Legal Snapshot: A Quick Overview (Part 3 of 4)
New bankruptcy laws. A “new” bankruptcy law (called BAPCPA) took effect on October 17, 2005. The new law contains many significant, complicated changes which affect individuals who seek bankruptcy protection. Among other things, the new law has revised the eligibility standards by excluding people who might be able to pay back part of their debts. Those who can pay something are usually required to file under Chapter 13 and reorganize. Reorganization requires giving up a part of your future income to pay some or all of what you owe, based on what the court decides you should pay. The rules governing how that gets decided are discussed further on in this guide.
New eligibility rules. The eligibility rules divide all bankruptcy filers into groupings of those who have above-median income and those who have below the median income. Those who have above-median income are subjected to a “means test.” The means test was devised to identify and then exclude from chapter 7 bankruptcy those filers who may be able to pay back some of their debts. The means test uses a calculation that combines a person’s real living expenses and certain hypothetical living expenses. The combined real and hypothetical expenses are then subtracted from a person’s “current monthly income” to see if there is any “projected disposable income” left over to pay creditors. If there would be any left over income, the law says that person may have to pay the “left over” amount to creditors if the amount left over is enough to pay general creditors during a 60 month time period: $10,000; or 25% or $6000 of the general debts, whichever is greater.
IRS Rules are used to determine what a person’s living expenses should be. In a case concerning someone with above-median income, the hypothetical living expenses are drawn form what the IRS uses as a “collection standard.” The IRS collection standards are used by tax collectors to determine how much money they will take from delinquent tax payers. These collection standards have very little flexibility and the imposition of these standards may result in unfairly penalizing a person who really can’t afford to pay any part of their debts.
The high-earner exclusion can be applied unfairly. Under this law, a person’s “current monthly income” is determined hypothetically. Current monthly income, called “CMI” is defined as the gross income (before taxes) from any source received during the six month period ending in the calendar month prior to bankruptcy filing, (divided by six to establish a monthly amount). For chapter 7 purposes, almost any kind of income is considered, (except Social Security payments and income such as payments to victims of war crimes). For chapter 13 purposes, income from Social Security, child support, and payments made into most kinds of retirement plans is excluded from the definition of “CMI.” The big problem with CMI is that it is calculated on someone’s previous income. The income a person had during the past 6 months is not accurate in a case where a person no longer has that income. A person may have just lost their job or gone on disability, but they might still be excluded from bankruptcy because during the previous six months, they enjoyed an excellent income (even though they don’t have it anymore).