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The Dreaded Means Test in Chapter 7 Bankruptcy

The Means Test is the fierce hurdle Chapter 7 bankruptcy filers have to clear to avoid having the Court dismiss or convert their cases. Sound important? It is.When Congress reformed the bankruptcy law it felt that too many people were filing Chapter 7 liquidations, who could otherwise repay their creditors. To understand the complex rules of the Means Test it helps if you keep the lawmaker’s objective in the back of your mind.

JohnMenszer-0732What is income? Income is the current monthly income of the debtor as based historically on the last six months before filing. It includes all sources of income with the exception of social security benefits and tax refunds. It includes gross wages, pensions, sole proprietor income, dividends, unemployment benefits, payments made on behalf of the debtor by others and child support actually received.

If the Debtor’s income is below the median household income for his state and the size of his family, then there is no need to fill out the rest of the Means Test. You can stop there. The presumption of abuse does not apply. It is OK to file a Chapter 7.

What are expenses? While the income calculation is based on the personal circumstances of the debtor, the expense calculation begins with figures published by the IRS, which are national standards. The IRS has determined allowances for food, clothing, housing expenses, transportation and medical expenses based on family size for different areas of the country. These national standards are adjusted for remaining debt payments on houses and vehicles, payroll taxes, education expenses for minors (but only within strict limits), court ordered support payments, mandatory retirement payments, necessary and provable healthcare payments that exceed the national standards and past-due priority claims, like taxes and child support.

What is the amount proportional to the debtor’s total unsecured debt? In determining abuse Congress looked to how much a debtor could repay every month and also to what percentage of his total unsecured debt he could repay in the maximum of 60 months of a Chapter 13 bankruptcy. Then Congress indexed these figures for inflation.*

As of the writing of this blog*, if a debtor’s Means Tested income minus expenses is less than $130.37 per month, there is no abuse and the debtor can go on and file a Chapter 7. If a debtor’s Means Tested income minus expenses is greater than $207.92 per month, there is always a presumption of abuse and the debtor should consider filing a Chapter 13 or not at all, unless there are special circumstances like the Debtor took a lower paying job during the 6 months prior to filing. If the debtor’s Means Tested income minus expenses falls between these figures, then it is necessary to look to the total of the unsecured debts. If the Means Tested net income shows the debtor can repay more than 25% of these debts in 60 months then abuse will be presumed and the debtor had better consider filing a Chapter 13 or not at all. If the ratio of monthly net income times 60 months to unsecured debts is 25% or less of the debts, then Congress deemed this to be a negligible amount and it is OK to file a Chapter 7.

The Means Test is dreaded not only because it prevents certain people from filing a Chapter 7 bankruptcy, but because it is such a darned hard test to take.

Are my income taxes dischargeable in a bankruptcy?

Income tax issues in bankruptcy are a can of worms.  In only limited cases are taxes or tax penalties dischargeable in bankruptcy.  The primary issue is timing and a separate analysis must be done for eachCanWorms- year’s taxes, interest and penalties.

In bankruptcy each tax debt or claim will fall into one or more of the following categories:

1)  Allowed secured claims include taxes, interest and penalties for which the IRS has filed a lien.  To the extent that the lien is not under-secured, they are probably not dischargeable.  However, in a Chapter 7 the penalties for late payment may be.

2)  Unsecured priority claims are usually paid in full in a Chapter 13, including interest but not penalties.  But the interest does not continue to accrue once the Chapter 13 is filed.  They are not dischargeable in a Chapter 7.

3)  Unsecured claims that are dischargeable in a Chapter 13 or a Chapter 7.  To qualify the tax return must have been filed on time, or in some cases if late must have been filed more than 2 years before filing bankruptcy.  It must have been more than 3 years since the tax return was due before filing the bankruptcy.  Also, the IRS must have notified the debtor of the taxes due (the assessment date) more than 240 days before filing.

Taxes are never dischageable if a return has not been filed, if a fraudulent return was filed or if the debtor willfully attempted to evade paying the tax.

The analysis of each year’s taxes begins with requesting a transcript from the IRS.  The debtor should file a Form 4506-T  Request for Transcript with the IRS (available on their website http://www.irs.gov/Forms-&-Pubs) for each year that may be dischargeable.  The transcript will show if the return was filed on time, or if it was late when it was filed, if the return was due within 3 years of filing bankruptcy and if the taxes were assessed within 240 days of filing bankruptcy.  Short take is that the tax return has to have been filed and the taxes have to be old.  Tax debts are the most frequently nondischargeable debts in bankruptcy.