Bankruptcy FAQ: The Chapter 7 Means Test

Almost all debtors filing for Chapter 7 bankruptcy must pass the “means test.” However, a few instances exist when a debtor can qualify for Chapter 7 discharge (the order that wipes out debt) without taking it.

• Business debt. If more than 50% of your debts are non-consumer, you’re excused from the means test requirement. Non-consumer debts generally refer to business debts that you incur for your business or with profit motives in mind. Consumer debts are incurred for personal or household expenses. However, some courts consider personal income tax debts and student loans as non-consumer debts.
• Disabled veterans. If you are a disabled veteran and your debts were incurred primarily while on active duty or engaged in homeland defense activities, you don’t have to pass the means test. To qualify for this exclusion, you must have a disability rating of at least 30%.
• Military reservists and the National Guard. The final exception to the means test requirement is for military reserve or National Guard members for the period they’re on active duty and for 540 days after that, as long as they were on active duty or performing homeland defense activities for at least 90 days. Once the exclusion period ends, if the time has not passed for objections to the means test qualification in your bankruptcy case, you will have to take and pass the means test.

If most of your debt is business debt, you won’t take the means test. Debt is usually considered a non-consumer business debt if incurred in connection with your business or in hopes of making a profit. Consumer debt is incurred for household or personal expenses.

Credit cards used to pay business expenses or to purchase items for your business would qualify as business debts, as well as business vehicle loans, money owed to suppliers or vendors, and business taxes. A mortgage is usually considered a business debt if a property was purchased for the business or as an investment property. Some jurisdictions consider personal taxes and student loans as business debts, while others classify them as consumer debts.

It depends. Either way, you’ll still list it on the means test form. Here's why.

The means test specifically excludes benefits you receive under the Social Security Act (“SSA”), and the federal government provides funding for state unemployment systems by the SSA. Some, but not all, bankruptcy courts say that unemployment is a benefit received under the SSA and shouldn't be included as income on the means test. The way you'll list SSA income on the means test form will depend on the rules in your jurisdiction. Your bankruptcy attorney can tell you the law on this issue.

Yes. You must list your current monthly income from all sources, including any regularly paid by someone else for you or your dependents’ expenses, such as daycare.

Although the means test requires you to disclose your “current monthly income (CMI),” CMI refers to the average monthly income you received during the full six-month period before filing for bankruptcy. Your CMI might not be the same as your actual current income for several reasons, such as getting or losing a job or a salary change.

Example. Your mother has been paying your $300 monthly daycare expense for at least a year. She has paid for daycare for the last six months, and you plan to file bankruptcy this month. $300 times six months is $1,800. Divide $1,800 by six months, and you get $300 per month. $300 is the monthly average you would include on your means test.

Example. If your mother just began paying your $300 daycare expense two months ago, you would list the average of the two payments made within the six-month period. $300 times two months is $600, divided by six months is $100 per month, which is the amount you would list on the means test.

Note that your petition has a separate schedule (Schedule I) where you must list the actual income you are receiving when you file bankruptcy instead of the income you received during the last six months. If someone just started or stopped helping you with your expenses, the means test and Schedule I amounts will be different.

Usually, someone with a high income will have a tough time passing the means test—especially if the filer doesn’t have dependents, a mortgage, or a car loan. But your school loans might help you avoid the means test altogether.

You don’t have to take the means test if your debts are primarily or more than 50% not consumer debts. Consumer debt is incurred primarily for personal, household, or family use. Some courts, however, have ruled that loans taken out to attend a professional school are non-consumer debts if the borrower took them out with a profit motive.

Because courts treat this matter differently, you’ll likely want to consult with a local bankruptcy attorney.

If you have a large mortgage payment, you typically have a better chance of passing the Chapter 7 means test than a debtor who rents. The means test allows you to deduct your mortgage payment to reduce your monthly disposable income. Here’s how it works.

If you don’t own a home and make mortgage payments, you can only deduct the amount of your local housing expense allowance even if your rent is higher than the local standard where you live. Unlike debtors who rent, a homeowner can deduct the entire mortgage payment on the means test (five years of monthly payments, assuming you have at least five more years to pay). If your mortgage payment exceeds the local housing allowance, the extra portion can help you reduce your disposable monthly income and pass the means test.

Example. Eleanor’s mortgage payment is $2,500 a month. She still has 20 years before her mortgage will be paid off. The standard local housing allowance where she lives is only $1,800. However, since her mortgage payment exceeds the local housing allowance, she can deduct her actual mortgage expense. This gives her an extra $700 to further reduce her disposable income. As a result, she has a better chance of passing the means test and qualifying for Chapter 7 bankruptcy than a debtor with the same income who rents.

If you have a car, the means test allows you to deduct certain expenses related to operating and owning a vehicle. As a result, owning a car can help you qualify for Chapter 7 bankruptcy.

On the means test, you’re allowed a standard operating expense deduction for up to two cars (a single debtor is typically allowed a deduction for only one vehicle). The operating expense allowance includes costs associated with driving a car, such as gas, maintenance, registration, and insurance. You’re allowed to use this deduction whether you have a monthly car payment. However, your deduction amount depends on the local standard allowance where you live, not the amount of your actual operating expenses.

If you lease or make monthly loan payments on your car, the means test allows you to deduct an ownership expense and your operating expense allowance to consider your monthly car payment obligations. The benefit of having a car loan is that you can deduct the standard national allowance or your average monthly car payment, whichever is higher. You’ll also get to deduct any arrearages if you’re behind on your payment.

When calculating your monthly car payment, the means test averages the total car loan obligation amount over the next 60 months. If your car will be paid off in less than five years, your 60-month average car payment on the means test will be less than your actual payment amount.

If your 60-month average exceeds the national standard, you can deduct the higher amount on the means test. However, if your average car payment is below the national standard, you can still deduct the standard allowance amount.

If you own your car free and clear, you might have a harder time passing the Chapter 7 means test than someone with a car loan. The means test allows you an extra car ownership expense deduction (in addition to your operating cost allowance) if you have a car payment.

You’re only allowed a car ownership expense deduction if you lease or make payments on your car. If you don’t have a car loan, you can’t use it to lower your disposable income. You can deduct the full standard ownership allowance even if your car payment is less. However, if your 60-month average car payment exceeds the standard ownership allowance, you can use your actual car payment on the means test to increase your deduction.

With certain limitations, you can deduct term life insurance premiums. Life insurance is one of the few areas on the means test where you can apply a deduction for an expense that isn’t necessarily required for day-to-day living.

On the means test, you can deduct term life insurance premiums for insurance on your own life and the life of a spouse who files jointly with you. You can’t deduct premiums that you pay for insurance on the lives of any of your dependents or a non-filing spouse.

The means test doesn’t provide a space to deduct college tuition. Although there’s a provision for special circumstances, it’s unlikely that the deduction should be allowed. In essence, bankruptcy courts don’t force creditors to forgo payment so that a filer can attend college (subsidized by creditors).

However, if you’re divorced and must pay all or a portion of your adult child’s college tuition under a court order, you might be allowed to deduct it as a court-ordered payment. Also, you can deduct educational expenses (subject to limitations) for children under 18 and special needs dependents and as required for employment.

You can deduct a standard educational expense for each child in your household under 18 years of age. The standard amount is rather low, so in most cases, you’ll be limited to deducting only a portion of private school tuition.

In addition to tuition, you can deduct other expenses related to your child’s education, such as uniforms and fees required for participation in certain classes. You can also include homeschooling expenses; however, the deduction is subject to the same per-month limitation.

You can also deduct childcare or preschool costs for any of your children who require care while you work and educational expenses for special needs children or dependents. You’ll report these expenses in another section of the means test, and they aren’t subject to the same limitations.

If your mother’s medical expenses meet certain criteria, you can deduct them on the Chapter 7 means test. You cannot deduct every type of medical expense, however. Your contribution to a family member’s medical expenses will qualify as an eligible deduction only if it meets each of the below requirements:

• Reasonable and necessary expenses. You can deduct the actual monthly expenses that are “reasonable and necessary” for the care and support of a household member or member of your immediate family. You might have to provide a prescription or doctor’s treatment plan to prove it is reasonable and necessary.

• Chronic medical expenses. You can only deduct the expenses for a qualifying family member if the expenses are because she is elderly, chronically ill, or disabled. Thus medical expenses such as over-the-counter medications for the common cold, or an annual checkup or dentist appointment would not qualify. However, the purchase of a wheelchair or other rehabilitative equipment would qualify. In that vein, you likely will be able to deduct the amounts you pay for your mother’s diabetes and blood pressure medicines.

• Eligible family members. You can deduct expenses for allowable family members, including your parents, grandparents, siblings, children, and grandchildren. You can also deduct expenses for any of your dependents, which could include foster children, step-children, or another distant family member who you claim as a dependent when you file your annual tax return. Also, if you file a joint case with your spouse, you may deduct his health care expenses so long as he is not a dependent of someone else.

• Inability to Pay. To deduct your contributing healthcare expenses, your mother must be unable to pay for the medical care herself. Therefore, you may have to prove her monthly income and expenses to show she cannot afford the expenses without your help. You may also have to prove that your mother does not qualify for additional government assistance or insurance for medical care.

Find out how bankruptcy can help eliminate debt owed after retirement, such as medical expenses, by reading Bankruptcy Planning for Senior Citizens.

You can deduct the amount you pay for preschool or childcare from your household income to qualify for Chapter 7 bankruptcy. To deduct these expenses, you must incur them so that you can work or for some other compelling reason. It's unlikely that you'll be permitted to claim childcare expenses if one parent in your household doesn’t work, although this could depend on the circumstances.

There’s no formal limit to how much you’re permitted to deduct. However, be prepared to show evidence of your expenses. Expect to be asked why the childcare arrangement is reasonable and necessary for your family.

Contributions to a tax-free ABLE account can help families prepare financially for the care of their special needs children or grandchildren. These contributions can also be deducted on the Chapter 7 means test, making it easier to qualify for Chapter 7 bankruptcy. To be included as a means test deduction, the contribution must not be more than the current IRS contribution limit, and it must be for the benefit of the bankruptcy filer’s child, stepchild, grandchild, or step-grandchild.

You’re allowed to deduct charitable contributions on the means test. As a rule, you must be able to prove that you have been making the donations regularly and for a long period as an ongoing monthly expense. A sudden increase in your charitable contributions will be suspicious and likely challenged by the trustee.

That’s not to say that you can’t increase the amount you donate before bankruptcy. However, you probably don’t want to do so unless you can show a good reason for the change—and be careful not to increase the amount too much. If it looks like you are doing so to pass the means test, the bankruptcy trustee might object to your attempt to deduct the full amount of your donation.

Also, be sure the recipient of your donation is a qualifying organization under bankruptcy law. For instance, your deduction must meet the following requirements:

• The expense must be a “qualified religious or charitable entity or organization” that qualifies as such under 26 U.S.C. 170(c) of the tax code. You can donate to your church, the government (as long as the funds are exclusively for public use), and to a charitable organization that is a tax-exempt 501(c)(3) entity.
• The contribution must be made by you and not, for example, a trust of which you’re a beneficiary or a business you own.
• The contribution must be monetary and not an item of personal property. Thus donating clothes to a church would not qualify, but tithes would.
• The charitable organization must not be involved in political legislation or candidates.

Remember that if you donate more than 15% of your gross income, the charity you donate to could run into trouble. This is because certain transactions you make within two years of filing for bankruptcy might be considered “fraudulent” if you don’t receive property of an equivalent value in return.

No, but if you meet certain conditions, your student loans might help you avoid the Chapter 7 means test altogether.

• Your court considers student loans “business debt” (not all courts do).
• You owe more in student loans (and other business debt) than you do consumer debt.

Consumer debt is incurred by an individual primarily for personal, family, or household purposes. Non-consumer debt is not incurred primarily for personal, family, or household purposes. Instead, it is incurred with a profit motive or for a business or investment purpose.

When these criteria are met, the filer doesn’t have to take the means test. The means test only applies to individual debtors whose debt is primarily consumer debt. Businesses or consumers with more non-consumer than consumer debt do not have to pass the means test to qualify for Chapter 7 bankruptcy.