Bankruptcy for Higher Income Debtors

In my Denver, Colorado based bankruptcy practice, I’m starting to see more higher income clients with higher levels of debt.  Many of these higher income debtors own real estate which has lost its equity as property values have plummeted in the past few years.  Some of these debtors are also managing a higher amount of credit card debt (and paying at least 20% interest on multiple credit cards).

For those who pass the Means Test, chapter 7 is the best option, particularly for those who owe no tax debt and who are not facing a home foreclosure or vehicle repossession.  A chapter 7 bankruptcy will discharge all unsecured debt (except for student loans) and is the quickest and easiest form of bankruptcy.  A chapter 7 debtor will keep all exempt (as allowed by Colorado state law) assets in obtaining a fresh start.

However, a debtor who does not pass the Means Test will be pushed into chapter 13 whereby anywhere from 0% to 100% of unsecured debt is required to be paid back over 3 to 5 years.  Under the new bankruptcy laws enacted under BAPCPA, the Means Test examines (business and personal) income and expenses, and household size, measured over a six month look back period prior to the filing.  Those who do not pass chapter 7 muster will likely face a Presumption of Abuse statement filed by the United States Trustee.

Debtors with higher gross income are not necessarily excluded from chapter 7 under the Means Test.  Many with a modest income and significant number of household members will be below median income and not required to take the Means Test.  For other debtors, expenses (in addition to mandatory withholding and payroll taxes) such as monthly mortgage or car payments, health insurance premiums, qualified retirement contributions, child care, out-of pocket medical expenses, and non-dischargeable taxes all are subtracted from gross income to determine monthly disposable income.  (The United States Trustee may examine all expenses under the Bankruptcy Code’s good faith and totality of the circumstances requirements to ensure that all expenses are necessary.)  Debtors with high enough expenses will pass the Means Test and qualify for chapter 7 regardless of income.   

The Bankruptcy Code excepts from the Means Test debtors with primarily business (and not consumer) debt.  Business debt within the consumer bankruptcy context typically results from an individual debtor, who owns a small business, personally guaranteeing business debt.  Whether is debt is primary business or consumer related is fact intensive (think rental property used for leisure) but most courts have found that tax debt is non-consumer related.

Overall, those with a higher number of dependents, larger payments on a house and/or car (particularly multiple secured debts), or higher priority debt such as mortgage arrears or taxes which cannot be discharged are more likely to pass the Means Test.  Simultaneously, these expenses must be reasonable and necessary.  Higher out of pocket medical expenses or expenses for monthly food and basic clothing will presumably be more reasonable than a debtor’s continued monthly payments on a rental property with a high mortgage or boat.  (Monthly payments for luxury items – particularly if accounted for solely to pass chapter 7 scrutiny – may unjustifiably reduce monthly disposable income and prejudice unsecured creditors.)

Debtors who do not pass the Means Test or who have high monthly disposable income are still eligible for chapter 13 relief, so long as their unsecured and secured debt does not exceed $1,081,400 and $360,475, respectively.  Chapter 13 allows the debtor to pay back anywhere from none to all of unsecured debt back, interest free, over 36 to 60 months (depending on disposable income).

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