offer your creditors partial repayment. The argument they'll make to your creditors is that it's better for them to take a fraction of what you owe them than losing everything if you're forced into bankruptcy.
This may sound like the DMP services credit counselors provide, but for-profit debt settlement typically carries much higher fees and can leave customers with more debt than they had before the process began. The resulting missed payments will do serious, lasting harm to credit scores to boot. And since creditors may not accept a debt settlement company's proposal, you could end up in bankruptcy court afterward anyway.
The Bottom Line
The bankruptcy process in the U.S. includes means testing to make sure that individuals with sufficient earnings to repay their creditors do so as part of their bankruptcy proceedings. By comparing earnings to median income for the bankruptcy filer's community, and expenses with median costs for comparable households, the bankruptcy court seeks to be fair in its expectations of individuals filing bankruptcy. By providing an opportunity to explain special circumstances and extraordinary expenses, it leaves some room for discretion on the part of bankruptcy courts.
Means testing can be complicated, and filing forms that contain errors can have serious consequences. If you are subject to a means test, it's wise to consult a bankruptcy attorney for advice on its implications.