Impact of the New Bankruptcy Act and the Means Test

INTRODUCTION

On October 17, 2005, the new Bankruptcy Abuse Prevention and Consumer Act of 2005 (the “Act”) became effective, which resulted in multiple and complex changes to consumer bankruptcy. Arguably the most important new provision of the Act is the so-called “means test,” which is a calculation of income and allowed expenses to determine whether a debtor is eligible for Chapter 7, or if the debtor has the “means” to pay a portion of the debt in a Chapter 13 bankruptcy.  This article will review the impact of the Act on case filings, and application of the means test to residents of northern Minnesota and northern Wisconsin.

IMPACT OF THE ACT ON CASE FILINGS

Clearly, the most immediate impact of the Act has been a dramatic decrease in the number of bankruptcies filed in northern Minnesota and northern Wisconsin.  In northern Minnesota, 554 Chapter 7 cases were filed in 2005 to date, and in 2006, 136 Chapter 7 cases have been filed to date. In northern Wisconsin, 1,804 Chapter 7 cases were filed in 2005 to date, and in 2006, 357 Chapter 7 cases have been filed to date.  Although the Act is intended to cause more Chapter 13 filings, there have been only 37 Chapter 13 filings in northern Minnesota in 2006 to date, compared to 88 in 2005. In northern Wisconsin, there have been only 8 Chapter 13 filings in 2006 to date, compared to 29 in 2005.

It was widely anticipated that total bankruptcy filings would decrease significantly after the Act became effective.  However, it was equally anticipated that bankruptcy filings would resume as practitioners became familiar with the Act and the means test, which is now occurring.  Although the Act is intended to cause more Chapter 13 filings, it does not appear that the means test will cause a significant increase of Chapter 13 bankruptcies in northern Minnesota and northern Wisconsin.

Under the Act, a debtor must first consider whether the debtor will be eligible for Chapter 7, or if the debtor must instead file a Chapter 13.  The beginning point is calculating “current monthly income,” which consists of average monthly income from all taxable and non-taxable sources over the last six months.  Social security payments are specifically excluded from the definition of current monthly income.

After calculating current monthly income, the debtor must then compare current monthly income to the median income for the debtor’s state.  The 2005 median family incomes for Minnesota and Wisconsin are as follows:

If a debtor’s current monthly income is equal to or less than the state median income (depending on the size of the household), the debtor is eligible to file Chapter 7.  In other words, there is no further consideration of the means test.

If a debtor’s income is greater than the state median, the debtor must pass the means test in order to be eligible for Chapter 7.

Assuming that the debtor’s current monthly income is greater than the state median income, the next step in applying the means test is deducting the debtor’s monthly expenses from current monthly income.  However, rather than using the debtor’s actual monthly living expenses, the Act now includes a set of expenses established by the Internal Revenue Service (“IRS”). The allowed monthly living expenses established by the IRS involve a complex combination of national, local and regional expenses in three primary categories as follows:

1. Food, clothing and other items;

2.  Housing and utilities;

3. Transportation.

In addition to the IRS monthly expenses, the Act allows debtors to deduct some additional expenses for caregiving, education expenses for dependent children, and sometimes additional housing and utility expenses.

Again, as stated above, the means test is only applied to a debtor whose current monthly income exceeds the state median income.  If a debtor’s current monthly income exceeds the state median income, an application and summary of the means test is as follows:

-If the debtor’s surplus monthly income after deducting allowed expenses is less than $100, the debtor “passes” the means test, and is eligible to file Chapter 7.

-If the debtor’s surplus monthly income after deducting allowed expenses is between $100 and $166.66, and the debtor can pay 25% of unsecured debts, such as credit cards and medical bills over five years, the debtor “flunks” the means test, and is ineligible for Chapter 7.

-If the debtor’s surplus monthly income after deducting allowed expenses is more than $166.66, the debtor “flunks” the means test, and is ineligible for Chapter 7.

Flunking the means test results in a presumption of abuse, which allows the court to dismiss the Chapter 7, or the debtor may voluntarily convert the case to Chapter 13.

Like most laws, there are exceptions to application of the means test under the Act, as follows:

-Many debtors in northern Minnesota and northern Wisconsin have income below the state median, and they will not be subject to the means test.

-The means test only applies to a bankruptcy case where the debts are primarily consumer debts as opposed to business debts. 

Some examples of application of the means test are as follows:

• Jim and Barb from northern Wisconsin have a combined current monthly income of $45,000.00, and credit cards, medical bills and other debts of $30,000.00.  Since their current monthly income is less than the Wisconsin median income of $49,918.00, they are eligible for Chapter 7, without further application of the means test
  
  
• Bill and Dottie from northern Minnesota have two children, and a combined current monthly income of $80,000.00.  Since their current monthly income exceeds the state median income of $75,990.00, they must continue to apply the means test by deducting allowed monthly expenses.  After deducting the allowed monthly expenses, their surplus monthly income exceeds $166.67 per month. Therefore, there is a presumption of abuse, and Bill and Dottie are ineligible for Chapter 7.
  
  
• Phil and Donna from northern Wisconsin suffered an unfortunate fire at their business, and are forced to file for bankruptcy. They have otherwise been financially responsible, and have virtually no consumer debt.  Since their debts are primarily business debts, they are eligible to file Chapter 7 bankruptcy without consideration of the state median income or other application of the means test.