A Comparison Between Means-testing for Chapter 7 and Chapter 13

Posted by Skyseo Roundtable on June 28th, 2024

A Comparison Between Means-testing for Chapter 7 and Chapter 13

Bankruptcy can be a daunting prospect, but for many individuals drowning in debt, it can offer a fresh start and a path to financial stability. Two common options for individuals seeking bankruptcy relief in the United States are Chapter 7 and Chapter 13 bankruptcy. Each comes with its own set of rules, benefits, and drawbacks. However, one crucial aspect that applies to both is means-testing. In this article, we’ll delve into the differences and similarities between means-testing for Chapter 7 and Chapter 13 bankruptcy, helping you understand which option may be best suited to your financial circumstances.

I. Introduction
Bankruptcy is a legal process designed to provide relief to individuals or businesses struggling with overwhelming debt. Chapter 7 and Chapter 13 bankruptcy are two of the most commonly filed types of bankruptcy in the United States. While Chapter 7 involves liquidating assets to pay off debts, Chapter 13 allows individuals to reorganize their debts and create a repayment plan. Means-testing is a critical component of both processes, determining eligibility and influencing the outcome of bankruptcy proceedings.

II. Understanding Chapter 7 Bankruptcy
Chapter 7 bankruptcy, also known as “liquidation” or “straight bankruptcy,” is the most straightforward form of bankruptcy available to individuals. Under Chapter 7, eligible debtors can discharge most unsecured debts, such as credit card debt and medical bills, without having to repay them. However, not everyone qualifies for Chapter 7 bankruptcy.

A. Explanation of Chapter 7 Bankruptcy
To file for Chapter 7 bankruptcy, individuals must meet certain eligibility criteria, including income limitations and a means test. The means test compares the debtor’s income to the median income in their state to determine eligibility for Chapter 7. If the debtor’s income falls below the state median, they typically qualify for Chapter 7 bankruptcy.

B. Eligibility Criteria
In addition to passing the means test, individuals seeking Chapter 7 bankruptcy must also meet other eligibility requirements, such as completing credit counseling and disclosing financial information to the court.

C. Liquidation Process
Once approved for Chapter 7 bankruptcy, a trustee is appointed to oversee the liquidation of non-exempt assets. These assets are sold, and the proceeds are used to pay off creditors. Certain assets, such as a primary residence and essential personal belongings, may be exempt from liquidation under state or federal law.

D. Pros and Cons
Chapter 7 bankruptcy offers a relatively quick and straightforward path to debt relief, allowing individuals to eliminate most unsecured debts without the need for a repayment plan. However, it may involve the liquidation of non-exempt assets, and not all debts are dischargeable under Chapter 7.

III. Understanding Chapter 13 Bankruptcy
Unlike Chapter 7 bankruptcy, Chapter 13 bankruptcy involves creating a repayment plan to pay off debts over a period of three to five years. Chapter 13 is often referred to as “reorganization” or “wage earner’s bankruptcy” and is typically used by individuals with regular income who want to keep their assets but need time to catch up on missed payments.

A. Explanation of Chapter 13 Bankruptcy
Under Chapter 13 bankruptcy, individuals propose a repayment plan to the court, outlining how they will repay their debts over time. The court must approve the plan, and creditors must agree to the terms.

B. Eligibility Criteria
To qualify for Chapter 13 bankruptcy, individuals must have a regular source of income and debts within certain limits. Unlike Chapter 7, there is no means test based on income for Chapter 13 bankruptcy.

C. Repayment Plan
The heart of Chapter 13 bankruptcy is the repayment plan, which outlines how the debtor will repay creditors over a period of three to five years. The plan must prioritize certain debts, such as mortgage arrears and tax debts, and may require the debtor to repay a portion of their unsecured debts.

D. Pros and Cons
Chapter 13 bankruptcy allows individuals to keep their assets and catch up on missed payments through a structured repayment plan. However, it requires a regular source of income and may take longer to complete than Chapter 7 bankruptcy.

IV. Means-testing in Chapter 7
Means-testing plays a crucial role in determining eligibility for Chapter 7 bankruptcy and ensuring that only those who truly cannot afford to repay their debts qualify for relief under Chapter 7.

A. Purpose of Means-testing
The primary purpose of means-testing in Chapter 7 bankruptcy is to prevent abuse of the bankruptcy system by individuals who have the means to repay their debts but seek to discharge them through bankruptcy.

B. How Means-testing Works
The means test compares the debtor’s income to the median income in their state for a household of similar size. If the debtor’s income is below the state median, they typically qualify for Chapter 7 bankruptcy without further scrutiny.

C. Impact on Eligibility
If the debtor’s income exceeds the state median, they may still qualify for Chapter 7 bankruptcy if they can demonstrate that they have no disposable income available to repay their debts after deducting certain expenses.

V. Means-testing in Chapter 13
While Chapter 13 bankruptcy does not require debtors to pass a means test based on income, means-testing still plays a role in determining the terms of the repayment plan.

A. Application of Means-testing in Chapter 13
In Chapter 13 bankruptcy, the means test is used to calculate the debtor’s disposable income, which in turn influences the amount they must repay to creditors through the repayment plan.

B. Differences from Chapter 7 Means-testing
The means test in Chapter 13 bankruptcy focuses on disposable income rather than eligibility for relief. Debtors with higher incomes may be required to repay a larger portion of their debts through the Chapter 13 repayment plan.

VI. Factors Influencing Choice Between Chapter 7 and Chapter 13
When deciding between Chapter 7 and Chapter 13 bankruptcy, individuals should consider various factors, including their financial situation, asset protection, long-term goals, and legal advice.

VII. Case Examples
To illustrate the differences between Chapter 7 and Chapter 13 bankruptcy and the role of means-testing, let’s consider a few hypothetical scenarios:

VIII. Common Misconceptions
Despite the prevalence of bankruptcy, there are many misconceptions about the process and its implications. Here are some common misunderstandings about means-testing and bankruptcy:

IX. Recent Changes and Developments
Bankruptcy laws are subject to change, and recent developments may impact the means-testing process and eligibility criteria for Chapter 7 and Chapter 13 bankruptcy.

X. Conclusion
In conclusion, means-testing is a critical aspect of both Chapter 7 and Chapter 13 bankruptcy, influencing eligibility and the terms of debt repayment. By understanding the differences and similarities between means-testing for Chapter 7 and Chapter 13 bankruptcy, individuals can make informed decisions about which option is best suited to their financial circumstances.