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Chapter 7 Bankruptcy for Persons with Above Average Income

In October of 2005, Bankruptcy laws were changed with a view towards making it harder for people with above median income to file a Chapter 7 case. The law before 2005 did not set any specific income guidelines but it in many ways still restricted people with substantial incomes from discharging their debts in Chapter 7 if after deducting reasonable expenses there were funds left over in the budget. If a client does not fit the income and expense requirements they are not allowed to get a Chapter 7 discharge and if they want relief need to file a Chapter 13 bankruptcy.

To understand the difference between the two most common bankruptcy chapters, a Chapter 7 bankruptcy does not have a payment component. You file the case and if everything is in order you ordinarily will finish the process in three and a half to four months and at the end discharge most debts. Chapter 13 is not a bad alternative; it’s a restructuring with a discharge at the end of the process. Chapter 13 is an income based repayment plan. This means in its simplest form the first test for what must be paid in the Chapter 13 is 100% of all disposable income after normal expenses for the 36 to 60 month plan period. In many cases there is very little money left over in the budget and the client ends up using the Chapter 13 to catch up back mortgage and car payments and taxes. Because there are no additional funds left over in the budget the credit card, medical bills etc. get nothing and are discharged at the end of the plan.

A person with high income who wants a Chapter 7 discharge needs to show that 1. His or her reasonable expenses do not leave enough money to fund a Chapter 13 plan. 2. The monthly average of all gross income earned in the six months preceding the filing of the bankruptcy is less than the median income for that State of residence. Once the client goes over the median monthly gross income average the client is restricted to using the arbitrary monthly living expenses permitted in the statute to determine if there is money left to fund a plan.

Most of the arbitrary expenses that are used in the means test are the same ones the Internal Revenue Service uses to determine a person’s ability to pay. Other expenses are set by the bankruptcy statute. Both the arbitrary timing and arbitrary expenses lead to some absurd results in many cases. A well paid school teacher who does not receive pay in the summer might not pass the means test at the end of the school year but may pass in August when school resumes. A real estate agent who makes most of her commissions in the spring might pass in January. This area is complex and full of issues that require the knowledge of an experienced Maryland Bankruptcy lawyer. Just because the client passes on paper does not mean a high income person will be able to weather the scrutiny that will inevitably be given in a close case.

          Not only is the timing of the calculation important and arbitrary. Some of the expenses that can help beat the means test are:

1.     Very large alimony or child support

2.     You owe an enormous tax liability that will not be discharged

3.     You have a very high mortgage expense

4.     Your children have learning disabilities and you have to pay for private school

5.     You have very large car payments

These won’t guaranty that you will pass but they may help get the means test to work.

The expense side also gives rise to some absurd results. The person, who is frugal, buys a small inexpensive car and does not have a loan on that car will get almost no means test deduction for owning that vehicle. The person who bought a $50,000.00 Lexus at 24% interest and still has 50, $850.00 per month payments gets to deduct the standard ownership allowance for the car plus the car payment. Similarly, someone with a $1,000,000.00 mortgage who pays a $4,500.00 a month payment gets to deduct that payment. The homeowner with a normal $250,000.00 house gets the IRS standard allowance. Despite passing on paper however this is an area where an experienced bankruptcy lawyer will make a difference. Even if you pass the requirements on paper there will be many questions that need to be addressed before you will make it through the process. These high income cases are not simple Chapter 7 cases. They require a great deal of experience and skill before and after they are filed.

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