The means test is a calculation used to determine whether a debtor has enough “disposable income” to afford a Chapter 13 repayment plan.

In the Ransom case, the debtor (Jason Ransom) claimed a means test deduction for both operation of a vehicle ($338 per month) and for ownership ($471 per month).  The problem – Mr. Ransom owned his vehicle free and clear.

In an 8-1 decision written by Obama appointee Elena Kagan (the lone dissent issued by conservative Justice Scalia), the Supreme Court held that a debtor who owns his vehicle free and clear can only claim a deduction for vehicle operation but not a deduction for ownership.

In Mr. Ransom’s case, this means that for bankruptcy calculation purposes, he has an extra $471 sitting around that he can use to pay credit card companies in a Chapter 13.

At first blush, the Supreme Court’s decision would seem to make sense – why should a debtor get to claim an ownership deduction if he does not have a car payment?

Here is the issue:  Chapter 13 cases last 5 years.  Assuming that Mr. Ransom has a paid off car, it is likely that his car is not new.  What happens when Mr. Ransom needs to replace his car?  He will have no funds to do so because any funds that he might have left over are being used to fund his Chapter 13.

Further, the means test budget is derived from IRS numbers that are used in tax settlement cases.  These means test budgets are a little better than a “rice and beans” budget but there is very little else.  Is it reasonable to expect that a debtor will have no emergencies during the next five years – a funeral to attend?  a roof to fix?  a major car repair?

The Supreme Court’s decision ignores the realities of life.  In the immediate near term the debtor may have $471 to pay towards his Chapter 13, but is it reasonable to expect that this “disposable” money will be there month after month?  The Chapter 13 trustee will expect it, and these funds will come out in a payroll deduction.  But I fear that even more Chapter 13 cases will fail when debtors lose their jobs because they do not have transportation or checks for mortgages will bounce because the funds were used for plumbing repairs or other emergencies.

The Ransom decision also sends a very strange message to debtors entering the bankruptcy process.  Instead of encouraging people to avoid debt, the Ransom decision encourages filers to incur more debt prior to filing.   In this upside down logic, a debtor would benefit from taking out a car title loan prior to bankruptcy since having debt owned on a car will allow that debtor to claim an ownership expense.

Creditors like credit card companies are concerned about getting as much as they can as quickly as they can, and such an position makes sense in a business context.  But who loses when court supervised repayment plans (Chapter 13) are doomed to fail because there are no accommodations for emergencies or other likely needs during a looming 5 year time span.

All of these choices, by the way, create unintended consequences – if you are reaching that point of desperation where you are thinking about selling things, cashing out retirement plans, etc., I would rather that you call me  before taking any action because of the risk that you might unknowingly lose some of the benefit from your bankruptcy filing, or possibly disqualify yourself altogether.

Retirement plan loans such as 401(k) loans create a variety of issues and are almost always a bad idea in a bankruptcy context.   Presumably you borrow against your 401(k) because you need cash now, you expect to repay that loan in the near term, you want to preserve your 401(k) account for the future, and because you do not want the tax consequences associated with cashing out your 401(k).

Bankruptcy trustees, however, look at 401(k) loans in a different light.   They see any allocation to repay a 401(k) loan (and sometimes any ongoing contribution to a 401(k) plan) as an unnecessary reduction of disposable income that would otherwise be available to pay creditors.    401(k) loan payments cannot be counted as allowable deductions in your means test calculations.   And both Chapter 7 and Chapter 13 trustees and/or creditors will often object if you include a 401(k) loan repayment allocation in your Schedule I and J budget in either a Chapter 7 or Chapter 13.

Since 401(k) plan funds are generally considered “exempt” or sheltered property in a Georgia Chapter 7 or Chapter 13, your best choice often means not using your 401(k) as a last gasp source of cash.

401(k) loans and on-going 401(k) contributions do not make bankruptcy impossible, but they do complicate matters.  If you are in financial trouble and are thinking about raiding your 401(k) or retirement plan but have not done so, you should not take any action until you have spoken to a bankruptcy lawyer.   If you have already cashed out or borrowed against your 401(k), make sure that your attorney is aware of this fact.

I recently read a column written by attorney John Mayoue, a divorce lawyer here in Atlanta who is known for his representation of celebrities and other high profile clients.   John notes that in the domestic relations legal community, Atlanta is known as the “divorce belt.”  In the bankruptcy lawyer community, Atlanta is known for having one of the highest bankruptcy filing rates per capita.  I do not think that this is a coincidence.

Just as an ethical bankruptcy lawyer will advise you to search for alternatives to Chapter 7 or Chapter 13, a thoughtful family law attorney will advise you to search for alternatives to divorce.  Bankruptcy or divorce may be inevitable, but when you seek legal counsel, look for a lawyer who does not offer “one size fits all” solutions and recommends alternatives – this would be a good sign that you are talking with a lawyer who has your best interests at heart.

John was gracious enough to give me permission to reprint his thoughtful article about why couples struggling in their marriages ought to consider alternatives to divorce.  I recommend that you take his message to heart.

Divorce Lawyer John Mayoue Offers Advice to Couples Contemplating Divorce

The divorce rates in the United States are some of the highest in the world. Increased financial pressure brought on by the current economy is fueling the fire for marriages already in jeopardy, and the rapidly increasing number of homeforeclosures further demonstrates the severe consequences these pressures can produce.

According to Atlanta, Georgia based divorce attorney John C. Mayoue, who has been counseling couples through divorce cases for more than thirty years, the approaching holiday season will cause these numbers to spike further and will also be a busy time for lawyers specializing in divorce cases, as the holiday season often proves to be a breaking point for marriages in crisis.

“During the holidays, people’s pent-up thoughts about relationships and careers and where they are with life become intensified,” Mayoue says. “In December, for example, we have the highest number of suicides, divorce filings and bankruptcies of any month. It’s just a very difficult time for people.”

Although our society makes divorce seem to be an easy and acceptable way out for couples who aren’t quite happy in their situation, Mayoue cautions couples not to be too hasty to start the divorce process. Divorces that make it to trial are painful and embarrassing, and the results are often not fair for both parties involved. If you are considering divorce, Mayoue suggest taking the following steps first.

1. Try to work out your differences

Ask yourself why you want a divorce. Are you just responding to life’s pressures? Are you looking for a way out of a stressful situation and not just your marriage? Or do you have legitimate concerns that are truly irreconcilable?

Ask yourself if this is your only option. Have you made every effort to communicate with your spouse and work things out together? Have you tried counseling or outside help?

More importantly, consider all of the consequences of divorce. Are there children involved? How will this affect them? Would the divorce be the best solution for everyone in the family or only the adults involved? Will the family be financially ruined by the process in the forms of home foreclosure, credit crises or worse?

Before you drag your family through a process that can make existing rifts even deeper and harder to overcome, make sure that you really want to go through with this life changing and emotionally taxing process.

2. If you can’t find a resolution, try to settle out of court

If at all possible, try to settle your case outside of court with the help of your attorneys. When you do take your case to trial, you lose control over important aspects of your case to the decision of the judge or jury, depending on your state. This can lead to painful custody rulings, alimony or settlement decisions and more.

Even if you feel like you are right in your claims, in a courtroom, your case is only as solid as the evidence you can produce. Judges tend to have biases and not all states will send divorce cases to a jury trial. Truth may not always win out, and oftentimes these proceedings become incredibly painful and embarrassing.

“I am always going to make every reasonable effort to get a case settled first,” Mayoue says, “because settlement is something that the parties can control. They can basically control things such as custody, visitation and the allocation of assets and debts. And the courtroom is a risky environment for anyone.”

3. Educate yourself before going to trial

Before you do anything, make sure to get educated. Use your attorney’s knowledge to understand the proceedings, possible outcomes and unexpected or painful events that you need to be prepared for.

“Divorce is hell for the vast majority of people,” Mayoue says. “People get angry, people get lost in the process of the courts and they lose everything. This can be avoided if they are calm and are educated about the process.”

Mayoue’s law practice is based in Atlanta, in the heart of the new “divorce belt,” a name which the South has recently earned by having the highest divorce rates in the country. Given the environment in which he operates, he says that his goals as a divorce attorney are to educate people about their options and the process and to help people who have thoroughly thought through their options and have decided divorce is the only answer for them.

“I really do think that we lawyers have an obligation to educate the public,” Mayoue says, “and it seems to me to be not very good consumerism to walk into a lawyer’s office knowing absolutely nothing, before paying someone several hundred dollars. I’ve always found it peculiar that people do not get educated in a legal matter that affects 50-plus percent of all people who get married. Yet if you had an illness, you would certainly read up about it, if you had a business you were interested in getting involved in, you would certainly read about it.”

I don’t always have the answers but I can usually think through one or two likely scenarios.  I can be more effective helping you if you give me the information I need.   Specifically that means the following:

• take the time to complete my intake questionnaire in its entirety.  Don’t leave out information that you believe is not relevant.   My intake questionnaire is keyed to my bankruptcy program and I have been developing and updating it for over 15 years.  Everything on my questionnaire is there for a reason – and I can serve you better if I have everything that is requested there
• get me copies of your credit reports.   AnnualCreditReport.com offers a free service to get current copies of your credit reports.  Current credit reports help us avoid leaving out creditors from our analysis and they can also provide other helpful information such as prior addresses and other names in which you have been extended credit
• get me copies of all payment advices for the past 7 months.  The Bankruptcy law now requires all debtors to engage in a median income test as well as a means test analysis.  The starting point of this analysis is evidence of income you and other members of your household have received.   Payment advices should be provided for salaries, investment income, one-time checks, some disability payments, dividends, etc.  If you are not sure, ask.

Sometimes I hear from clients who want to submit their information on a spreadsheet or Quicken file.   Feel free to send those files along, but do not send them in lieu of my questionnaire and the other requested information.

This could help consumers gain more control of their own annual budgets–especially those who are making Chapter 13 monthly plan payments.  In Chapter 13 plans, the Trustee expects the Debtor to continue to make current and timely payments on secured debts like their homes and automobiles.  Unexpectedly large increases in property taxes could hinder successful completion of these plans.
At a time when large automobile manufacturers, like General Motors, face the real possibility of Chapter 11 bankruptcy, Georgia consumers need all of the assistance they can get.

The Winter Legislative session begins January 12, 2009.  I encourage everyone to contact his/her local representative to support this measure capping the percentage increases to real estate assessments.

Sheila

Jonathan Ginsberg responds:  Sheila, you raise a number of points in your question – let me address one by one:

First you ask how to calculate your median income given your change in employment.  When you file bankruptcy, the law requires us to look at your income over the 6 month period preceding the month you actually file.  For example if you were planning on filing in December, we would look at your median income from June through November.

If your income is lower than it "normally" is because of a job loss, that’s fine.  You would have an easier time passing the "median income" test.  The reverse, unfortunately, is also true – if you currently have no income but had a large income during the six month look back, your median income may exceed the limit and you would have to go into a means test calculation.

Additionally if you pass the means test but now have a high salary going forward, then you might have trouble fitting into Chapter 7 because of your budget.

Secondly, you raise the issue of your tax refund.  Your tax refund does count when looking at your median income.  Don’t be confused – all sources of income or revenue count in a median income calculation.

Third, you raise the question about what to do about your tax refund.  Your tax refund is an asset that would have to be listed on Schedule B of your petition.  Depending on how much you have or will receive, your tax refund may or may not be "exempt."  In Georgia, you can use 1/2 of your unused real estate exemption + your wildcard exemption and shelter up to $5,400 of cash or cash equivalent like a tax refund.  A qualified attorney can help you plan the timing of your filing to preserve as much of your tax refund as possible.

Semi-annual Changes in the U.S. Trustee published median income numbers.  Your gross household income impacts whether you can file a Chapter 7, and whether your Chapter 13 must extend three or five years.  Since the October, 2007 enactment of BAPCPA, the U.S. Trustee has published new median income figures approximately every six months.   The last update was effective February 1, 2007 and the next expected update is scheduled for October 1, 2007.   When the median income figures are adjusted on October 1, 2007 the median income numbers will go up.  To give you an idea about how much they might go up, here is how the figures for the median income in Georgia for a family of 4 have adjusted since October, 2007:

• October 17, 2007 – February 12, 2006 – $58,060
• February 13, 2006 – September 30, 2006 – $60,028
• October 1, 2006 – January 31, 2007 – $64,427
• February 1, 2007 – present – $66,508

Assuming that the figures adjust again in October, 2007, we might be looking at $68,000 to $70,000.  If your household income is close to these limits, it would make sense to wait.

Similarly, the approved expense figures for your county may also adjust.  Since just about every debtor will benefit from applying the expected October, 2007 numbers I am encouraging any client who can wait to do so.

Changes to Your Family Size.  If you are pregnant, you should try to wait until after your child is born.  An Oregon bankruptcy judge recently ruled that an unborn child cannot be counted for purposes of determining family size for your median family income.  The difference in the median income for a family of 3 as opposed to a family of 4 can be significant.  For example, currently in Georgia, the median family income for a family of 4 is $66,508.  The median income for a family of 3 is $55,293.  While you could amend your means test after your baby is born, you will likely incur additional legal fees and a lot of unnecessary stress.

Expected changes in your employment.  The median income/means test looks at the past six months to determine your "ability to pay."  However, if your trailing six month average does not paint a realistic picture of your capacity to pay, your case is still subject to dismissal if your budget shows disposable income.

Bankruptcy assumes stability.  If your income is going up and down, you can expect the trustee and creditors to assume that you have the capacity to earn at the highest level of your past earnings even if that is not realistic.  Whenever possible file your bankruptcy case when your income situation is stable and likely to remain stable.

Do you have any additions for this list.  Send me an email or comment on this blog post.

Yes you can.  However (and you knew there was going to be a "however") your non-filing spouse’s income and expense information, and possible his/her asset information may be relevant to your case.

In my pratice, I start my potential client interviews with an overview of the potential client’s financial situation.  I first look at the debt side of the ledger to confirm in my own mind that the potential client has enough debt to justify the cost and hassle of bankruptcy.  For example, if a potential has $10,000 of debt total, there are not too many scenarios other than a pending mortgage foreclosure that would lead me to advise bankruptcy.

So, assuming that there is enough debt to move forward, the next thing I look at is household income, regardless of whether the spouse will be involved.  By the way, Georgia is not a community property State.  For those of you who live in community property States, the analysis I am describing may not apply.  My colleagues in the Bankruptcy Law Network are a great resource for bankruptcy advice outside of Georgia.  My colleague Cathy Moran writes often about community property issues and bankruptcy in Bankruptcy Law Network posts. 

The median income test requires us to look at household income.  If your combined household income is less than the median for Georgia, then you pass the median income test and we would proceed to preparing a budget.

If your combined household income exceeds the median, then we would proceed to the means test.  The total gross household income is called "Total Income."  However, we are pemitted to subtract from Total Income the portion of your non-filing spouse’s income that does not get contributed to paying your household expenses.  After subtracting this part of your spouse’s income, we end up with a number called the "Current Monthly Income" or CMI.

For example, if your spouse uses $550 per month to pay for a car in her name only and $300 to pay for her student loan, then the Total Income would be reduced by $850 to calculate the CMI.

The CMI would then be used to calculate your "disposable income" under the means test.

Similarly, when we move out of the land of theory into real life budgeting (also known as the Schedule I & J budget), your spouse’s separate expenses count as line item expenses that reduce your disposable income.

One word of caution – the U.S. Trustee as well as the Chapter 7 and Chapter 13 trustees recognize that some debtors will try to manipulate the system by shifting joint household expenses to the non-filing spouse.  Also, your case is likely to draw a "good faith" objection if your budget includes your spouse’s $900 per month car payment .   I think that the key concept here is "reasonableness."   Bankruptcy  is intended to balance the rights of creditors with the rights of debtors and the Bankruptcy Court will balk at attempts to manipulate the system.

That being said, individually filed bankruptcies by married debtors are common and should not present any unusual problems.

Technorati Tags: filing bankruptcy without spouse, means test, median income test, bankruptcy budgets

My case involves a man in his mid-40′s who lost his sales job and went through a divorce within the last two years.  Although he is well educated and has an extensive background in sales, he currently works as a cashier at a grocery store.   The income he earns at the grocery store does not cover his expenses, which includes rent, a car payment and child support.  As a result, his parents have been helping him with his monthly cash flow needs.

When I prepared the median income test, I only included his employment income as well as some residual commission income.   The median income test result with these numbers showed his six month average to be well below the median for a single individual in Georgia.

I then turned to the actual budget at Schedules I & J.  Here, too, my client’s income was far less than his expenses.  We discussed the situation and my client acknowledged that he was receiving financial support from his parents as needed.  I added "support from parents" as a source of income and prepared a budget that showed $1 left over at the end of the month.

Earlier this week I received an email from an analyst at the U.S. Trustee’s office asking me to modify my means test to show include "support from family" as an income category.  This extra "income" may throw my client into a means test situation.

I don’t foresee this extra "income" to be a problem in this case, but I can easily see how it would be a problem in other cases.  Specifically, if you need to reaffirm a car loan or furniture debt, you cannot show a negative budget – the court will deny the reaffirmation on the grounds that you do not have sufficient money to afford keeping the secured collateral.  On the other hand, if you show "support from family" as a way to bring your budget to zero, that support will need to count as income for median income/means test purposes as well.

The big picture here is that you have to look at your finanical data as a whole.  Your tax returns figures need to correspond to the yearly totals shown on the statement of financial affairs.  Your Schedule I & J budget needs to agree with your means test numbers.  This is why I tell all of my clients that every figure on their peititon – and on the budget in particular – may require backup evidence.  If you rely on estimates or hunches, your case may end up being a lot more complicated than you expected.

Technorati Tags: means test, median income test, budgets, Schedule I & J, income and bankruptcy

Jonathan Ginsberg responds:  Jeff, thanks for your question.  Here is how I would analyze your situation:

1. Bankruptcy is always a last resort.  Whatever positive information you hear about bankruptcy (and there are some positives), you always run a risk when you file for bankruptcy.  Why?  Your financial future will be in the hands of others (trustees, judges).  Creditors can put you in the position of having to litigate (expensive) or give up bankruptcy protection.  While most bankruptcy cases process through the system without hassles, there is always the chance that your case could blow up.  Additionally, you will see your credit score destroyed (at least in the short term) if you file for bankruptcy.
2. Given your income, I would think that you would be limited to filing Chapter 13.   Although the median income limit for a single individual changes once or twice a year, the current median income for an individual filing in Georgia will be in the $40,000 range.  Your income is significantly higher – therefore I suspect that you will be looking at a Chapter 13.
3. Currently, you are paying $900 per month + your mortgage + high on-going medical expenses.  Chapter 13 might make sense if it could reduce that $900 payment to $600 or  $500.   The only way to know that would be to submit all of your financial information to a bankruptcy lawyer for a personalized review.  If you want me to review, I would direct you to a special download page of my Atlanta bankruptcy web site, where I identify exactly what I need to analyze your specific case for a possible bankruptcy.