Means Test in Action

The rallying cry in Congress for bankruptcy reform two years ago was “needs-based relief”: only those who really needed bankruptcy would be permitted to file Chapter 7. The filter imposed for finding the needy was the means test.

The means test is widely thought to involve just looking at the debtor’s income. In fact, it’s a three part test; you could say that the first part is true or false; the second part multiple choice; and the third part is essay. Most people don’t have to go beyond the first or second part. Means test map.

The first step compares the debtor and his spouse’s income to the median income for his state of residence for families of the same size as the debtor’s household. Note that we are comparing apples to oranges: we determine how many people in the debtor’s household (which may include extended family, adult children living at home, exchange students, etc.) and compare the debtor’s income to the income of families of the same size as the debtor’s household. If the debtor’s income exceeds the median, we go to part two.

The second step computes the debtor’s allowable expenses using a combination of fixed allowances from the IRS Collection standards for some categories, and the debtor’s actual expenses for other categories. Included in the permissible expenses are the payments that come due over the next five years for mortgage, property tax and car payments. Only if there is a positive number in excess of $100 on the bottom line does the presumption of “abuse” arise.

In the third step, the debtor gets an opportunity to rebut that presumption either by convincing the trustee that the situation is not abusive, or by convincing a judge at a hearing.

In a year and a half of working with the means test, I’ve had only 2 families who wanted to file Chapter 7 excluded by the means test. The UST in the Eastern District of California recently recounted that their office only succeeded in knocking a fraction of one percent of filers out of Chapter 7. The means test may well be a paper tiger.