Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, S. 256, Public Law 109-8, Chicago Bankruptcy lawyers, Chapter 7

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 [Text, PDF, HTML, Summary ]
The full text of the new law is available online
25 Changes to Personal Bankruptcy Law
Selected Provisions of the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” S. 256.
Latest Bankruptcy News
ABI’s special section on the bankruptcy bill
Major Consumer Bankruptcy Effects of the 2005 Reform Legislation
Prepared by Eugene R. Wedoff
United States Bankruptcy Court
Northern District of Illinois
July 11, 2005

The Bankruptcy Abuse Prevention and Consumer Protection Act — P. L.
109-8 (S. 256) — was signed into law on April 20, 2005. A key provision
of the new law subjects certain petitions for debt relief under Chapter
7 to a means test. Bankruptcy petitioners with relatively high incomes
could be prevented from filing under Chapter 7 (where many unsecured
debts are discharged, or wiped out, by the court) and instead given the
choice of converting to Chapter 13 (where some debt must be repaid out
of future income) or having their petitions dismissed and receiving no
bankruptcy relief at all. The means test takes into account the
petitioner’s income, debt burden, and various allowable living expenses,
which can vary significantly according to the debtor’s place of
residence and particular circumstances. If income minus allowable living
expenses exceeds certain levels, a Chapter 7 petition is presumed to be
abusive.

Virtually all consumer bankruptcies are either Chapter 7 or Chapter 13
cases. Chapter 7 is the most common form of bankruptcy, accounting for
71.5% of non-business filings in 2004, or over 1.1 million cases. In
Chapter 7, the debtor’s assets are liquidated and distributed among
creditors, and many remaining debts are discharged, or cancelled,
leaving the debtor free to make a fresh start. (Some debts are not
dischargeable, and secured debts like mortgages are not affected by
bankruptcy.) In practice, most Chapter 7 filings are “zero asset” cases,
where unsecured creditors get nothing. (Several types of assets are
exempt from liquidation and cannot be distributed to creditors.)

In Chapter 13 bankruptcies, debtors with regular incomes agree to a plan
to pay back some or all of their debt under court supervision over a
period of several years. At the plan’s conclusion, remaining debts are
discharged. An advantage of Chapter 13 for debtors is that a wider range
of debts can be discharged than under Chapter 7. If the debtor is unable
to complete the series of payments required by the Chapter 13 plan, the
case may be dismissed or converted to Chapter 7. Upon dismissal,
remaining debts are not discharged, unless the court finds that the
debtor cannot justly be held accountable for failure to complete the
plan, and creditors have received at least the amount of repayment they
would have received under a Chapter 7 filing. Under the old law, the
choice of chapters was left entirely up to the debtor. Supporters of
reform long argued that the “excessive generosity” of the old bankruptcy
system encouraged abuse and allowed some debtors to repudiate debts that
they could have repaid, at least in part. P.L. 109-8 responds to these
concerns by restricting access to Chapter 7 in cases where debtors’
income is determined to be sufficient to repay some debt, after allowing
for reasonable living expenses. The means test set out in Title I of the
reform act will determine eligibility for Chapter 7 relief. Debtors who
“pass” the means test will either have their Chapter 7 petitions
dismissed or converted to Chapter 13 or Chapter 11.2 (Conversion will
not occur without the debtor’s consent, but no other form of bankruptcy
relief will be available.)

The Basic Test

Under the means test, a Chapter 7 filing is presumed to be abusive if
the debtor’s monthly income, reduced by numerous allowances and living
expenses (discussed below), and multiplied by 60 (that is, over a
five-year period), is greater than $10,000. If income thus adjusted is
less than $6,000, there is no presumption of abuse, and the debtor is
free to choose Chapter 7. If adjusted income is between $6,000 and
$10,000, abuse is presumed only if income exceeds 25% of nonpriority,
unsecured debt in the case. An abusive Chapter 7 filing is subject to
dismissal or conversion.

Living Expenses and Allowances

A key determinant in whether a debtor passes the means test is the amount by
which actual monthly income3 is reduced by various allowances and living
expenses. The law sets out several categories of allowable monthly
expenses. Debtors’ monthly expenses are calculated primarily by
referring to a set of allowances established by the Internal Revenue
Service (IRS) that are used to help determine a taxpayer’s ability to
pay a delinquent tax liability. The allowances, which the IRS calls
Collections Financial Standards, set out monthly living expenses in
three basic categories: (1) food, clothing, and other items; (2) housing
and utilities; and (3) transportation. The allowable living expenses are
subject to several variables.

In the food, clothing, and other category, the IRS sets out living
expenses that vary according to the size of the household and gross
monthly income. For example, a single person with a gross income of
$832/month would be allowed $403 in living expenses, while a family of
four earning $5,834/month would be allowed $1,564 for expenses in this
category. These amounts are national standards — uniform across the
contiguous 48 states — except that higher schedules are provided for
Alaska and Hawaii.

The allowance for housing and utilities varies according to size of
household and geographical location. The standards provide separate
dollar figures for each county in the nation, for households of one or
two, three, and four or more persons. A single person living in
Wilkinson County, in southwest Mississippi, would be allowed to deduct
$774/month, while a family of four in Manhattan would be allowed $4,799.

The transportation standards provide regional allowances, with
variations for persons living in any of 28 specified metropolitan areas.
Allowable living expenses include ownership costs ($475 for one car, an
additional $338 for a second car) and operating costs (or public
transportation costs, for those with no car). Operating or public
transportation allowances range from $161 per month for nondriving
Pittsburghers to $479 for New York City residents with two cars.

These allowances are not reduced if a bankruptcy petitioner’s actual
expenditures are less than the standard. In some cases, the IRS
recognizes actual expenses that exceed the standards; under the reform
act, a debtor’s monthly expenses may include actual expenses in
categories specified as Other Necessary Expenses by the IRS for the area
in which the debtor resides.

Beyond the IRS allowances, the bankruptcy reform law permits current
income to be reduced by several other types of expenses. Monthly
expenses for purposes of the means test may include:

reasonable and necessary spending to care for an elderly, chronically
ill, or disabled member of the debtor’s immediate family or household;
reasonably necessary expenditures for health insurance, disability
insurance, and health savings accounts;
actual expenses for the primary or secondary education of a dependent
child (under age 18), up to $1,500 per child per year;
home energy costs in excess of the IRS housing and utility standards,
with proper documentation and justification;average monthly payments on
secured debts (most commonly home mortgages and car loans)
average monthly payments on priority claims (e.g., child support,
student loans, alimony, etc.);
reasonable and necessary expenses to maintain the safety of the debtor’s
family from family violence, as identified under Section 309 of the
Family Violence Prevention and Services Act; and
administrative costs incurred in a Chapter 13 bankruptcy plan.

Finally, a debtor may claim higher monthly expenses if special
circumstances exist that require additional expenditures. To establish
special circumstances, the debtor must itemize such expenses and explain
in detail why each of them is reasonable and necessary.

Given the number of factors that may reduce monthly income for purposes
of the bankruptcy means test, it is clear that simple gross income is
not a good indicator of whether a debtor will be allowed to file Chapter
7. Because some of the allowable expenses can be very large in dollar
terms (e.g., support for the elderly or infirm), it is not difficult to
imagine hypothetical cases in which a debtor with a relatively high
money income would be allowed to make a fresh start under Chapter 7,
while a lower-income filer might have to choose between Chapter 13 and
dismissal. Other provisions of the reform legislation address this
potential disparity by creating safe harbors for lower- income
individuals and households.

Safe Harbor Provisions

Under P.L. 109-8, a motion must be filed in bankruptcy court to dismiss
or convert a Chapter 7 petition.

The law provides that if the debtor’s income exceeds the median family
income (adjusted for household size) as calculated by the Bureau of the
Census9 for the applicable state, any party in interest, including a
creditor, may bring an abuse motion under section 707(b).

If the income of the debtor (or debtor and spouse, in a joint filing) is
less than or equal to the median family income (taking household size
into account) for the applicable state, only the judge or a bankruptcy
trustee or administrator may file a motion to dismiss or convert a
Chapter 7 petition.

If the combined income of the debtor and the debtor’s spouse is equal to
or less than the state median income for a single-earner household
(again adjusted for household size), no motion to dismiss or convert may
be filed.

In addition, P.L. 109-8 creates an exemption from means testing for
disabled veterans whose debts were incurred while they were on active
duty or performing a homeland defense activity.

Rebutting the Presumption of Abuse

A Chapter 7 petition by a debtor who passes the means test is presumed
to be abusive. The law provides that this presumption may only be
rebutted by demonstrating special circumstances, such as a serious
medical condition or a call to active duty in the Armed Forces, that
justify additional expenses or adjustments to current monthly income.