What Is the Presumption of Abuse in Bankruptcy?

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You need to meet certain eligibility requirements to file Chapter 7 bankruptcy. If your income is higher than the median income for a similar-sized household in your state, this flags the bankruptcy court of a "presumption of abuse." This doesn't mean you can't file Chapter 7 or that you've abused the system. It does mean you must do more calculations as part of the means test to prove that you don't make enough money to repay your debts and that you aren't taking advantage of the bankruptcy process.

Many people who file Chapter 7 bankruptcy get to walk away from their debts with a financial fresh start, without losing any of their property. As you can imagine, this is a financial outcome that some people might try to take advantage of even though they shouldn’t. So, there are special rules in place to prevent people from unfairly using the Chapter 7 bankruptcy process. One of these is the presumption of abuse.

If your current monthly income exceeds the income limit for Chapter 7, then a “presumption of abuse” exists in your bankruptcy case. This article will explain what a presumption of abuse is, why it exists, and how to overcome it.

What Is the Presumption of Abuse?

If the Chapter 7 means test shows you have a certain level of disposable income and can afford to pay back at least some of your debts, the court may find there’s a presumption of abuse. That’s because Chapter 7 bankruptcy can only be used by individuals who can’t afford to pay back their debts. If the presumption turns out to be true, you may have to file for Chapter 13 bankruptcy instead, which requires you to take part in a repayment plan.

There are two points to keep in mind about this concept:

• First, it’s a presumption, which means it can be overcome. If the bankruptcy court determines there’s a presumption of abuse, you’ll get a chance to rebut it. You can do this by identifying special circumstances or exceptions that apply to you (more on this later in this article).
• Second, if a court presumes abuse, that doesn’t necessarily mean the court thinks you’re trying to commit bankruptcy fraud. Instead, it’s an assumption that you might be better suited to filing bankruptcy under Chapter 13 instead of Chapter 7 of the Bankruptcy Code.

Why the Presumption of Abuse Exists

Chapter 7 is only intended for individuals and families who can no longer afford to pay their bills. A 2005 act changed federal bankruptcy law by adding a means test requirement. Means testing is a threshold test that compares your household income to the median household income of a similar-sized family in your state. Means testing exists to prevent bankruptcy fraud. It’s also designed to ensure that only individuals who truly can’t afford to pay their bills can take advantage of Chapter 7 bankruptcy.

If a filer can’t pass this test, a presumption of abuse exists, and they’re not eligible to proceed with a Chapter 7 bankruptcy.

Income Limits Under the Means Test

The Chapter 7 bankruptcy means test is a two-part income limit test. In the first part, you’ll calculate your average income in the Chapter 7 Statement of Your Current Monthly Income form. You’ll then compare your income to the median income of a similarly sized household in your state. The United States Trustee Program maintains a special database that shows median family household income by state.

If your current monthly income is equal to or less than the median income of a similar-sized household in your state, then there’s no presumption of abuse in your case. In other words, you pass the Chapter 7 means test. But if your current monthly income exceeds this threshold, then you have to do additional means test calculations to determine whether you can file a Chapter 7 bankruptcy.

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Part 2 of the Means Test: Means Test Calculation

If your income is more than the median income for your state, you can still overcome a presumption of abuse by showing you don’t have enough disposable income to repay even a portion of your debts through Chapter 13. To show this, you have to complete the second part of the means test on the Chapter 7 Means Test Calculation form. On this form, you’ll calculate certain allowable deductions, which are expenses. Those expenses are subtracted from your income to determine how much, if any, monthly disposable income you have.

If you have a negative disposable income or a number close to zero, there likely won’t be a presumption of abuse, and you probably qualify to file Chapter 7. If you have a lot of disposable income, you’ll probably need to file Chapter 13 instead.

Means Test Exemptions

Although most individuals who file for Chapter 7 bankruptcy must complete the means test, there are two exemptions.

1. If your debts are primarily business (non-consumer) debts, then you aren’t required to complete the means test. Business debts must be debts incurred as part of starting or operating a business. This includes things like purchasing inventory or leasing office space. To claim this exemption, more than 50% of all your debts must be business debts.
2. Disabled military veterans whose debts were incurred while on active duty aren’t required to complete the means test. But you must have at least a 30% disability rating. Also, military reservists who filed for Chapter 7 bankruptcy before being called to active duty are granted a temporary exception from completing the means test for up to 540 days or 14 days after their active duty service ends.

If you feel one of these exemptions applies, you’ll claim the exception on the Statement of Exemption for Presumption of Abuse form.

Special Circumstances That Override the Means Test

If you’re required to complete the means test and don’t pass it, there’s still a way you can file Chapter 7 bankruptcy, even with the presumption of abuse. You do this by retaking the means test with an explanation that the test should be modified due to special circumstances that exist in your case.

Special circumstances are unanticipated situations beyond your control. And because they’re not your fault, they justify allowing you to deduct additional expenses during the means test. They may also allow you to make additional adjustments to your current monthly income when taking the means test. Two common types of special circumstances include a serious medical condition and being called to active duty service in the military. But before you can use special circumstances to pass the means test, you’ll have to ask the court to approve your request.

Filing Bankruptcy Under Chapter 13 Instead of Chapter 7

If you can’t pass the means test and exceptions or special circumstances don’t apply, then you can’t file Chapter 7 bankruptcy. But if you still want to file bankruptcy, then the bankruptcy court may convert your case to Chapter 13.

A Chapter 13 bankruptcy doesn’t liquidate or discharge your debt. Instead, your debts are reorganized. Reorganization typically involves consolidating all your debts, while reducing some of them. It also creates a monthly repayment plan. The idea is that you have enough disposable income that it wouldn’t be fair for you to walk away from all of your debts as part of a Chapter 7 bankruptcy.

Instead, you’re allowed to repay at least some of your debts over three to five years. During this period you’re still under the protection of the bankruptcy court with the automatic stay. So, your creditors can’t pursue their debts or harass you as long as you make all of your required payments. Then at the end of the repayment plan period, any eligible debts that remain can be discharged.

Let’s Summarize…

The presumption of abuse is something that occurs when filing Chapter 7 bankruptcy. The presumption of abuse is intended to prevent people who can afford to pay off some of their debts from using the Chapter 7 bankruptcy process. A presumption of abuse exists if you fail to pass either part of the Chapter 7 means test and special circumstances or exceptions don’t apply to your situation. If you can’t overcome the presumption of abuse, you can still file bankruptcy, but it’ll be under Chapter 13 of the Bankruptcy Code, not Chapter 7.