Individuals often seek chapter 7 bankruptcy relief to obtain a “fresh start” to discharge debts they have difficulty satisfying. In most chapter 7 cases “eligible” debtors discharge most if not all of their debts and keep most if not all of their property. If they do not properly plan however, they could be shut out of chapter 7, where debts can be discharged in as little as 3 months. Instead, the only alternative may be a choice between a chapter 13 bankruptcy (where creditors are paid all or a portion of their debts from the debtor’s future income over three to five years), or not filing at all. As soon as financial trouble appears on the horizon it is critical to consult with a qualified bankruptcy professional so proper planning can occur.
Timing comes into play in numerous aspects of bankruptcy planning. One example is in application of the “Means Test” for debtors with consumer debt.
Bottom line, the “Means Test” is nothing more than an eligibility test. The test has nothing to do with the “present” income of the debtor notwithstanding that (i) the average of the prior 6 months income is called that person’s “current monthly income” and (ii) that number multiplied by 12 is used to determine yearly income for eligibility purposes.
Fixed Local and National Expense Standards, secured debts on which payments are currently being made, limited other expenses and in some cases special circumstance expenses are deducted from the “current monthly income” amount. The difference between the “current monthly income” and allowable expenses equals that person’s disposable income. If the disposable income is over a certain amount, the individual will be ineligible for chapter 7 relief. That leaves the options of not filing bankruptcy at all or to file under some other chapter where disposable income will be paid to creditors over time. Oftentimes an individual who does not pass the “Means Test” will balk at filing a chapter 13 wage earner plan because their actual expenses exceed the Local and National Standard expenses thus leaving them with higher disposable income on paper than they really have in their pocket at the end of each month. Many debtors are not prepared to change their lifestyle to make a chapter 13 plan work. For example, the boat, family vacations and child’s college expenses are not allowed expenses in a chapter 13.
A person earning more that the median income during the 6 month look back period but who is presently underemployed, unemployed with no earnings, or declared permanently disabled and unable to work, will not pass the Means Test. Whether fair or not, they must wait until their “current monthly income” is below the Means Test median income amount or their disposable income low enough to pass the Means Test. In the meantime collection activity and lawsuits will not be stayed and assets that otherwise might be exempt from the reach of creditors in bankruptcy can be seized and lost.
A more common scenario is where an individual has spiraled downward financially over a period of time from job loss or reduction in income and decides to file bankruptcy only after they have gotten back on their feet and secured employment or higher income. If they wait too long to file bankruptcy they may be subject to the Means Test or not pass the Means Test thereby foreclosing the ability to discharge debts in a chapter 7 case – something that might have been possible had they filed when they had little or no income. The result is that they may have assets seized or have to pay money to creditors in a chapter 13 reorganization from their disposable income that they could have otherwise discharged. If no bankruptcy is filed they will have to deal with continued creditor collection efforts. Individuals who do not learn their rights and plan appropriately often find out that they used assets that would be exempt in bankruptcy to pay debts that could have been discharged – precious money that could have been saved or used to obtain proper legal advice.
When money is tight people think that they cannot afford to file bankruptcy or even a nominal bankruptcy consultation fee. The exact opposite is often true – they cannot afford to not file bankruptcy or not get proper advice. The reality is that early intervention, education, planning and proactive action will provide peace of mind and better outcomes for most people.