Nearly 8 years after the implementation of BAPCPA, and while not everyone understands it, most people have at least heard of the infamous “Means Test” – the form that calculates how much disposable income a debtor has available for his or her unsecured creditors. The Means Test looks back at your past six months of gross income, doubles it to compute your gross annual income, and compares it to the median income level for your state and household size. If below, you’re presumed to have no disposable income, and qualify for Chapter 7 Bankruptcy (if no prior bankruptcy disqualifies you). If above median, you must complete the second part of the Means Test, which accounts for certain actual expenses, certain debt repayments, and certain IRS living standards to compute disposable monthly income. Again, if your DMI is low enough or negative, you are in Chapter 7 territory. Too high, and you’re in Chapter 13 territory.
But is that the end of the income inquiry? No. You must still prepare a budget – Schedule I (income) and Schedule J (expenses). If, after preparing a reasonable budget, it shows that you have a considerable amount of disposable income – you could be forced into Chapter 13 Bankruptcy under 11 U.S.C. § 707(b). This provision, at (3) allows the court to either dismiss or convert a case if the totality of the circumstances demonstrates that the debtor filed a petition for Chapter 7 relief in bad faith, or that a filing would be abusive of the bankruptcy system. Most attorneys refer to this section as “the smell test” (if the case seems like it shouldn’t be filed under Chapter 7 – if it smells funny – then it perhaps shouldn’t be).
Why would the Means Test and the budget tell different stories about how much money a debtor has available for unsecured creditors? I have discovered three major themes that crop up every time there is a discrepancy between the budget and Means Test.
One. The Means Test does not count all income – namely, Social Security income. Usually not a big deal, since most people’s social security benefits are a pittance, their sole source of income, and not enough to cover their monthly expenses. Nevertheless, once I’ve ruled out a Means Test problem, if a debtor is getting SSA income, I do have to look at the big picture to make sure that my client is not going to have a budget problem.
Two. The IRS living standards are often more generous than what my clients actually spend. You wouldn’t think so, but I have found it to be true in the majority of my cases. Sometimes we have the opposite problem – an expense that is not an allowed deduction on the Means Test (which is a topic, perhaps, for a different day). But again, the big one I keep an eye out for is the debtor who does not have a home mortgage or rent expense. This may happen anytime they live with mom and dad, or with a boyfriend or girlfriend. The Means Test assumes a home payment. But if that expense doesn’t exist on the budget, that’s a significant expense that is missing.
Three. The Means Test looks to the past to predict the future. The budget just looks to the future. So, a single debtor with no kids who has been on unemployment for 4 out of the past 6 months may easily pass the Means Test, but if his new job has him making $60k a year, it is going to be difficult, if not impossible, to create a reasonable budget that shows he has no disposable income left over.
There is a fourth unusual circumstance. 11 U.S.C. § 707(b) applies only to debtors whose debts are primarily consumer debts. A debtor whose debts primarily arose from the operation of a business – they are not subject to the Means Test.
But what about their budget? 11 U.S.C. § 707(a) – which does apply to business debtors – allows the court to dismiss for “cause”. Three examples are given in this section, but they are not held out as an exhaustive list. Most courts have held that since the ‘smell test’ is laid out in 707(b), if Congress had meant for it to apply to non-consumer debtors, then it would have been explicit in 707(a). But not all courts agree.
In re Rahim, 442 B.R. 578 (Bankr. E.D. Mich. 2010) – held that a debtor who continued to live a lavish lifestyle with no effort to curtail his expenses – was not entitled to Chapter 7 relief, despite his debts being primarily non-consumer. This ruling was upheld by the District Court on appeal (federal district courts have appellate jurisdiction over federal bankruptcy courts).
While this decision is not binding on courts in our jurisdiction, it is worth noting that the case exists – and that it may be used as persuasive authority in the future on a case in our area.