Stephen R. Harris, Esq.
6151 Lakeside Drive
Reno, NV 89511
Nevada Bar #001463
The Means Test
Means Testing is involved in determining eligibility for filing either a Chapter 7 or Chapter 13 case and is critical as to determining whether a debtor has the financial means to repay part of his nondischargable debt.
Chapter 13 takes 3 to 5 years. Instead of giving up property, you repay a portion of your debts and live within a strict budget that is monitored closely by the bankruptcy court trustee. If you can't make the required monthly payments, your Chapter 13 bankruptcy fails and your debts will remain (unless you convert to a Chapter 7 bankruptcy). Under the new bankruptcy law, which took effect in October 2005, a mathematical formula called the "means test" establishes an initial determination of the kind of bankruptcy you qualify for: Chapter 7, Chapter 13, or either. If your annual income is less than the Nevada median income for your household size, then you can file for Chapter 7 or Chapter 13, (assuming you meet other qualifications). If your income is higher than the state median, you must first complete a long list of expense deductions to estimate what your 'disposable income' will be over the next five years. The result of this calculation determines whether you can file for Chapter 7, or are stuck with Chapter 13 as your only option. The means test applies to individuals whose debts are primarily consumer debts (such as mortgages, car payments, credit cards). Many individuals are forced into bankruptcy because of a business that failed, or a large business related judgment. Debtors with primarily business debts are exempt from the means test and may file Chapter 7 bankruptcy regardless of their income and expenses.
The Means Test Formula
The means test formula is designed to evaluate whether the debtor has the financial means to pay back a substantial part of his/her debts in a repayment plan through Chapter 13 bankruptcy. The means test formula considers measures of income and allowable expenses. If, according to the results of the formula, you have sufficient net monthly income to repay debts you then are not eligible for Chapter 7 bankruptcy, but you may be eligible for relief in Chapter 13 bankruptcy.
How does the "Means Test" Work?
The means test evaluates your income in comparison to the official median income for households in Nevada as reported by the Bureau of Census in the most recent reporting year. The median income base increases with the size of your household. First, the means test evaluates whether your current monthly income (from all sources) is greater or less than the applicable median income. Current Monthly Income (CMI) has a special meaning in the new bankruptcy law. CMI is defined as the average monthly gross income received during the six full months just prior to your filing bankruptcy. CMI includes gross income from all sources including income of a non-filing spouse, regular gifts or assistance from family members, and gross income from a wholly-owned business. (Business expenses are deducted elsewhere in the means test calculations.) On the other hand, social security income is excluded from the definition of CMI.
Nevada Median Income
If your average monthly income for the past six months is below the state median for your size household, you meet the requirements of the "means test" (section 707(b)(2) of the bankruptcy code) to qualify for Chapter 7 Bankruptcy.
2-person families 56,612
3-person families 59,802
4-person families 69,371
5-person families 70,660
6-person families 61,087
7-or-more-person families 81,426
If your CMI exceeds Nevada's median income, then the means test applies a more complicated expense formula to arrive at your eligibility for Chapter 7 bankruptcy. The formula starts with your CMI and then deducts several categories of allowed expenses to calculate your "net monthly income" which is presumed to be available to pay general unsecured creditors. The means test deducts the following expense categories from "current monthly income" to arrive at your "disposable income."
Standard Living Expenses
You can deduct an amount of "standard living expenses" established and published by the IRS as guidance for its agents negotiating consensual payment of overdue taxes. Debtors may claim documented living expenses up to 5 percent above the IRS standard if such expenses are "reasonably necessary." Housing Expenses The IRS publishes "local standards" of transportation and housing expenses. The local housing allowance is different for each county in Nevada and further varies depending on your household size. The housing allowance includes estimated cost of home ownership and operating expenses such as utilities and taxes. If you are buying a home and have a mortgage, you are also allowed to deduct from your CMI the amount of mortgage payments due during the ensuing five years. However, if you are paying a mortgage, the local housing allowance will be reduced by the amount of its assumed ownership expense so that your mortgage payments are not counted twice in the means test formula. Renters are limited to the IRS local standard allowance.
Transportation expenses are comprised of two separate expense categories related to vehicle ownership: "operating expenses" and "ownership expenses." Operating expenses are standard published expenses which vary according to the number of cars owned and your location. Your deductible ownership expense is computed as the higher of (1) the IRS national standard ownership allowance based on the number of family cars; or (2) your actual car payments during the ensuing five years after filing divided by 60. (Debtors who purchase expensive cars with large car payments increase their ability to pass the means test eligibility for Chapter 7. If your car is owned free and clear you deduct the standard ownership and operating expenses.)
Debtors may also deduct from their CMI actual expense for categories the IRS specifies as "other necessary expenses." These expenses include, but are not limited to, items such as:
Medical and dental expenses including medical insurance for debtor's family (debtor's without health insurance may buy insurance before filing to help pass the Chapter 7 means test);
Term life premiums;
Private school tuition up to $125 per month per child;
Alimony, child support, and other court order payments;
Care of elderly or disable dependents;
Health savings accounts;
Internet and phone service (including cellular phones);
Actual expenses for food and clothing up to 5 percent above the IRS allowance.
Secured Debt Payments
Payments due secured creditors, such as scheduled home mortgages and car loans during the five years after the bankruptcy filing date. This amount also includes required payments to creditors secured by personal property such as appliances or furniture.
Required debts such as taxes or domestic support obligations.
Reasonable and necessary private school educational expenses up to $1,500 per child per year. Debtors are allowed to deduct the greater of either the IRS local housing allowance or the total of actual mortgage payments plus allowed home maintenance expenses, such as utilities. For cars, you can deduct either secured debt payments or the IRS car allowance, whichever is greater. Your current monthly income, less your allowed expenses summarized above, is your Net Monthly Income (NMI) which is a defined term under the new bankruptcy law. If your NMI is more than $166.66 per month, you fail the means test which means there is a "presumption of abuse" applied to your filing a Chapter 7 bankruptcy. If your NMI is between $100 and $166, the law applies a mathematical formula to determine substantial abuse of a Chapter 7 bankruptcy. As stated above, eligibility for Chapter 7 bankruptcy under the new bankruptcy law requires a detailed computer analysis with software designed for means test calculations. Failing the means test means there is a "presumption of abuse" and you cannot file a Chapter 7 bankruptcy, but you may be able to overcome that presumption if special circumstances call for an adjustment to your income or expenses. Some examples of possible "special circumstances" are job loss or pay cut, a serious medical condition, or unusually high child care expenses. To establish that your financial situation is a special circumstance that warrants a waiver of the means test formula, you will have to show that your expenses incurred are reasonable and that you have no reasonable alternative. Judges are given discretion to determine if special circumstances allow filing a Chapter 7 bankruptcy by a debtor who cannot pass the means test formula.