Wednesday, March 30, 2011

Chapter 7 Bankruptcy: Above and Below Median Debtors and the “Presumption” of Abuse.

A "presumption of abuse" may prevent you from filing Chapter 7.  There are two prongs to determine a "presumption of abuse".  The first prong asks, "is your income above or below your state's median income?"  If you are below, then the presumption of abuse does not arise as you are a "below median debtor".  The second prong asks, "even if your income is above the state's median, do you pass the "means test"?"  If you "pass" the means test, then under application of the second prong, the "presumption of abuse" does not arise to allow you to file a Chapter 7 petition.

Below is the link to the table of state median incomes.

Let's use some examples to see how the presumption works:

Mr. and Mrs. X – family of 4
The above web link is a chart of the median income by state and family size.  For example, Mr. and Mrs. X have two children, and even though Mr. X is the only one filing for bankruptcy , we look for New Hampshire on the state chart for a family of four to determine that the state’s median income is $89,990 for a family of four. 

Mr. X earns a gross income of $35,000 as manager of a local grocery store.  Mrs. X works at a day care center and earns $25,000.  Their combined gross income is $60,000.  The amount of $60,000 falls below the NH state median income average for a family of four ($89,990 is the median), so Mr. X may file for Chapter 7 bankruptcy as the presumption of abuse does not arise by virtue of his family's income falling below the state's median.  Mr. X had previously been out of work for about a year and was very ill, with no medical insurance.  So, the medical bills piled up and the credit card balances increased.  Mr. X intended to repay all of this debt once he got back on his feet, but because he could not find a job paying more than $35,000, he just can’t do it and is overwhelmed with the debt.

Because Mr. and Mrs. X earn below the median, a “presumption” of no abuse arises, and allows Mr. X to file for Chapter 7. 

A case may not be dismissed or converted to another chapter for the sole reason that Mr. X is a “below median debtor”.  Each bankruptcy petition has a box that must be checked off as to whether or not the “presumption” of abuse arises.

However, the inquiry does not end here.  Mr. X still must provide information about his family income and expenses on his bankruptcy paperwork, at the portion called Schedules I and J.   Even though Mr. X is a “below median debtor”, if he has substantial excess monthly income after paying his monthly expenses, which shows he has the ability to pay back a good portion of his debts, it may still present a problem for Mr. X to stay in Chapter 7, the substantial excess monthly income providing a separate basis for the Bankruptcy Court to consider dismissing his Chapter 7 bankruptcy petition or converting it to Chapter 13. 

Mr. X fills in the information on the bankruptcy schedules about his family’s combined monthly income and combined expenses to ascertain just how much money is left over at the end of the month.  He has nothing left over at the end of the month.

The way the Bankruptcy Code determines Mr. X’s average monthly income is to look at the prior six months and add up all of his family’s income from any source (here, it would be Mr. X’s pay checks for the past six months, Mrs. X’s pay checks for the past six months, an income tax refund they received last week, and six $100 monthly checks from Mrs. X’s mom who helps them out every month).  Mr. X adds up all of this income from all sources for the past six months, then divides the total by the number six, which gives Mr. X the average monthly income for the X family.  On the bankruptcy schedules, Mr. X then deducts his family’s monthly expenses in the categories allowed (such as mortgage, taxes, utilities, food, etc.) to arrive at his net monthly income.  In Mr. X’s case, after doing this, he has no money left at the end of the month. As such, it does not appear to be a problem for him to file a Chapter 7 case and stay in Chapter 7 and receive his discharge of debt.  The Chapter 7 bankruptcy case normally would discharge all of Mr. X’s unpaid credit card debt and all of his unpaid medical bills.

Mr. and Mrs. Z – family of 4
Mr. Z has pretty much the same situation as Mr. X above.  Mr. Z was out of work for quite a while, but Mr. Z now has a job and has been working for the past six months.  However, Mr. Z just cannot get out from under the debt that accumulated while he was out of work – it is mainly medical bills and credit card debt.

Mr. Z is married, his wife does not have an income and they have two children.  They also live in NH and their gross annual income is now $99,000.  On the NH median income chart (above web link), for a family of four, the median income is $89,990.  So, Mr. Z is an “above median debtor".  While he has failed the first prong of the test, he still has a chance to avoid the "presumption of abuse" under application of the second prong, namely taking the “means test".  Thus, because Mr. Z's family income falls above the median, he must fill out the paperwork called the “means test” to determine if after deducting certain expenses allowed by the Bankruptcy Code, his net monthly income now qualifies him for Chapter 7.

The above web link is the list of allowed expense deductions (called the National and Local Standards) as appicable to an “above median debtor” – so, the above median debtor is not necessarily able to deduct all of his family’s monthly expenses, but rather only those expenses allowed by statute in these Standards.  The means test was designed by Congress to see if Mr. Z has the “means” to pay back a portion of his debt after comparing his monthly family expenses to his monthly family income, under the allowed formula.  If the formula determines that Mr. Z has the “means” to pay back a portion of his debts, then normally Mr. Z would not qualify for Chapter 7 but could still file a bankruptcy case under another chapter, normally a Chapter 13 case.  Chapter 13 bankruptcy still allows Mr. Z to discharge his unpaid medical bills and credit card debt, but only after he has completed a repayment plan which normally pays back a percentage of these debts.

Back to Chapter 7:  After filling out the means test form, Mr. Z learns that he has passed the "means test".  He may file a Chapter 7 bankruptcy petition.

Mr. and Mrs. A
Mr. A is in the same situation as Mr. Z – Mr. A is back to work after losing his job.  He now has an annual gross income of $99,000 with two children and Mrs. A has no income.  However, unlike Mr. Z, after applying the Standards for expenses to his income, Mr. A still has monthly income in excess of that allowed under the "means test" and his income still does not fall below the median.  Because of this, he cannot file a Chapter 7 case.

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