Chapter 7 Bankruptcy Income Limits

Most people who file for bankruptcy because of personal debt file Chapter 7 bankruptcy, a four-to-six month process that, in theory, “liquidates” a person’s assets to pay off their unsecured debt.

But you should know there is an income limit to Chapter 7 – kind of.

To qualify for Chapter 7, you must pass a “means test” which you will, if your family income is under the median income for a family your size in your state.

If not, you must pass the secondary “means test” which is a lot tougher. The secondary means test weighs your income against your expenses to determine whether you actually have the means to pay your debt.

“About 90% of the people who file bankruptcy can file Chapter 7 based on their income alone because their income is below the median for a family of their size in their location,” Pamela Foohey, a professor of law at Benjamin N. Cardozo School of Law, said.

The reason the state median isn’t an “income limit,” is that those whose income is higher may still be able to file Chapter 7 if the means test determines they don’t have the income to pay the debt they owe. Those who don’t pass the means test, but still want to file bankruptcy will have to file for Chapter 13 bankruptcy instead.

The means test is part of the 2005 Bankruptcy Abuse Prevention Consumer Protection Act (BAPCPA), designed to limit bankruptcy fraud after a record million-plus Americans filed for personal bankruptcy in 1996 despite a relatively strong economy. BAPCPA was the result of a decade of wrangling over how to turn that around., but a record 2.08 million bankruptcy cases were filed in 2005, the year the law passed.

The Bankruptcy Means Test

Every state has a different median income, the number at which half the incomes in the state are less than and half are higher than. The number is determined by the U.S. Census and changes several times a year.  The more people in the household, the higher the number can be. To determine whether you meet the “income limit” to file for Chapter 7, your average income over the previous six months must be lower than your state’s median. That’s the first step in the means test, and often the only one those filing Chapter 7 bankruptcy have to take.

“The means test is rarely a stumbling block,” said Foohey, who is part of the Consumer Bankruptcy Project, an ongoing study of people who file bankruptcy. “When it passed BAPCPA, Congress may have thought that people were abusing the bankruptcy system. In reality, the people who file bankruptcy make less than the median comparable household, own little property, and owe a lot of debt. Most have struggled to pay their debts for years. They are in need of the help that bankruptcy law provides.”

Exceptions to the Means Test

There are two exceptions to the means test: Filers with more than 50% non-consumer debt (business debt) don’t have to take the means test, since the debt comes from “business or profit motive.”

Foohey said that exception doesn’t apply to most people who file Chapter 7 bankruptcy. “There are only two types of debt – business and consumer. If someone does not own or run a business, thereby incurring debt in the course of that business, they should exclusively have consumer debt,” she said.

Another is the Exception for Qualifying Service Members and Veterans. Because of passage of the 2018 HAVEN Act (Honoring American Veterans in Extreme Need), the service income of disabled veterans, reservists on active duty and National Guard members aren’t included in household income calculations. Veterans and active-duty military may find themselves with a lot of financial challenges as they deploy or frequently move. But there are also a lot of veteran debt relief options and benefits.

People who derive their income solely from Social Security also don’t have to take the means test.

Calculating your Household Income

To determine your Chapter 7 bankruptcy income limit, add the last six months of your gross income – this is what you earned before taxes and other deductions were taken out. Divide that number by six. While that may seem like a waste of time – why not just take one month instead of adding six, then dividing by six? – income can vary month to month, and the means test finds the average. Your figure should include not only your wages, but also rental income, child support, alimony, pension or other regular monthly income. Social Security income does not count.

After you’ve added six months of gross income and divided by six, multiply the result by 12. What you get is your annual household income.

For example, let’s say you make $2,500 a month, gross, at your main job; you also have a part-time job where the hours vary, which means your earnings also vary. In that job, you made $500 in January, $400 in February, $450 in March, $200 in April, $500 in May and $400 in June.

Six months of your main job ($2,500 X 6) is $15,000.  Six months of your part-time job wages added up comes to $2,450 for total income of $17,450. Divide that number by six = $2,908 for an average monthly income. Multiply that by 12 and you get an annual income of $34,900.

Congratulations! No matter what state in the U.S. you live in, your income of $34,900 is well below the state median and you pass the Chapter 7 means test.

Finding the Median Household Income of Your State

The next step in determining your Chapter 7 income limit is to compare your household income to the median household income of your state.

The median household income for your state is determined by the U.S. Census Bureau and changes frequently. In 2021, the lowest median in the country was Mississippi’s, with a median of $45,317 for a one-person household. The highest was Hawaii’s, at $72,396.

The U.S. Department of Justice, which oversees the country’s bankruptcy courts, makes it easy for you to find out what the median in your state is, though. Its means testing webpage has a box titled “Data Required for Completing the 122A Forms and the 122C Forms,” with a dropdown that has the latest state median household income data.

If your median income is below your state’s median, you’ve met the income limit for Chapter 7 bankruptcy and don’t have to complete the rest of the means test.

Your Current Monthly Income vs. Your Household Expenses

“Just because someone’s income is higher than the median for a family of their size in their location does not mean that they cannot file chapter 7,” Foohey said.

Getting professional help when filing may also help you meet the income limit for Chapter 7 bankruptcy when it comes to sorting out income vs. expenses.

Andrew Latham, a certified personal finance counselor and managing editor at Supermoney.com, suggests talking to an experienced bankruptcy attorney.

“There are ways to qualify for a Chapter 7 bankruptcy even if your income is higher than the state median for a family your size,” Latham said. “For example, you can deduct eligible expenses, such as your mortgage, car payments, health and life insurance premiums, taxes, child care, and charitable contributions.”

That’s why the means test is only “kind of” an income limit for Chapter 7 bankruptcy. If your income is higher, it means you have more math to do. Simplified, you have to determine your disposable income, which is what you have left after paying your living expenses. But it’s not simple. What you may think is necessary for living month to month may not be the same thing the bankruptcy court thinks is necessary.

It may be worthwhile to hire a bankruptcy lawyer to help at this point. Hiring a bankruptcy attorney generally costs between $1,500 and $2,500.

Here are some of the things to keep in mind when determining allowable monthly expenses:

Paycheck Deductions

Paycheck deductions are those things that are taken out of your wages before you get your check. This includes taxes, Social Security payments, insurance, health and flex savings accounts and retirement savings. These are all considered allowable expenses.

Wage Garnishments

Wage garnishments are also deducted from your paycheck, but they are not allowable expenses. Wage garnishments are by creditors and are taken as a last resort if you’re way behind on payments.

Monthly child support and alimony payments, however, are considered allowable expenses because they are not discharged through the bankruptcy process. In other words, you are required to make these payments even after bankruptcy.

Regular Living Expenses

Some living expenses are calculated nationally, while others vary by region.

National standards are determined by the Bureau of Labor Statistics Consumer Expenditure Survey, which collects information from people across the country on their buying habits as related to their income and type of household.

These apply to:

• Food
• Housekeeping supplies
• Apparel and services
• Personal care products and services
• Health care

Local standards differ across the country. For instance, those who live in a cold climate will pay more for home heating than those who don’t. Transportation expenses can vary wildly depending on whether a region has public transportation or it’s a remote rural area where owning a car is a must to get to work. The cost of housing also varies greatly depending on region.

These expenses include:

• Utilities/housing maintenance
• Mortgage/rent
• Transportation
• Vehicle operating

Necessary Expenses

Some monthly expenses are necessary, but aren’t included in the allowable living expenses. As you list these, keep in mind that you’ll have to document them if you’re audited by your district U.S Bankruptcy Trustee.

Necessary expenses generally include:

• Term life insurance
• Education required as a condition of employment
• Caring for a disabled child
• Child care
• Medical debt
• Insurance premiums
• Charitable contributions

Ongoing Debt Payments

Secured debt, which also won’t be discharged in a bankruptcy, is also an allowable expense. This includes car and mortgage payments. Secured debt differs from unsecured debt in that it’s “secured” by the item you’re paying for. If you don’t make your house payments, the bank can foreclose. If you don’t make your car payments, the lender can repossess your car. Bankruptcy is to clear unsecured debt – things like credit card debt, medical debt and personal loans, which aren’t tied to a specific item that can be retrieved if you don’t pay.

Monthly tax payments to catch up on tax debt are also allowable.

Passing the Means Test

Passing the means test doesn’t mean that you are all set to go on a Chapter 7 bankruptcy. There are still many steps to take before your unsecured debt is discharged.

The next step is documenting income and expenses through the Schedule I and J forms, officially Form 106I and 106J. On Schedule I you list monthly income – every single place you get money from on a regular basis. Schedule J is for all your monthly expenses. The court uses this information to determine, even if you passed the means test, whether you have enough money to pay creditors. If the court thinks you do, it may convert the case to a Chapter 13 bankruptcy.

Keep in mind, too, that just because you qualify for Chapter 7 doesn’t mean you should file for bankruptcy. Chapter 7 may get rid of all your unsecured debt, but it also stays on your credit report for 10 years. It makes it difficult to get loans or credit, including for buying a house or car.

A required part of the process of filing is taking a required credit counseling course. This course may help you put your finances in perspective, and you may decide that a debt management or debt settlement plan may be less disruptive and a better option.

Failing the Means Test

If you fail the means test? “The options are to file Chapter 13 or not file bankruptcy at all,” Foohey said.

Chapter 13 bankruptcy is a longer and more complicated process, particularly if people have a lot of assets, including owning a house, that they want to keep.

“People who file Chapter 7 have access to a relatively quick discharge of most of their debts,” Foohey said. “Chapter 13 requires people to pay their creditors a greater percentage of the debts owed through their income over a 3-to-5-year repayment plan.”

She added, “In many cases, the people who are ‘forced’ to file Chapter 13 also have assets and debts that make Chapter 13 a better legal choice.”

Michael Cibik, of Cibik & Cataldo, in Philadephia, said that Chapter 13 is “a great alternative” for those who aren’t eligible for Chapter 7.

“Instead of getting all your debt discharged in Chapter 7, you would get the same debt discharged in Chapter 13, but would pay a percentage on the total,” said Cibik, who is a former bankruptcy trustee and has handled more than 15,000 bankruptcy cases as an attorney. He said people who file Chapter 13 generally may only have to pay 10-20% on the dollar back to creditors of unsecured debt.

With Chapter 13 bankruptcy, you agree to a repayment plan for your secured debt that’s determined by the court, your trustee, you and your creditors. It’s based on your income and assets, with a focus on making sure your secured debt is paid. Once you successfully complete the payment plan, unsecured debt that wasn’t paid off as part of the plan is forgiven.

If you have trouble sticking to the plan, it’s possible to return to the court to ask for modifications if your circumstances change, and many people do. Still, more than half of the people who file for Chapter 13 bankruptcy don’t make it to the end, most because they can’t make the payments. Those who don’t end up in the same situation they were before filing – creditors can again pursue repayment of the debt.

Because of the complexities involved with Chapter 13 bankruptcy, it’s a good idea to hire a bankruptcy attorney to help navigate the process.