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.

The Bankruptcy Code looks to median household income figures compiled by the U.S. Census to determine whether or not you have the “means” or capacity to pay back some or all of your bills.   Means testing was introduced into the consumer bankruptcy process in 2005.

The chart below summarizes the impact of the revised numbers:

The impact of this change is most pronounced on two person and three person families.   Lower median income numbers mean that more filers will end up in Chapter 13 since anyone “above median” will be presumed to have enough money to pay back creditors in a Chapter 13.  Chapter 13 cases filed using the new numbers will also result in higher monthly trustee payments because the amount of funds “available” to pay back creditors will be higher.

Above median debtors are not without hope – those filers can still qualify for Chapter 7 under part 2 of the means test, but that process puts more scrutiny on a filer’s budget and adds to the complexity of the filing.  Read more about the forthcoming change to the median income tables on the Bankruptcy Law Network, where my colleague Jill Michaux has posted an article entitled “The Means Test Gets Meaner.”

Bottom line:  if you are considering Chapter 7, look closely at that option prior to November 1, 2010 or risk an unpleasant post-Halloween surprise.

The issue in Lanning is one that has troubled bankruptcy lawyers since 2005, when the “means test” was added to the Bankruptcy Code.   The means test functions as a test – do you have the “means” or disposable income to fund a Chapter 13 repayment plan?  If the means test shows that you do not have sufficient disposable income to make a Chapter 13 work, then you qualify for Chapter 7.

As one of the assistant United States trustees once told me – the purpose of the means test is to disqualify as many people as possible from Chapter 7, and to force them into Chapter 13.

In practice, the means test does not work very well in predicting who can make a Chapter 13 work.  One of the biggest complaints has to do with the mechanical nature of means testing.   To run a means test, I have to gather pay stubs from the past 6 months.  I then create a monthly average, which represents available income.  Next I prepare a means test budget, but I do not use actual expense amounts.  Instead, the means test tells me how much my clients are allowed to spend for food, medicine, utilities, etc.  And where do these budget numbers come from?  Means test numbers are based on IRS budgets used in delinquent tax repayment plans.  In other words, the means test budget allocations are not especially generous.

This explanation of the means test is somewhat oversimplified, but you get the main idea – every bankruptcy debtor’s income and expense numbers have to be run through the means test, and not surprisingly this somewhat mechanical test produces some absurd results.

The classic example of absurd results occurs when a debtor has received a Christmas bonus or a one time payment.  That bonus/one time payment has to be included in the monthly income numbers even if it is not guaranteed or likely to happen again.  In other situations a debtor may have earned a comfortable income but has now lost his job – under a strict reading of the means test, he earns too much money to file Chapter 7.  And he can’t afford to file a Chapter 13 because he now has no income.

The Supreme Court has injected some common sense into this situation.  In the Lemming case, which was filed in Topeka, Kansas, the debtor’s 6 month average was skewed by a one time payment arising from a buyout from her former employer.  The debtor filed a Chapter 13 plan that called for a payment that the debtor could afford based on her actual, current income.  The trustee objected on the grounds that the means test dictated a higher number (that the debtor clearly could not afford based on his actual income).

The Topeka bankruptcy judge agreed with the debtor and approved a plan that Ms. Lemming could afford.  The trustee appealed and lost in the 10th Circuit Court of Appeals.  The trustee appealed again and the Supreme Court granted certiorari.

The Supreme Court affirmed the decision of the 10th Circuit Court of Appeals and held that bankruptcy judges need not apply a “mechanical approach” to means testing in Chapter 13 cases.  Instead, judges should “take into account other known or virtually known certain information about the debtor’s future income or expenses.”  Rather than looking backwards, judges can take a forward looking approach and consider the realities of a debtor’s income.   This forward looking approach should be considered in cases with unusual facts and the Lemming decision should not be construed as an invalidation of the means testing formula.

Despite the Supreme Court’s warning that a “forward looking” approach should only be used in limited situations, I suspect that bankruptcy judges will use “Lemming arguments” mitigate some of the harsh results of Chapter 13 in general.   Bankruptcy judges recognize that Chapter 13 cases often do not work because means testing and aggressive trustee arguments force debtors to agree to plans that commit debtors to pay every last dime to the trustee.  Unfortunately, family emergencies and unexpected things happen over the course of a five year bankruptcy plan and many plans will fail – not because the debtor did anything wrong, but because there is no “give” in the plan.

I predict that judges will use the rationale of Lemming to reduce some of the harsh results of the means test and help debtors improve their chances at success in Chapter 13.

If you want to read the Lemming decision, click on the link.  I also found a nice summary of Lemming in attorney Jordan Bublick’s fine South Florida bankruptcy blog.

Here is a comparison table

Current Median Income Numbers            Median Income numbers
after November 1, 2009

Family size

1                                $40,760                                  $40,691

2                                $54,054                                  $55,258

3                                 $61,959                                  $61,104

4                                 $71,554                                  $68,502

Let’s consider how this change affects you if you have a family of 4.  If you file by October 31, 2009, you can have household income of $71,554 and still qualify for Chapter 7 without having to qualify under the means test.  As of November 1, 2009, if you earn $71,554, the presumption of abuse arises and you must try to qualify by rebutting the presumption using the means test.

If your six month average gross income (April-September) is close to the current median income numbers and you expect the May-October numbers to be similar, it may make sense to try to file prior to November 1 – or at least to discuss this possibility with your lawyer.

If you are computer savvy I would almost suggest that you download the BestCase trial version (full featured except that it prints  “demo” on the output) instead of the Nolo version.  I supect that the folks at Nolo assume that most prospective debtors will get frustrated and call one of the lawyers who buy advertising space at the Nolo site!

In any case, here are links to both the Nolo calculator and to the BestCase download:

Nolo means test calculator

BestCase petition preparation program with means test calculator

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.

While it would seem that the number of people in your family ought to be easy to calculate, it turns out that issues do arise relating to this very important calculation.

I recently received an email from a blog reader named Sheila who asks the following law school exam type of question:

I have been told conflicting things about determining household size for purposes of the chapter 7 means test.  My 20 year old son currently lives with me for free. He will probably move out in the next couple months.  My 18 year old daughter lives with me, but will be going away to college in the fall. A divorce decree allows my ex-husband to use her as a dependent for tax purposes.   My 16 year old daughter lives with me and is my dependent for tax purposes.  How do I determine my household size for the purpose of the means test?

Here is my response: First, I think that Sheila’s question calls for legal advice, which I cannot offer on this blog.  I do not know the location where Sheila may be filing, so I have no way to research the family size issue for her jurisdiction.  However, I can help identify some of the issues that Sheila and her lawyer ought to think about.

• 20 year old son – if the 20 year old son is living with her at the time of filing and has no definite plans to move out, I think that there is a good argument to count him as part of the household for means test purposes.  If he is working, however, his income may be included as part of the household gross income.  If his income is included for median income test purposes, I think you could make an argument that because he is not part of the filing, his separate expenses should count as line item expenses that reduce disposable income on Form 22 (the means test).  You would definitely want to see if there are any circuit court or bankruptcy court holdings regarding this issue in your jurisdiction.
• 18 year old daughter – because the ex-husband claims the daughter as a dependent on his tax returns, it may be difficult for Sheila to include the daughter as a member of the household.  Several years ago, a Northern District of Georgia bankruptcy judge ruled against me on this issue, finding that the income tax dependency was a deciding factor.  In that case, however, the college age child was not living with my client.  Here, it appears that Sheila’s daughter lives with her, eats her food, consumes electricity and gas, Sheila may have a contrary argument.  This might be an issue that Sheila’s lawyer will have to argue.
• 16 year old daughter – I think that Sheila can count the 16 year old as a member of her household

So, Sheila’s household could be as small as 2 or as large as 5 depending on how her bankruptcy judge rules on the household size issue.  Her lawyer is going to need to research this issue for holdings in the jurisdiction where this case might be filed, and he/she may need to present arguments if there is no binding precedent.

Unfortunately this means that Sheila may be a “test case” for this household size issue.

How can I file chapter 7 by myself without paying someone, anyone $ 99.00 $199.00, $299.00 etc… Three different people( with a financial intrest of course) said representation is required.

Here is my response: Jim, you certainly have the right to file a Chapter 7 case by yourself.  The forms are available either on-line or at an office supply store.  There are also several books about how to do this.  I am currently reviewing a book entitled The Complete Chapter 7 Personal Bankruptcy Guide by attorney Edward Haman that is published by Sphinx Publishing that is quite comprehensive.

Here are the issues:

1. the bankruptcy process has become significantly more complicated since October, 2005, when the BAPCPA changes to the bankruptcy laws were enacted.   I know a number of lawyers who used to file the occasional Chapter 7 here in Atlanta, but who have now given up the practice because of the complications.  In particular, you need to fully understand how the median income test and the means test works – if you do the calculations incorrectly, you could end up in a deposition at the United State’s trustee’s office, face a motion to dismiss or face a motion to convert to Chapter 13.

2. you need to understand about the pre-filing credit counseling requirement as well as the pre-discharge financial management course requirement

3. in order to actually file your case, you will need to go to the Clerk of Bankruptcy Court and scan your pages to get your case filed.  I suspect that this process is not particularly complicated, but I have not used the scanning equipment at the Clerk’s office.

4. you cannot dismiss a Chapter 7 voluntarily if you change your mind.  For example, if you file, but it turns out that you earn too much or own too many assets the judge may not let you out of your case, at least until after your assets are liquidated.

5. you need to understand how the Georgia exemption law works and how it applies in Chapter 7 to protect property that the law allows you to protect.  If you don’t properly declare property as exempt even if the law would otherwise allow you to protect it, then you could lose your property anyway.

6. do not expect to receive advice from the Chapter 7 trustees or the U.S. Trustees.  Their interest is to maximize the recovery of the estate (i.e. your creditors).

While folks contemplating bankruptcy obviously do not have a lot of money, I think that in most situations the complexity (which, no doubt is unnecessarily complex) makes a pro se filing a mistake.

My Bankruptcy Law Network colleague, Michael Doan, has posted a very useful article about the timing of filing.  Specifically, Michael points out that if you start the bankruptcy information gathering process towards the end of a month, and the process rolls over to the next month, then a lot of the work has to be redone.  For example, the six month medican income test look back would involve a new six month period, your credit counseling certificate validity date may run out and the required tax return might change.  I encourage you to take a look at Michael’s well thought out post entitled "File by the End of the Month or Start Over."

I think that in a big picture sense, what Michael is saying is that you need to communicate regularly and accurately with your lawyer.  If you meet with your lawyer on the 20th of the month and promise to have all necessary documentation by the 27th, but you end up rescheduling your appointment to the 5th of the following month, don’t be surprised if you have to pay a higher fee to account for all the new calculations.

In my practice, I do not start the time consuming process of analyzing pay stubs and figuring out the median income and/or means test until I have pretty much all of the required documentation.  This means that I can’t give my client bottom line numbers unless and until my client provides me with pay stubs and tax returns.  I can still give a "big picture" analysis based on my experience, but the actual number crunching has to wait.   This is a major shift from pre-BAPCPA practice where I could run numbers almost immediately.

Some of my colleagues are more willing to tolerate the risk of not getting documentation in time and they end up running their calculations two or three times.  If you are a lawyer and this is how you have set up your practice, I would advise you to keep your notes so at least your’ll have a head start on the calculations.

In each of these cases, I have had to respond to the prospective client with the bad news that about 99% of the time, Chapter 7 is not going to be available to an individual or couple whose household income exceeds $100,000.   Why?  Under the current bankruptcy law, something called a "presumption of abuse" arises is your gross household income exceeds the "median income" for a similarly sized family in the State where you live.

In Georgia, where I practice, the median income for a family of 4 is $66,711.  If there are more than 4 people in a household, you would add $6,900.  If you make $100,000, you would need a family of 9 to fit within the median.  Note that these figures will be adjusted upward as of January 1, 2008 but the general principle here still applies.

If you do not meet the median income test, you could still qualify for Chapter 7 under something called a "means test" which allows you to deduct certain permitted expenses from your median income figure.  Unfortunately the means test is derived from IRS calculations used when people negotiate installment payments on overdue tax debt.  In other words, you don’t get a lot of deductions.

As a practical matter, you might squeeze into a Chapter 7 if your income is just over the median, but if you are $20,000 or $30,000 over the median, you are facing a real uphill battle.

If you don’t fit into a Chapter 7, your only alternative is Chapter 13.   Here, too, the $100,000 income family is likely to feel a squeeze.  My experience with the means test suggests that families the $70,000 to $100,000 range won’t qualify for Chapter 7, and the means test will require a Chapter 13 payment that often is not affordable.

Over the next few weeks, I’ll be working on a video presentation that will demonstrate how the means test works.