The New Bankruptcy Law
Below is a MRR and PLR article in category Finance -> subcategory Other.
Understanding the New Bankruptcy Law
Introduction
With the implementation of the new bankruptcy law on October 17, 2005, many are confused about the "means test" requirement. This article aims to clarify how the means test determines eligibility for Chapter 7 or Chapter 13 bankruptcy, helping consumers understand how these new rules might affect them.
The Role of the Means Test
Traditionally, bankruptcy is associated with Chapter 7, where unsecured debts can be fully discharged, giving debtors a chance for a fresh start. Chapter 13, however, requires debtors to repay a substantial portion of their debts over three to five years, typically five under the new law.
Before the "Bankruptcy Abuse Prevention and Consumer Protection Act of 2005," many filed under Chapter 13 to preserve equity in their homes or property. While this remains a factor, the new law mandates many to choose Chapter 13, regardless of equity, based on their income level.
How the Means Test Works
The means test examines a debtor's average income over the six months before filing, comparing it to the state's median income. For instance, in California, the median annual income for a single wage-earner is $42,012. If your income is below this median, Chapter 7 could be an option. If it exceeds the median, further evaluation is required.
Next, the courts calculate your income after subtracting living expenses (excluding debts in bankruptcy). This figure is multiplied by 60, representing five years of income available for debt repayment.
- If this five-year total is $10,000 or more, Chapter 13 is unavoidable. Essentially, if you earn above the median and have at least $166.67 monthly disposable income, you cannot opt for Chapter 7. For instance, $200 monthly excess income equates to $12,000 over five years, pushing you towards Chapter 13.
- If above the median but with less than $166.67 monthly for debt, the final test is applied. If your available income is below $100 monthly, Chapter 7 remains an option. If between $100 and $166.66, it’s compared against 25% of your debt.
For example, with $125 monthly available income on a $50,000 debt: $125 times 60 equals $7,500. As $7,500 is less than 25% of $50,000, Chapter 7 is possible. However, if the debt is $25,000, that $7,500 exceeds the 25% threshold, requiring Chapter 13.
Practical Steps
1. Determine if your income is above or below your state's median (find figures at http://www.new-bankruptcy-law-info.com). Include your spouse's income if applicable.
2. Subtract your average monthly living expenses from your monthly income and multiply by 60.
- Above $10,000 directs you to Chapter 13.
- Below $6,000 keeps Chapter 7 as an option.
- Between $6,000 and $10,000 requires comparison against 25% of your debt?"exceeding this means Chapter 13.
Considerations and Challenges
An important aspect of the new law is that the court uses IRS schedules for living expenses, not your actual expenses. This can lead to disparities, as household budgets often differ from IRS figures. Thus, even if you seem eligible for Chapter 7, the court may still mandate Chapter 13.
Uncertainties remain, especially regarding mortgage or rental costs that exceed IRS guidelines. Will debtors need to adjust to cheaper housing to meet court standards? The practical interpretation of these rules will evolve as more cases are processed in the court system.
You can find the original non-AI version of this article here: The New Bankruptcy Law.
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