Congress reformed the bankruptcy system in 2005 when it passed the Bankruptcy Abuse Prevention and Consumer Protection Act. The Act was intended to have consumers file for Chapter 13 rather Chapter 7 bankruptcy protection. Chapter 13 requires that they must repay at least some of their debts. A Chapter 7 bankruptcy erases their debts entirely. One of the reforms introduced by the Act is the means test.
It calculates whether debtors (those filing for bankruptcy) have sufficient money left over each month after paying their necessary expenses to make payments toward reducing their unsecured debt. The means test considers credit card balances, payday loans, signature loans, medical bills, unpaid utility bills, and even unpaid income taxes.
The means test first examines your income to determine whether you fall into the upper or lower half of earners in your state. You'll automatically pass the means test if you fall into the lower half, but the means test then examines your expenses to determine whether you pass if you're in the upper half.
Median income is established for each state annually by the U.S. Census Bureau based on family size. "Median" means that half of all families located in the state earn less than this figure, and half earn more.
For example, the median income for a single individual with no dependents was $71,941 in New Jersey as of April 2021. It was just $43,105 in Mississippi. This individual would pass the means test at an income of $70,000 in New Jersey, but would have to proceed to an examination of expenses if they lived in Mississippi.
The next step of the means test is to deduct certain allowable expenses from your income. Expense deductions aren't based on the money you actually spend, but rather on figures the IRS considers to be "normal" expenditures for a family of your size. Again, this depends on your state of residence. Rent costs more in New York than it does in Kansas.
The IRS employs the same metrics it uses to determine the amount of money delinquent taxpayers can afford to pay in back taxes when they fall behind. These amounts might or might not reflect your personal situation.
Allowable expenses are those that "are necessary to provide for a taxpayer’s (and his or her family's) health and welfare and/or production of income," according to the U.S. Department of Justice.
The IRS factors in fixed amounts in the following categories:
This category includes:
- Housekeeping supplies
- Apparel and services such as dry cleaning
- Personal care products
- Out-of-pocket health care expenses
Different health care limits will apply depending on whether you're under age 65 or over 65.
These are national standardized amounts based on which state you live in.
The standards for housing are broken down to both state and county levels. They include the following fixed amounts:
- Mortgage or rent
- Property taxes
- Maintenance and repairs
- Utilities, including gas, electric, water, heating oil, garbage collection, telephone, cellphone, internet, and cable
Vehicle costs are categorized either as ownership expenses (monthly loans or lease payments) or operating costs (maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking fees, and tolls). These amounts can differ by region, and only the operating costs would apply if you own your vehicle outright—you didn't finance its purchase or you've since paid off the loan.
Other Necessary Expenses
The means test calculation lets you deduct the average of the actual amounts you spend for yourself and your dependents for some other types of expenses. These include:
- Federal, state and local taxes, including income tax, self-employment tax, Social Security and Medicare taxes, real estate taxes, and sales taxes
- Items required for your employment, such as union dues, uniform costs, and mandatory retirement contributions
- Court-ordered payments like spousal support, alimony, or child support
- Life insurance
- Education for employment or for a physically or mentally challenged child
- Child care expenses
- Health insurance, disability insurance, and health savings account expenses
- Continued contributions to the care of household or family members who are elderly, chronically ill, or disabled
- Protection against family violence under the Family Violence Prevention and Services Act or other applicable federal law
- Charitable contributions not to exceed 15% of your gross monthly income
Additional Reasonable and Necessary Expenses
The following expenses can be claimed if you can document that they're both reasonable and necessary:
- Excess home energy costs
- Education expenses for dependent children under the age of 18, not including private school tuition
- Additional food and clothing expenses
Payments on unsecured debts such as medical bills, credit cards, and payday loans don't qualify as expenses for the means test. The following debts can be deducted, however:
- Payments on secured claims, including loans taken for the purchase of real property, automobiles, and other personal property
- Payments on priority claims like income taxes
- Administrative expenses, which are an estimate of what your projected average monthly Chapter 13 payment would be along with the fee that the Chapter 13 trustee would charge for administering the case
Qualified Retirement Deductions
You can deduct voluntary contributions to an ERISA retirement account, such as a 401(k), as well as payments you make on loans taken out from retirement accounts.
The means test form provides a space where you can list expenses that derive from what you believe to be special circumstances. You have no reasonable alternative to spending this money. But you must provide explanations and documentation that supports your claim.
Updated by Carron Nicks.