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Why Bankruptcy Means Test Is Paper Tiger In Bay Area

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Bankruptcy’s means test is a paper tiger in the San Francisco Bay Area.

Really!

You can see why few Bay Area residents are constrained by the means test when you compare the latest median income figures  used in the means test with the allowed cost of rental housing here.

To review:  Congress  in 2005 tried to write a universal formula to limit bankruptcy relief to those who “needed” it. Bankruptcy judges were to be stripped of discretion in favor of a formula that would be universal.

Those whose average income in the past six months exceeded the median for their state would have to show that they had little more than $200 a month left over after subtracting some standardized allowances for food, clothing and housing and their actual projected expenses for other allowed costs of living.

Never fear, the cost of housing in the Bay Area stands this formula on its head.  (While the exact numbers have changed since 2016, when this piece debuted, the principle remains the same.)

The means test numbers

The means test starts with the median income in the state for a family of each size.  Income numbers and the fixed deductions from income are updated twice a year.

The new numbers become effective for cases filed April 1, 2016 or after.  

Newer numbers don’t change the story

Our survey says, the median income in California for a single person household is $ 50, 579.  Make a dollar more than that and you have to pass the means test to file Chapter 7.

That median income translates to a monthly gross income of $4215 for one person.

How does that work in the Bay Area?

Bankruptcy in San Mateo County

Apply the new cost of housing numbers, and passing the means test is a piece of cake:

The allowed deduction for rent for a single person in San Mateo County is $2508.  Non rent costs of housing like utilities add $461 a month to the cost of putting a roof over your head.

Seventy percent of a median income single worker’s gross income goes to housing! Most financial advisors target 31-35% of gross income for the cost of housing.

A single person in San Mateo County would have to gross nearly $9000 a month before their housing expenses were only one third of their gross monthly income.

Since the numbers vary by the size of the family, let’s look at a hypothetical  family of four in San Mateo County.

Median income for a family of four in California is $81,837, or $6820 a month, before taxes and other deductions.

Rent in San Mateo County for those four people is $3462, with an additional $636 in additional housing expense.

Our median income family is paying 53% of their gross income for housing.  They’d have to gross $12,418  before the allowed cost of housing was only one third of their income.

With slight variations, the result is the same for all Bay Area counties.

What the numbers mean for Bay Area debtors

It’s no news that it costs a lot to live in the Bay Area.

After you’ve put a roof over your head, there isn’t a lot left for all the other things that you need, like food, transportation and health care.  All of those things are deductible on the means test as well.

Not to mention reserves for the unexpected, savings for college, and provision for retirement.

So, if you are servicing credit card debt, you are probably spending money on long ago purchases that is desperately needed  for current expenses.

Know that the means test is not likely to bar you from bankruptcy.

Only you know what is keeping you from a fresh start.

More about deciding about debt

Alternatives to bankruptcy

What holds you back

Bankruptcy makes the future better

Image:  licensed under Creative Commons license by Cucchiaio

Updated with April, 2016 numbers.

Does Bankruptcy Bar Retirement Savings?

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Ongoing retirement saving by Chapter 13 debtors has been a touchy subject since the means test became a part of the bankruptcy scene.

The means test was intended to squeeze every available dollar from consumer debtors. It works by limiting the expenses that can be deducted from income in figuring what a debtor can/must pay his existing creditors.

Retirement savings accounts have been broadly protected from the reach of Chapter 7 trustees and excluded or exempted in the asset analysis in Chapter 13.

But courts have been split over whether debtors are permitted deduct as a reasonably necessary expense their ongoing contributions to voluntary retirement schemes while in Chapter 13.

So, I’m cheering the 6th Circuit’s decision in Davis which held that monies withheld by a debtor’s employer to fund her 401(k) plan were an allowable deduction from income under the means test.

Ongoing 401(k) contributions allowed

The Davis decision effectively allows the debtor to reduce the amount the means test formula would require her to pay to her creditors by the amount of her 401(k) contributions.

The court described its ruling as narrow: it applied to contributions withheld by the debtor’s employer from her wages during the means test look-back period of six months.

Only by virtue of the provisions of Section 541(b)(7) that reference sums “withheld by an employer” were the contributions deductible in calculating “current monthly income”. The self employed or those whose contributions to retirement savings took another form are not protected like Ms. Davis.

In deciding that Ms. Davis could make ongoing 401(k) contributions, the appeals court had to wade through more sloppy drafting of the bankruptcy “reform” act of 2005. The drafters inserted this protection for ongoing contributions to retirement in a section that deals with property of the estate, rather than with the means test. The Davis decision decided that the judicial canon that says “every word matters” trumped the location of the text in the Bankruptcy Code.

Californians still barred from savings

Sad to report, but the retirement-friendly Davis decision comes from the 6th Circuit, not the 9th Circuit which includes California.

federal judicial circuits

The 9th Circuit BAP held in Parks, 475 B.R. 703 (B.A.P. 9th Cir. 2012) that a Chapter 13 debtor could not deduct any voluntary retirement contributions in calculating what debtors pay in Chapter 13.

While it’s unclear the extent to which BAP decisions bind bankrutpcy courts in its circuit, as a practical matter, it will take an appeal to the 9th Circuit or legislation to assure Californians filing bankruptcy that they can continue to make provisions for their old age.

Retirement savings are necessary

I’ve long advocated for treating retirement savings as a necessary expense for purposes of both the means test and the debtor’s projected budget.

It is ludicrous to contend that individuals don’t have to make regular and meaningful contributions to their retirement accounts to enjoy a stable retirement.

And by mandating that savings are not permitted in Chapter 13, we condition debtors to spending every penny they make either for current living expenses or plan payments to deal with past debts. We forfeit the opportunity to habituate debtors to looking at their needs beyond the upcoming month.

Planning to file bankruptcy

Too often, individuals find themselves filing bankruptcy with little or no forethought. But if you see a bankruptcy in your future, and have the opportunity to have 401(k) contributions deducted from your paycheck, do it.

Skip Bankruptcy’s Means Test

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skip means test

The couple was despondent when another bankruptcy attorney told them that, despite $100,000 in old taxes, they couldn’t file Chapter 7.

This fine fellow told them that the means test showed they had $3000 of disposable income per month.  A Chapter 7 would be an abuse of  bankruptcy under the law.

Only Chapter 13 was possible, he said, and the monthly payment would be $3000.  That didn’t seem like any kind of relief from debts.

Only he never apparently considered the gating question:  were their debts were “primarily consumer debts”.

He forgot the gotcha baked into the means test:  it only applies to ***consumers.***

Only consumers have to prove they are worthy of the Chapter 7 discharge.

Folks with primarily business debts or, taxes aren’t subject to the means test.

So, lots of disposable income is not a bar to Chapter 7 when your debts are primarily taxes.

Who takes the means test

So, just why are some above median income families not subject to the means test?

Bankruptcy Code § 707 allows a judge to dismiss a Chapter 7 case  filed by an individual debtor under this chapter whose debts are primarily consumer debts …. if it finds that the granting of relief would be an abuse of the provisions of this chapter.

The means test is the tool for determining whether the debtor is (supposedly) able to pay their debts.

But,  the means test only applies to debtors whose debts are “primarily consumer debts”.

So, we need to know…

What is consumer debt

The Bankruptcy Code defines consumer debt:

 The term “consumer debt” means debt incurred by an individual primarily for a personal, family, or household purpose. § 101(8)

So, the gating question is:  why was the debt “incurred?”

Tort damages aren’t consumer debts either

Obviously, business debt was not incurred for a personal purpose.

Further, taxes are not incurred by choice, say the cases;  taxes are imposed by government.  And therefor, not a consumer debt.

And that’s the rule, even when the taxes are on personal, household income, or property taxes on the family home.

So, if the total of taxes (and other, non-consumer debt) is greater than the balance of the other debt a person owes, their debt is not “primarily” consumer debt.

And the means test ONLY applies to debtors whose debts are primarily consumer debts.

Skip the means test

The couple who were told that they couldn’t file Chapter 7 because of their generous income, in fact, can file Chapter 7 because their debt is overwhelmingly back taxes.

It doesn’t matter that most of their taxes are so old that the tax is dischargeable.

If it’s tax, it isn’t consumer debt.  And they don’t have to take the test.

More

Cheat sheet to pass means test

Discharging taxes

 

What Your Bankruptcy Lawyer Can’t Tell You

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bankruptcy secret about means testI can share a secret, just between us.

Bankruptcy “reform” in 2005 tried in a number of ways to discredit and gag lawyers from helping debtors.

One of those additions to the Bankruptcy Code prohibits lawyers from advising those filing bankruptcy from incurring new debt.  The statute makes no distinction about the kind of debt involved or the purpose served by the loan.

Lawyers are not to advise incurring new debt.

But I’m not your lawyer, so I can tell you what you need to know about cars.  Or really about car loans, since I know nothing about cars beyond that.

Cars and the means test

Car loans are the most frequently found secured debt.  And secured debts on cars are deductible on the means test introduced by bankruptcy “reform”.

The IRS standards, on which the means test is based, allowed a debtor deduct a certain amount per month to acquire a car.  Courts were split on whether you had to have a car payment to get the ownership allowance.

Then the Supreme Court in Ransom said  the debtor with a paid for car gets no ownership deduction.  But if you have some remaining payments on a car loan, you get to claim the full car ownership deduction  of $517 here in California on the means test.

More deductions on the means test, more likely you qualify for Chapter 7, or for a very cheap Chapter 13. [Read more…]

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