If you have consulted with an Arizona bankruptcy lawyer, you face the choice of filing a Chapter 7 or Chapter 13 bankruptcy. Chapter 7 is a basic bankruptcy that allows you to get a discharge of most of your debts. In return, you must turn over non-exempt property to the bankruptcy trustee. Most people don’t have to forfeit anything to the trustee because most of their property is exempt (for more information on what types of property a debtor is allowed to keep in bankruptcy, click here). An experienced Arizona bankruptcy lawyer will help a Chapter 7 debtor minimize property loss.
A Chapter 13 bankruptcy is a payment plan bankruptcy that requires debtors to make monthly payments for three to five years. Because Chapter 13 requires monthly payments, most debtors prefer to file a Chapter 7 because it is easier and cheaper. For more information on the differences between Chapter 7 and Chapter 13 bankruptcy, click here.
Your income may be too high to qualify for Chapter 7.
If your gross income is too high, you will be disqualified from Chapter 7 and forced to file a Chapter 13. Your gross income is too high for Chapter 7 if it exceeds the monthly median income for Arizona (which is set by the IRS). As of April 1, 2023, the current Arizona monthly median income for purposes of qualifying for Chapter 7 is as follows:
- One-Person Household: $5,348/month
- Two-Person Household: $6,687/month
- Three-Person Household: $7,516/month
- Four-Person Household: $8,679/month
- Add $825/month for each additional person
To determine whether your monthly gross income is too high to qualify for Chapter 7, add all of your gross income (i.e., before tax and insurance withholdings, 401(k) contributions, etc.) for the six months before filing and divide such amount by six. Let’s call this your “Average Six-Month Gross Income”. You include everything when computing your Average Six-Month Gross Income: gross income earned by both spouses, business income, rents received, unemployment, dividends and pension/retirement payments. The only source of income that is not included in this test is Social Security payments.
For example, let’s say you, your spouse and your two kids live together, forming a household size of four people. Assume you and your spouse want to file bankruptcy by the end of July. Both spouses will add up their gross income from January 1 through June 30 (the six months before the month you file–you don’t include income earned the month you file) and divide by six. Suppose such calculation yields an Average Six-Month Gross Income of $8,025/month. Because the Arizona monthly median income for a household size of four is $8,679/month, your Average Six-Month Gross Income is less than the state monthly median listed above, and you automatically qualify for Chapter 7. And because the test is based on your last six months of gross income, people who have had a bad six months are more likely to qualify. In other words, timing is everything. Confused? You’ve seen nothing yet!
The Means Test: More Confusing than Trigonometry?
If your Average Six-Month Gross Income exceeds the Arizona monthly median, you may still qualify for Chapter 7, but more detailed calculations must be performed. This is called the “Means Test” and gets very complicated. In a nutshell, you start with your Average Six-Month Gross Income. You then deduct certain monthly expenses from your Average Six-Month Gross Income, many of which are fixed by national and local IRS standards. These expenses vary according to your family size, county of residence, and other factors.
Some of the monthly expenses that you are allowed to deduct include:
- IRS standard allowances for living, housing, transportation and other necessary expenses (these are fixed expenses, regardless of your actual monthly expenses in these categories)
- Debt payments on secured and priority debts, such as mortgage and car payments, as well as court-ordered support payments (these expenses are whatever you actually incur on an average monthly basis and are not fixed by IRS standards)
- Monthly tax withholdings and payments (again, these amounts are not fixed; you deduct what you actually expend, so long as you have a good faith basis for such amount)
- Childcare costs (not fixed by IRS standards)
- Health insurance premiums and other out-of-pocket health care costs (not fixed)
For example, as of August 2023, the allocated monthly expense amount for food, clothing, personal care and other household items is $1,389/month for a household size of two. This category of expenses is based on IRS national standards and is fixed. If you have a household size of two and you actually spend less than $1,389/month, you still get to deduct $1,389/month from your Average Six-Month Gross Income. If you spend more than $1,389/month, you can only deduct the $1,389/month (unless the higher amount is necessary for your health and welfare, which is a rare exception for most debtors). If you have childcare and/or health care costs, you can deduct the average monthly amount you actually incur on such costs (as long as you have documents to support your listed amount). There is no fixed limit for these types of expenses.
After you deduct such expenses from your Average Six-Month Gross Income, the remaining amount left over is your “Disposable Monthly Income” (DMI). You multiply your DMI by 60 months, which is your “Total Disposable Income” over such a 60-month period (TDI).
- If your TDI is less than $15,150, you qualify for Chapter 7
- If your TDI is more than $15,150, you do not qualify for Chapter 7 and must file Chapter 13
- If your TDI is between $9,075 and $15,150, and such amount will pay less than 25% of your unsecured debt, you qualify for Chapter 7
- If your TDI is between $9,075 and $15,150, and such amount will pay at least 25% of your unsecured debt, you do not qualify for Chapter 7 and must file Chapter 13.
Never thought algebra and scientific calculators would come in handy again after high school, right?
As you can see, if your Average Six-Month Gross Income and/or your expenses are exceptionally low or high, this will make a difference in whether you qualify for Chapter 7. Strangely, those people with higher expenses in categories not fixed by the IRS standards (like high mortgage payments, car payments, health care costs, child care, etc.) may qualify for Chapter 7 more easily than someone with less expenses and is more fiscally responsible. Common sense? Maybe not. Blame Congress.
And, there might be other exceptions!
There is a major exception to having to pass the means-test. If your debts are primarily non-consumer debts (i.e., more than half of your total debt is business debt or tax debt), then you may qualify for Chapter 7, regardless of what your income is. Vice-versa, even if you do pass the means-test, if you are making more money, and the last six-months of your income artificially skews your income to be lower than what it truly is, then you still may be disqualified from filing a Chapter 7 and must file Chapter 13, even if you pass the means-test.
Yes, it’s complicated!
Have a headache yet? You aren’t alone. Even lawyers and judges get confused. If you only remember one thing, remember this: It is extremely complicated to do these calculations on your own. Millions of dollars and countless hours have been wasted litigating what the Means Test means. How can Congress apply an objective test to each person’s unique financial circumstances? If you attempt to figure all of this out by yourself or hire a document preparation service to do it for you, it will get screwed up and cause serious complications with your bankruptcy (which could cost you a lot of money). And I am not just saying that because I am an Arizona bankruptcy lawyer. I see it happen regularly. It is essential to consult with an experienced Arizona bankruptcy lawyer to assess your unique financial circumstances and determine what type of bankruptcy you qualify for.
Proceed with caution!