If a consumer sees no way to pay their debt, they may decide to file for bankruptcy in California. Most filers choose Chapter 7 bankruptcy, which liquidates nonexempt assets to pay creditors. However, filers must pass a means test to determine their eligibility.
How the bankruptcy means test works
Congress enacted the means test as part of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005. This legislation attempted to make Chapter 7 bankruptcy harder to file so that high earners wouldn’t take advantage of it, getting debts discharged that they actually had the ability to pay.
The means test focuses on whether the filer has enough income to pay creditors with a two-step process. The first part compares the filer’s gross income to the state median for a household of a similar size. If they fail this step, the court will deduct allowed expenses from their gross income, so they can still pass.
When consumers fail the means test
Filers who fail both steps cannot file Chapter 7 and must try Chapter 13, which is a repayment plan. There are a few exemptions:
- A disabled veteran with a minimum 30% disability rating
- A service member who had to get discharged because of injury
- An active homeland security service member or reservist who accrued half of the debt during service of at least 90 days
- A consumer who has at least 50% business debt
If the filer believes they qualify, they should recheck exemptions, their household size, income deductions and updated income. They should ensure that they are using updated income and not include Social Security or dependent benefits, which helps lower income. Eligibility for Chapter 7 is based on six months of income, so if they wait, they could qualify.
Sometimes, filers who fail the means test may pass the test with a special circumstance, such as a medical issue. Bankruptcy should be a last resort since it impacts credit for several years.