In Bankruptcy Information, Bankruptcy Questions

“Above median” or “below median” are phrases bankruptcy attorneys use a lot. What does it mean and, more importantly, why does it matter?

Above or below median refers to whether a person’s income is above the median income for a family of her size in her state, or whether it is below that same level. Making the calculation is sometimes called the Means Test. First we’ll consider how the debtor’s income is calculated and then we’ll talk about why it matters.

How is Income calculated?

Calculating a person’s income is different from simply asking, how much money do they make, or what was their reported income on their tax return last year. At the heart of a debtor’s income is the notion of Current Monthly Income, or CMI. CMI is the average of all income from all sources (with a couple of exceptions such as Social Security) during the six months leading up to the debtor’s filing bankruptcy. The six-month period ends with the month prior to the month in which the person files. If the debtor files in April, the six months begin with October and end with March. If the person ends up not filing until May, October drops off and April is added.

The bankruptcy attorney will ask for paystubs from all sources for the last six months. That’s so she can calculate CMI. It doesn’t matter whether the debtor is still working at any of the jobs she worked at during those six months. It doesn’t even matter if the debtor isn’t working at all. The attorney still needs six months of paystubs to calculate CMI. The attorney adds up all the income (gross, before deductions) on the paystubs for those six months and divides the total by 6. That number is the debtor’s CMI.

It’s easy to see that CMI can have nothing to do with the debtor’s current situation. The debtor might have been unemployed for six months and have no CMI, but recently got a good paying job. Or the reverse might be true: the debtor had a good job but recently lost it. None of that matters. CMI is what the calculation says it is. Once CMI is calculated, that number is multiplied by 12 to arrive at the debtor’s annual income. It’s this number that is compared to the median income for a family of the debtor’s size to determine whether the debtor is “above median” or “below median.”

Why does it matter?

Once the debtor is designated as above or below median, the Bankruptcy Code tells the debtor whether she qualifies for Chapter 7 or whether she must file Chapter 13. If a debtor is above median, there is a presumption that the debtor is “abusing the bankruptcy system” by filing Chapter 7, and therefore must file Chapter 13. There are some exceptions to this rule, such as if the debtor’s debts are primarily non-consumer (business) debts. If the debtor is below median, she has the option of filing either Chapter 7 or Chapter 13.

Determining whether a person can file Chapter 7 or must file Chapter 13 isn’t all the above-or-below median calculation does. It also determines how long a person must remain in Chapter 13 and even how much she must pay as a Chapter 13 plan payment. An above-median debtor must remain in Chapter 13 for the maximum period, 60 months (unless the Plan will repay all creditors in full in a shorter time); while a below-median debtor must only stay in Chapter 13 for 36 months (again subject to repayment in full in less time).

Even worse, above-median debtors are told what their plan payments must be based on CMI, not on what they actually earn. An above-median debtor must contribute 100% of her “disposable monthly income” or DMI to repayment of her unsecured creditors. The Bankruptcy Code starts with CMI and then allows deductions for living expenses such as rent or mortgage payments, food, clothing, medical, transportation, and the like. These expenses are not the debtor’s actual expenses. Instead, they are based on IRS Living Standards. CMI minus these IRS standards equals DMI. That much must be set aside to repay unsecured creditors. If there are other debts to be paid through the Chapter 13, such as delinquent mortgage payments, secured debt like car payments, past taxes or anything other than payment of DMI to unsecured claims, the debtor’s monthly plan payments must be enough to cover everything.

Fortunately, the IRS standards are fairly liberal and it isn’t unusual for the calculated DMI to be less than zero. When that happens, the debtor does not have a minimum repayment obligation to unsecured debt. In that case, whatever the debtor can pay becomes the plan payment and unsecured creditors receive what is left after other payments, such as delinquencies, secured debt and tax debt.

Timing bankruptcy to determine above or below median status.

If a debtor has seasonal or uneven income, it often makes sense to time her bankruptcy filing so that her CMI is lowest based on the last six month income. Suppose a debtor works in yard and lawn maintenance. Most of her income is earned from late spring through early fall. If she files bankruptcy in November, her CMI might show she is above-median. However, if she waits until April, her CMI could well put her into the below-median category. Another example would be if the debtor had been unemployed for several months but recently accepted a high-paying job. By filing immediately the debtor might qualify as a below-median debtor, whereas if he waits a few months, his income could put him into the above-median category.

The above-or-below median income determination has wide-reaching implications for bankruptcy. If you have bankruptcy questions, contact us.

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