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How does the means test work in bankruptcy?

Important income calculations are applied to bankruptcy petitioners

One of the most important features of the Bankruptcy Abuse Prevention and Consumer Protection Act reforms in 2005 is a means test that determines a debtor's financial status.

The two-part test applies a formula for exemptions to determine if the debtor can afford to pay back creditors for unsecured debts such as credit cards and medical bills. The second part of the test is based on how the debtor's income and household expenses compare to the average for the state in which he or she lives.

When debtors' income is more than the state median and they are able to pay at least 25 percent of their unsecured debt, filing under Chapter 7 is not allowed. They may be allowed to file under Chapter 13 instead.

In addition to the debtor's income and assets, the bankruptcy court considers the monthly income of a spouse that is not included in the bankruptcy petition. Self-employment income and any special financial circumstances that are germane to the case are also included in the means test.

A possible exception

In some cases, an above-median filer may be able to qualify for a Chapter 7 bankruptcy, which calls for all their non-exempt property to be sold to pay off creditors. That typically happens when the more detailed, second part of the means review shows that a debtor's income will barely cover a creditor repayment plan. However, that scenario is rare.

"If you have the ability to fund a reasonable Chapter 13 repayment plan out of your income you must do so," states Massachusetts bankruptcy attorney Nicholas Ortiz. "This little, common-sense nugget is at the heart of the bankruptcy system."

The means test plays an additional role in the case of Chapter 13 debtors so the court can decide whether their repayment plan should last three or five years. Their finances for the six months prior to the bankruptcy filing are reviewed to determine if they are "over median" or "under median" debtors, according to the National Association of Chapter 13 Trustees (NACTT).

Over-median debtors are considered to be able to afford a repayment plan that lasts five years, although the NACTT warns that this criteria may differ in various court districts. Under-median debtors aren't expected to commit to a plan that is longer than three years, although the court will consider a longer plan for them if that's what they need to get their financial issues under control.

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