Considering filing Chapter 7 Bankruptcy? Learn what the income limit is and other useful information about filing Chapter 7 in our guide.
The average American in 2020 rotates between four credit cards and carries almost $6,200 in credit card debt. That’s an increase of almost 20% from a decade ago.
Whether you think $6,200 sounds distressingly high or startlingly low probably says a lot about where your finances are right now. If it sounds low, you might be thinking about filing Chapter 7 bankruptcy. It could be the next step toward more financial breathing room.
Still, there’s a catch: you could be thousands of dollars in debt and still have too much money to qualify for Chapter 7. The key to finding out if you pass under the income limit for Chapter 7 is to take the means test.
The Different Types of Bankruptcies
If you are filing for bankruptcy as an individual, you basically have two choices: Chapter 7 and Chapter 13. There are a few other types of bankruptcies, but the vast majority of people file under these two (while businesses and corporations typically file under Chapter 11). Which bankruptcy is the right choice for you mostly depends on your level of income and assets, although there are other considerations when filing bankruptcy.
Chapter 7: Liquidation
Most individuals file under Chapter 7 bankruptcy, also known as liquidation or straight bankruptcy. Under Chapter 7, a court-appointed trustee will oversee the sale of all your assets in order to pay off your creditors. In some states, you can keep certain essential assets like your car or house, but that is not always the case. Any unsecured debt (usually credit card debt or medical bills) remaining after that is erased, but there are some exceptions when filing bankruptcy that do not get erased, like student loans or tax debts.
You can only apply for Chapter 7 if you pass the means test, which we’ll describe later. Otherwise, you will need to file for Chapter 13.
Chapter 13: Reorganization
The second most common way individuals file for bankruptcy, after Chapter 7, is Chapter 13. While Chapter 7 forgives your unsecured debt, Chapter 13 reorganizes it. Simplified somewhat, the court approves a three-to-five-year plan for you to repay all your secured debt and a portion of your unsecured debt. During this time, the court gets to review your spending and make sure you stick to a certain budget.
After the payment plan is finished, any remaining debt is forgiven.
People generally choose Chapter 13 if they make too much money to file for Chapter 7, or if they want to keep certain assets that they would need to sell under Chapter 7. It is generally for people who have the means to repay their debts over time, but cannot pay down their debt right away.
The Benefits of Filing Chapter 7 Bankruptcy
For most people, filing for Chapter 7 is generally more affordable and quicker, especially if you:
- Have mostly unsecured debt
- Own little or no property
- Cannot commit to a multiyear repayment plan
But there are some drawbacks. Filing for Chapter 13 lets you keep certain assets. Likewise, a Chapter 7 bankruptcy will stay on your credit report longer (ten years) than a Chapter 13 bankruptcy (seven years).
The Means Test Part 1: Income
Of course, as noted above, to file for Chapter 7, you need to pass the means test. This determines if you have enough disposable income to repay your debts, in which case you’ll need to file for Chapter 13. The test compares your household income to the median income in your state for the same size household.
Exemptions to the Means Test
There are two key exemptions to the means test for filing Chapter 7 bankruptcy.
If more than 50% of your debt is non-consumer debt, then you are exempt from the means test. Consumer debt is mostly money used to pay personal, familial, or household expenses. Anything else, usually money used for business expenses, is non-consumer debt.
The other exception is for income related to military service. Disabled veterans, reservists called to active duty, and members of the national guard don’t have to count any income they earned for their service when calculating their household income.
Calculating Annual Household Income
To check your income under the means test, you’ll need to start with your monthly income and then use that to calculate your annual income.
Your current monthly household income depends on your income for the six months before you filed for bankruptcy. To calculate it, perform the following steps:
Add up all your gross (pre-tax) income for the past six months.
Add any other income you receive on a regular basis, like alimony, child support, or rent.
Divide by six to find your monthly income.
Multiply that result by 12, and you have your annual income.
Comparing Your Income to the Median Income
Once you know your annual income, you can compare it to the median income in your state for a household that is the same size as yours. This data changes multiple times each year, but the U.S. Trustee Program has the most current figures.
Using their data, compare your annual income to the median annual income in your state for a similar household. If your income is lower, you qualify for Chapter 7. If your income is higher, you may still be eligible for filing Chapter 7 bankruptcy, but it will depend on your household expenses
The Means Test Part 2: Expenses
You may still be eligible for Chapter 7 if you do not have enough disposable income after paying your household expenses. If your disposable income is still too high after expenses, you will need to file for Chapter 13.
Only certain expenses are included, and understanding which expenses can be counted gets technical, so you may want to ask a bankruptcy lawyer for help. Allowed expenses include:
Some wage garnishments
Regular living expenses (based on national and local standards)
Necessary monthly expenses (for instance, insurance, education, or child care)
Once you calculate your allowed monthly expenses, subtract that number from your monthly income. If the number is negative, you pass the means test.
You also pass if the number is positive but, when multiplied by 60, is still less than the current limit for disposable income. This limit is adjusted every three years. The U.S. Trustee program should also have this information.
If your disposable income exceeds this limit, you will need to file for Chapter 13.
Be Smart About Your Choices
Finding out if your income comes in under the means test is complicated enough, and that is just the first step in filing Chapter 7 bankruptcy. If you want to come out of this process in the best possible financial shape, you’ll want proper advice for every step, including the means test.
To find out more about bankruptcy, browse some of our other posts on the Husker Law Blog. Then, when you’re ready to take the next step to get your financial future in order, explore our bankruptcy services and then call us at (402) 415-2525.