How bankruptcy means testing works
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Updated 4:48 a.m. UTC Jan. 25, 2024
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In 2005, Congress passed a hotly contested bankruptcy bill that tightened bankruptcy eligibility rules, thereby placing greater restrictions on eligibility to file Chapter 7 bankruptcy. One of the measures implemented by the new law was the bankruptcy means test.
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What is the bankruptcy means test?
The means test is the national, standardized way to determine how much of your debts you can feasibly repay (which may be very little). The results largely determine whether you qualify to file for Chapter 7 bankruptcy.
If you don’t meet the requirements and want to move forward with Chapter 13 bankruptcy instead, you’ll likely take a similar means test to assess the amount you’ll repay in a debt settlement plan.
Most individuals will complete some form of the means test when filing for bankruptcy.
How does it work?
The means test takes a snapshot of the last six months of your income and compares it to the median income in your state and to your personal debt and expenses.
Determines your total income
To average out any inconsistencies from seasonal earnings, the means test considers your total income for the six months prior to the month of your bankruptcy filing. For example, if you plan to file in July, the means test will evaluate your earnings for January through June.
To form a picture of your annual income, your six month earnings are used to calculate one average monthly income and then multiplied by 12. This also makes it easy to compare it to the statewide median annual income.
Cost of living
Since the cost of living varies greatly depending on your location, the means test considers how your income measures up to the median income for households of the same size within your state of residency.
If you earn less than the median income in your state, you automatically pass the means test.
As of October 2022, the Department of Justice reports this median income data for the following states.
For example, in a household of four, with an annualized income of about $70,500, you would automatically pass in all of the states listed above, since your earnings are below average. However, if you made the same amount of money, but only had two people in your household, you wouldn’t get an automatic pass in Alabama or Arkansas.
If you earn above the median income it is still possible for you to pass the means test by taking deductions.
Personal expenses
The test allows you to deduct acceptable expenses to determine how much you can afford to repay your creditors.
Acceptable deductions include the costs for housing, utilities, transportation, groceries, childcare, healthcare and other basic necessities. Secured debt payments, court-ordered payments, life insurance and other paycheck withholdings are also considered allowable expenses.
There are deduction limits for each category determined at both the state and federal level to guide your calculations.
Assess the numbers
The difference between your monthly income and expenses determines your discretionary funds. For example, if your monthly income is $5,800 per month and your expenses are $5,600, you have $200 in monthly discretionary funds.
The means test assumes that these discretionary funds are available for debt repayment and calculates how much you could repay in total over five years, or 60 monthly payments.
If the amount is under $9,075 or covers less than 25% of your total unsecured debt, you pass the means test.
If you can repay more than $15,050 or over 25% of your debt, there is a presumption of bankruptcy abuse and you need to either claim special circumstances that would still allow you to pass or consider another solution, such as Chapter 13 bankruptcy.
What to do if you pass
If you pass the means test, you cleared a major step to file Chapter 7. An optional next step is to get a lawyer. (You could also hire a lawyer as a first step to assist you in completing the means test.)
While you don’t need a bankruptcy attorney, one can be a valuable guide and increase your chance of success. The National Bankruptcy Forum estimates the total cost to file Chapter 7 with a lawyer ranges from $1,500 to $3,000. Many offer a free consultation.
Whether you work with a lawyer or not, you’ll also need to:
- Complete credit counseling. You are required to attend a credit counseling course no more than 180 days before you file for bankruptcy. A counselor can help you assess the best option for your circumstances. Many reputable credit counselors often offer their service for free or at low cost.
- Document your finances. You need to fill out the appropriate bankruptcy documents for the U.S. Court system.
- Be ready to pay some fees. Filing for bankruptcy isn’t free. It costs $338 to file a new petition and there are a series of miscellaneous court fees, including a $78 administrative fee.
With these steps done, you’re likely ready to petition for bankruptcy.
What to do if you fail
If you don’t pass the means test, you still have options.
Completing the required credit counseling could help you evaluate your next steps. Consider tapping the National Foundation for Credit Counseling, a network of nonprofit agencies, to start your search for help.
One option is to complete the other requirements and file for Chapter 7 anyway, noting special circumstances.
You could also switch your focus and aim for Chapter 13 bankruptcy. The result of the means test will help determine how much disposable income you have available for debt repayment in that type of filing.
Moving forward after bankruptcy
The US Bankruptcy Code allows debtors the opportunity to escape paralyzing debt and gain a fresh start. Despite the freedom that bankruptcy can offer, rebuilding your credit will require some time and effort.
The best thing you can do to rebuild credit is to pay your bills on time. The largest component of your FICO credit score is payment history (35%), followed closely by amounts owed (30%) and then length of credit history (10%), credit mix (10%) and new credit (10%).
Make sure to cover at least the minimum payment for all of your bills. If possible, set up automatic bill pay to ensure you’re not late on payments.
Following the bankruptcy discharge, when the process is complete, you’ll be eligible to take on new debt and start rebuilding your score that way as well. But given the severe negative impact of bankruptcy on your credit score, many lenders may not be willing to extend unsecured credit.
Instead, consider secured credit. Secured credit cards cover your credit line by retaining a cash deposit to protect the creditor if you default on your payment. Despite the difference in collateral, secured credit cards will impact your credit score just like unsecured cards.
Frequently asked questions (FAQs)
Chapter 7 bankruptcy protects certain cash assets. The federal government exempts an $1,512,350 in eligible retirement accounts. Additionally, funds held in Education IRAs, tuition savings, ABLE accounts are exempt unless those funds were deposited within the last one to three years. For those recent deposits, the federal government exempts $7,575.
Calculate all earnings for the six full months prior to your bankruptcy filing month. You should include wages, unemployment retirement payment, alimony, child support, any regular payment other family members make and all business or rental income. Benefits from the Social Security Administration are not considered income.
Divide this number by six to calculate your average monthly income and multiple that number by 12 to identify your annual income for bankruptcy.
You are exempt from the means test if more than 50% of your debt is business debt rather than consumer debt. Additionally, military service members may be exempt if they:
- Are a disabled veteran who acquired most of their debt while on active duty
- Are a Reservists or National Guard personnel who was called to active duty following September 11, 2001 and performed a homeland defense activity.
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