There are penalties for filing subsequent bankruptcy cases within one year after a prior case has been dismissed. The main penalty is that the automatic stay, which prevent creditors from commencing or continuing any legal action against the debtor, terminates 30 days after the petition is filed (and in cases of multiple dismissals, never goes into effect). However, this “penalty” is excluded from cases which are dismissed as a result of failing to “pass” the means test under 707(b) of the bankruptcy code (11 U.S.C. 707(b)).

A judge can still order a prohibition on re-filing a case for 180 days, but that is only usually done where there are harsh facts showing an abuse of the bankruptcy system.

I have been unemployed for nearly a year now and will be running out of unemployment benefits in about 3 months which will leave me with no income at all and I am single. The prospects of finding a job in my line of work anytime soon is looking pretty grim so I am seriously considering launching another business of my own but that will take at least a year. I make about $960 a month on unemployment and have no residual savings other than my 401k and own no real property. My personal property is limited to my 13 year old car, my clothes and some minor furnishings which really aren’t worth anything. My dischargeable debts amount to about $35,000 and are comprised of strictly credit cards and medical expenses. I have never filed bankruptcy before and have spent the last 10 years rebuilding my credit after paying off debts from a business I was forced to close, so it’s heartbreaking for me to have to seriously consider bankruptcy now.

Here’s what I would like to know.

1. With little income which is on the verge of disappearing can I file directly for a Chapter 7 or do I need to file Chapter 13 first and complete the means test?

Answer: The “means test” must be completed if you are over the median income in your State, given your household size, in order to determine what you are eligible for. The so-called “means test form” must be completed in any bankruptcy case. You can file Chapter 13 first, but from the above facts it sounds like you would qualify for a Chapter 7 case, but you need to have a comprehensive consult with a bankruptcy attorney in your area to make that determination.

The Ninth Circuit Court of Appeals ruled today, in the case of In re Egebjerg, that 401k loans are not a debt as defined in the bankruptcy code and as such, the amount of any loan repayment cannot be considered in calculating a debtor’s budget/ability to repay his/her debts.

The basic rationale is that since a 401k loan is repaying funds to the owner of the 401k, it is not an actual debt, and the funds used to repay it are not a necessary living expense.

There are tax consequences for failure to repay a 401k loan, and these may be able to be argued as an offset, but the loan repayment itself cannot be used to determine eligibility to file a chapter 7 case.

But what about those who have the ability to make some monthly payments to their creditors and don’t qualify for chapter 7?   Their primary bankruptcy option in many cases is Chapter 13, which allows for, usually, a partial repayment of the debt.   Armed with this choice, most people decide that debt consolidation, rather than filing a Chapter 13 bankruptcy case, is their optimal solution.   However, this is almost never true.

In Chapter 13, the amount you have to repay to your creditors will almost always be less than (or, at worst, equal) to what you will have to repay outside of bankruptcy.    This is true even if you are required to repay 100% of your debts in a Chapter 13 case.  Depending on various factors–primarily your income and expense– you can get a discharge of your debts in a Chapter 13 case repaying anywhere from 0% to 100% of your unsecured debts for 36-60 months.

Why is it better to repay 100% in a Chapter 13 rather than doing debt consolidation?  Because you do not have to pay for interest accrual on unsecured debts in a Chapter 13.   Even under the best consolidation deal outside of bankruptcy there is going to be interest paid.  Also, in Chapter 13 your repayment plan will be for a maximum of 60 months (and in many cases can be as little as 36 months).   This can result in significantly less paid out over time than one would have to pay in a debt consolidation arrangement.

So if you are in a position where you may have too many assets or income to qualify for a Chapter 7 case, but are having trouble managing your monthly payments on your credit cards or other unsecured debts, you should consult with a bankruptcy attorney about the possibility of filing a Chapter 13 case.   You very well may be able to pay off all your unsecured debts with affordable monthly payments in less than 5 years!

The means test only applies if one’s debts are primarily (i.e. more than 50%) consumer debts.   Consumer debts include secured mortgage debt obligations on a personal residence, as well as most credit card-type debts. The means-test also only applies if the total income received in the 6 calendar months prior to filing the bankruptcy case (explained more fully below) is above the median income for your state, given your household size. See the means test flow chart created by Judge Maureen Tighe of the United States Bankruptcy Court, Central District of California, as presented in the informative blog of the Moran Law Group.

What is the means test?  It is extremely complex. The basic definition can be seen here.  But essentially, it takes all income received (and this means ANY income, regardless of whether it’s taxable income, so that includes gifts, withdrawals from a 401k, and almost any other type of income EXCEPT social security income) in the 6 calendar months prior to filing the bankruptcy case–including that of your spouse, if any– and subtracting out certain allowed expenses. These “allowed expenses” are mostly IRS-based allowances for living expenses, food, clothing, shelter, etc. and have little connection with reality.  There are specific allowances for secured debt payments, such as mortgages and car payments, but almost every aspect of the means test has been, is being, or will be challenged in the courts, because it is frequently nonsensical, internally inconsistent, and confusing.   It is not as simple as determining that your income is below or above the median income for your area and household size (and determining your household size is another hotly contested issue). You need a qualified bankruptcy attorney familiar with the court decisions in your area, to properly evaluate your eligibility for bankruptcy.  (For example, self-employment income is not analyzed exactly the same way as wage-earner income from a job)

Which brings me back to the point of eligibility.   Passing the means test is just the first step. It is possible to pass the means test but still be showing–for example–a surplus in your current monthly income and expenses. For example, let’s say you were unemployed for the 6 months prior to filing your bankruptcy case, but you just landed a new job that pays you $100,000 per year. In that instance, you would likely pass the means test and show you are eligible to possibly file a Chapter 7 case. However, you would most certainly draw an objection (via a Motion to Dismiss your case) from the US Trustee’s Office as having too much income.

The means test and assessing eligibility to file bankruptcy is a field of land mines and evolving interpretations of law.  As they say on television, “We are trained professionals. Don’t try this at home”

What is a short sale? A short sale occurs when you want to sell your property, but owe more to the lienholders (mortgages) on your property than a buyer is willing to pay to purchase the property. As a result, one (or more) of the lienholders secured by your property must agree to accept less than 100% of what is owed to them, in order to allow the sale to proceed. But who does this benefit? Certainly the mortgage broker, because he/she gets their commission.

Historically, a short sale was used in these circumstances in return for an elimination of any obligation that the seller has and an agreement that no negative marks will appear on their credit report as a result. NEITHER of these is true today. I am seeing increasing numbers of people who do these short sales, and then the lienholder who didn’t get paid in full seeks to collect from the seller for the deficiency amount. On top of that, the short sale appears on the credit report in the form of a negative defaulted loan mark.

Furthermore, doing a short sale can sometimes affect the ability to relieve the seller of certain tax burdens if they subsequently file a bankruptcy case.

Compare this with the foreclosure process. You end up with the same liabilities and negative credit marks, but you can usually live rent-free in your home for months, if not years, while the lenders go through the foreclosure process. Most lenders will wait as long as possible to foreclose in today’s market.

This is an extremely complicated area of law involving both tax and bankruptcy law, but suffice it to say that the optimal strategy is that if you are going to file a bankruptcy, it is usually best to allow your property to go to foreclosure, and file your case before the foreclosure sale takes place (and, even better, have the foreclosure sale occur DURING the bankruptcy, but this is difficult to achieve).

One spouse has certain debts which are only in that spouse’s name and may have even been incurred entirely prior to the marriage. He (or she) wants to file a bankruptcy to deal with those debts without involving their spouse. That is no problem. A bankruptcy case can always be filed by one spouse without the other. However, when determining eligibility for bankruptcy, which includes the ability to repay debts, the other spouse’s income MUST be included in the analysis.

This has always been the case in community property states, such as California. But with the changes in the bankruptcy laws which became effective in October 2005 (see new bankruptcy laws) Congress stated specifically that unless the spouses are legally separated or living apart (and not just for the purpose of evading the bankruptcy laws) or have a valid prenuptial agreement, then the non-filing spouse’s income must be included in the means test analysis (which is one of the several eligibility tests now required). [11 U.S.C. 707(b)(7)(B)].

The reason for this in community property states is that every spouse has a community property interest in the income earned by their spouse (and vice versa).

These requirements have absolutely nothing to do with which spouse owes the debt, whose name is on the debts/accounts, or which spouse is filing the bankruptcy case.

This also does NOT mean that the non-filing spouse will be “affected” by filing the bankruptcy case. It merely means that their income must be factored into the eligibility analysis and may result in a Chapter 13 repayment plan needing to be filed instead of just a straight chapter 7 liquidation case.

Whether or not to include a non-filing spouse’s debts in the bankruptcy of the spouse that files is partially dependent on state law and is the topic for another discussion.

Since the new bankruptcy laws became effective in October 2005, the new means test was added as a requirement to determine eligibility for Chapter 7 vs. Chapter 13 as well as to determine–if a debtor was ineligible for Chapter 7–how much the Chapter 13 monthly plan payment would be, and how long it must last. While the means test admittedly bears little resemblance to reality, it is the test Congress chose. It uses an average of the debtor’s income received from ALL sources (including gifts) from the 6 calendar months prior to filing, and then subtracts out certain allowed expenses (e.g. mortgage payments, allowed IRS-standard living expenses, etc.). There are many times where, for whatever reason, the means test shows the debtor having a certain amount of disposable income, whereas the actual current monthly income and expenses, reflected on bankruptcy schedules “I” and “J” show a much higher amount. Up until this decision, the Trustees in Chapter 13 cases were requiring debtors to pay the amount of their current, actual surplus income, rather than what the means test showed.

As far as the plan term goes, if the means test shows negative income, then a 3-year plan term (which is the minimum allowed in Chapter 13) would suffice.

With its decision in Kagenveama, the Ninth Circuit has stated that the means test controls. However, it did point out in a quick sentence that nothing in the opinion prevents a creditor or Trustee from seeking a modification of the Chapter 13 plan after it is confirmed.