When filing a Chapter 7 bankruptcy in California, it’s important to know if you’re a consumer or a non-consumer debtor. If you’re a consumer debtor, then you need to meet the Means Test, an income threshold you cannot go above and still qualify for a chapter 7. If you’re a non-consumer debtor, then you do not need to meet the Means Test; how much you earn won’t necessarily disqualify you from filing for Chapter 7 if you’re a non-consumer debtor. So what? Why does it matter? In a Chapter 7, your debts are wiped out. In a Chapter 13, you enter a repayment plan for three to five years, after which remaining debt will be wiped out. Most everyone would prefer a chapter 7 to be free and clear of their debts without going through years of repayment first. Moreover, the Bankruptcy Court scrutinizes a debtor’s income and expenses far more in a Chapter 13 than a Chapter 7 bankruptcy, making it an even more invasive process.
Chapter 7 Bankruptcy Is Debt Liquidation
There are two kinds of personal (versus business) bankruptcy. A chapter 7 bankruptcy is primarily an erasure of debt: if the debtor is qualified and receives a discharge at the end of the process, then their debts are fully written off. However, there are debtors with more assets than they are allowed to take through bankruptcy. Every chapter 7 debtor is allowed to take certain things through bankruptcy, rather than having the Bankruptcy Trustee (who is like a judge and oversees the bankruptcy) sell those assets to repay debts.
The items a debtor may take through chapter 7 (without risk of their being sold by the Bankruptcy Trustee) are:
(2) household furnishings & goods; personal electronics, sports equipment, pets worth approximately $1,000 in garage or flea sale value;
(3) approximately $8,500 in art or jewelry (such as engagement and wedding rings);
(4) a vehicle worth up to $7,500 or a vehicle with up to $7,500 of equity;
(5) up to $1.2 million in retirement IRAs and an unlimited amount in retirement 401k or 403b plans; and
(6) either the homestead exemption which is worth approximately $700,000 in equity in a primary residence in Los Angeles, Ventura and Santa Barbara and most of the high-cost coastal counties, or the wildcard exemption which is worth approximately $33,650 in whatever other assets the debtor chooses.
If a debtor has more assets in any of these categories, then the Bankruptcy Trustee is legally obligated to take that asset, sell it, and use the sales proceeds to repay the debtor’s creditors. Any debt left over after the Trustee has sold what s/he legally can to repay creditors, is then fully discharged.
Chapter 13 Bankruptcy is Debt Repayment
A chapter 13 bankruptcy is primarily a repayment of debt, with erasure of any remaining debt only at the end of a 5 year repayment plan (sometimes a 6 year plan). The debtor in a chapter 13 makes monthly payments in the amount of the excess of their monthly income over their monthly expenses. This amount is determined by bankruptcy law and the Bankruptcy Trustee. Monthly payments are made by the debtor to the Bankruptcy Trustee for period of three to five years. The Bankruptcy Trustee uses the debtor’s monthly payments to repay the debtor’s creditors on a proportional basis. If there are any debts remaining at the end of the 5 or 6 year payment plan period, then those remaining debts are discharged (erased). Fewer than half of chapter 13 bankruptcies are completed. Changing financial circumstances and the challenge of maintaining monthly payments cause most debtors to fall out of this plan before it’s completed.
Consumer Debt and the Means Test
Congress established the Means Test in 2005 to ensure that high-earning people do not “abuse” bankruptcy law by erasing their debts with a chapter 7 when they could be repaying at least some of their debts (in a chapter 13). The Means Test tests a debtor’s income to see if the debtor should be in a chapter 13 bankruptcy, were they repay what they can over a period of 5 years, before their remaining debt is erased. However, the Means Test applies only if 50 percent or more of your debt is consumer debt.
Consumer Debt Defined
Consumer debt consists primarily of:(1) credit card debt NOT incurred for a business, (2) medical debt, (3) almost all student loan debt, (4) mortgages for personal property (as opposed to investment or income-producing property) and (5) car notes or loans. If more than half your debt is non-consumer debt, however, then you do not need to meet the Means Test to qualify for a chapter 7 bankruptcy.
Non-Consumer Debt Defined
Non-consumer debt consists primarily of: (1) business debt including business-related credit card debt, (2) tax debt, both state and federal, and (3) certain legal judgements such lawsuit awards (some legal judgements, such as child support and alimony are not dischargeable in bankruptcy).
Yes, this means that a high-earning entrepreneur who owes millions to business creditors can file a chapter 7 bankruptcy and walk away without paying a cent to their creditors, while a high-earning corporate officer who owes $100,000 on credit cards and has a mortgage will need to submit to a five-year court-disciplined payment plan. Hey, I didn’t write the law – complain to Congress if you don’t like this.
Means Test Specifics
So, what are the specific income limits for meeting the means test and qualifying for chapter 7 bankruptcy? Unfortunately, the means test is a complex formula, rather than a single income number one cannot exceed. In general, if a debtor’s monthly household income is less than the California median income for a household of their size, then they’re likely to pass the means test and are eligible to file a Chapter 7 bankruptcy. This is what the Means Test form that is filed with the other parts of a Chapter 7 bankruptcy petition look like.
Household income is determined by averaging a debtor’s monthly income over the last six months. If a debtor’s monthly income is over the median income, but perhaps has been declining during that period, then waiting a few months to file bankruptcy often brings the debtor under the median income for California. This is why bankruptcy planning can be so important: someone may not qualify today but easily could tomorrow. Once a debtor’s average monthly income is calculated, that is multiplied by 12 to determine their annual income for the purpose of California median income test.
In 2023, the Means Test income levels for Californians filing bankruptcy were approximately as follows:
But, wait! There’s more! Debtors filing Chapter 7 are allowed to include expenses in the income calculation for the Means Test. What this means is that a single person, for example, earning $100,000 may still fall under the Means Test threshold of $75,250 once the allowable expenses are deducted from their income. These deductible expenses are (1) mandatory employer fees such as union dues and mandatory retirement contributions; (2) health insurance premiums; (3) income taxes; (4) childcare; (5) term life insurance premiums; (6) mortgage and car payments; and (7) alimony and child support.
When hiring a bankruptcy attorney, make sure she knows the intricacies of the means test and can explain its application to your financial situation. Better yet, call me: I will show you exactly how the Means Test impacts your ability to file Chapter 7 and any available alternatives you may have for addressing your debt. Then, take the information I give you, speak with other attorneys, and get second and third opinions. The best consumer of legal services is an educated consumer.
October 27, 2023