Eligibility for chapter 7 bankruptcy (P1)

Eligibility for chapter 7 bankruptcy has long been subject to some form of income-based test. Formerly, the only test was for "substantial abuse". If a debtor's monthly income significantly exceeded monthly expenses, then the case might be dismissed. But enforcement was sporadic, and the standard was subjective.

On October 17, 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), which made major modifications to the Bankruptcy Code, became effective. BAPCA's centerpiece was an ostensibly objective test to weed out abuse (according to the proponents of the Act, abuse of the bankruptcy process was endemic, but statistics show it was rare).

This income-based eligibility test has two parts. They are often referred to together as the "means test", but, technically, that is the second part. Often the inquiry ends before that is reached.

This post explains the first part of the test (Form 122A-1 Statement of Current Monthly Income), which calculates the filer's current monthly income ("CMI") and compares it to the median family income for the filer's state and household size. If that number is less than or equal to the state's median, the filer is "under median" and therefore is eligible to file for relief under chapter 7 bankruptcy without further analysis.

This part of the eligibility test is not as simple as it may appear. Many people do a rough calculation on their own, conclude they are over-median, and resign themselves to living with debt. But even in this initial stage of the eligibility test there are important strategic considerations which might be overlooked, and may spell the difference between qualifying and not qualifying.

Of singular importance is what income enters into the calculation and what income can be legitimately excluded.

CMI must include income from "all sources", including alimony, employment income, business income, rental income, interest, dividends, royalties, unemployment compensation, and pension and retirement income. All household income must be counted, whether or not there is a non-filing spouse. But there are special rules that may allow you to effectively disregard some income of the non-filing spouse (more on that later).

Moreover, "all" really means "most", because social security payments are excluded. Also, included business income is net of business expenses.

CMI only includes income received during the "look-back period", the six-month period ending on the last day of the month prior to the month in which the bankruptcy petition is filed. The bankruptcy process is voluntary. So, the filing can be timed so as to minimize income caught in the look-back period; for example, by excluding annual bonuses, or including periods of unemployment or underemployment for laid-off or seasonal workers.

If you are still over-median, hope is by no means lost. I will cover the second part of the chapter 7 eligibility test (the means test proper), and other alternatives in separate posts. In the meantime, it is important to remember that you should not draw conclusions about your eligibility for bankruptcy relief without consulting with an experienced attorney.