Means test means shift to Chapter 13

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The means test for Chapter 7 filings is seen as one of the most significant elements of the Bankruptcy Reform Act. Failure will result in a case being converted to Chapter 13 or dismissed.

One aspect of that test is a comparison of the filer’s income with the median family income in Wisconsin. Paul G. Swanson, a partner at Steinhilber, Swanson, Mares, Marone & McDermott in Oshkosh, explained that consumer debtors who exceed the median income must look at the entire family income, including money made by dependent children. That figure is based on income during the six months prior to the date of filing.

Chief Judge Margaret Dee McGarity, U.S. Bankruptcy Court, Eastern District of Wisconsin noted that when a husband or wife files Chapter 7, the court will also have to consider the spouse’s income. The total income would "include the income of a nonfiling spouse whether they want to be involved in the bankruptcy or not," McGarity said.

"That’s true now to a certain extent, but it’s more quantified under the Act," she explained. "If you’ve got a spouse who is living with the debtor, but, nevertheless, doesn’t want to be involved in the debtor’s finances, then you’ve got a problem. If they’re living separate and apart, there’s a provision that’s made for that. But there’s not a whole lot of wiggle room for the great variety of living arrangements that people have entered into."

The test excludes money from Social Security or veteran’s benefits. Clients also are allowed to deduct payments which would become due to secured creditors within 60 months after the bankruptcy filing. Swanson noted that balloon payments on mortgages raise some questions about what should be included. Other exclusions include secured debt priority claims, child support claims, and tax debt.

Failing the means test means a client will either have to convert to a Chapter 13, dismiss the Chapter 7 case, or have it dismissed.

"I think it’s going to catch those that it was probably designed to catch, that is, people who make pretty good money but run up a lot of consumer unsecured debt and have the ability to pay some of it back but can’t pay all of it back," Swanson suggested.

However, the complexity of the process means that those filing Chapter 7 will need to rely on a good lawyer to navigate the test. Issues arise about those who truly cannot afford to pay a lawyer and decide to approach the process pro se.

"There are going to be a lot of people who can’t afford attorneys," Swanson observed "They’re going to show up on our doorstep or the court’s doorstep and want help."

He predicts that will create a lot of problems for the bankruptcy judges and trustees.

Potential increases in litigation are also likely to create more work for courts.

Judge McGarity observed, "If you have to litigate every time as to whether there are special circumstances which will allow the debtors to deviate from the IRS provisions, then that’s just more litigation."

At that point, she noted, the judges could end up ruling on things as explicit as how much food is consumed each month. "If you’ve got a three-year-old, maybe you don’t need as much food as a 16-year-old — Things that we’re real well-trained to do. But that’s going to be our job is to determine those special circumstances."

Swanson responded, "The act did authorize 28 new temporary judgeships. So, apparently, Congress was thinking that there would be additional litigation, at least on a temporary basis."

Litigation related to IRS expense standards will also raise questions for creditors and their attorneys. They will have to decide whether it is worth spending the money to pursue those issues in court.

– Tony Anderson

Tony Anderson can be reached by email.