MEANS TEST TREATMENT OF VEHICLE & SECURED DEBT EXPENSES

The new bankruptcy law provides for a “means test” to determine bankruptcy eligibility using a system of allowable deductions from gross income based on IRS standards to arrive at net disposable income. The net disposable income qualifies the debtor for the kind of bankruptcy that he can file. If the debtor has zero or minimal disposable income, then he qualifies for a Chapter 7 discharge of his debts without paying his creditors anything. However, if debtor has some disposable income that is within the minimum threshold set by the “means test”, then debtor would not qualify for Chapter 7. Instead, he would qualify for a Chapter 13 or 11, depending on the amount of money he owes. Most debtors want a Chapter 7 discharge so they can start fresh without debt. On the other hand, debtors who are trying to save their houses normally resort to Chapter 13 where they are given 3 years to pay the default portion of the mortgage. For example, debtor is a registered nurse. Her gross income with two jobs is $120,000. She owns a home with some equity and she is current on mortgage payments. However, she owes $80,000 of credit card debt. She wants to have a fresh start without credit card debt so that she can become productive again. Normally, she would want a Chapter 7 discharge of her debts. If means testing determines that she is qualified for a Chapter 7, she will no longer owe any credit card debt while keeping her house, her income and most if not all of her assets.

Let’s change her circumstances a bit. If she is 6 months behind in her mortgage payments because of some emergency and now wants to save her house from foreclosure, she would opt for Chapter 13. If her mortgage default amount is $12,000, the Chapter 13 will stop the foreclosure for 3 years while she pays the trustee $366 monthly for 36 months. At the end of the third year, she will be back on current status. Thus, she saved her house by Chapter 13.

Qualifying for 7 or 13 depends on allowable deductions from gross income. Gross income is income from any and all sources. Determining gross income is simple. You just add all income from everywhere. But arriving at net disposable income is can be tricky. In California, bankruptcy courts are not yet unanimous in their interpretation of what can be deducted particularly in the matter of vehicle ownership and secured debt expenses. Indeed, even across the country, there is no common thread yet at this time. Let’s just say that it helps if you know how the Judge assigned to your case treats the expense, and how the U.S. Trustee in your area looks at the expense.

 This is how the problem comes up. Let’s say you own a house with a mortgage of $3,000. You decide to abandon the house and rent a house for $1,500. The bank has not foreclosed on the house so you still own it. You file for Chapter 7 bankruptcy because you owe $100,000 of credit card debt and hospital bills of $200,000. Your gross income is $7,000 a month with total allowed monthly expenses and deductions under the means test of $4,000 before you deduct your housing expense. Now is where the fork in the road appears. At this point you have $3,000 of disposable income left which will be erased by your mortgage of $3,000. So, if you can deduct your mortgage of $3,000 because you still own the house even if you have abandoned it and moved to a rental, you will qualify for Chapter 7 and wipe out $100,000 of credit card debt and $200,000 of hospital bills. You are debt free. But if you can only deduct $1,500 for your rent because you have left your house and now only pay rent, you actually have $1,500 of disposable income qualifying you for Chapter 13 paying $1,500 monthly for 5 years.