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What Is Income And Why Is It Important? - Part 2 of 12

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A 12-part Series On All You Need To Know About The Process of Filing for Chapter 7 Bankruptcy

Part Two – What Is Income And Why Is It Important?

When a debtor files for Chapter 7 Bankruptcy three snapshots of the debtor’s income will be taken. First what the income is now; Second what the average monthly income is over the past six months prior to filing the petition; and Three the last three years of income.

Each snapshot has a purpose. The amount the debtor makes now, and last six-month average is meant to measure whether or not the debtor qualifies for Chapter 7 Bankruptcy and to see if income has fallen or increased. The past three years of income is to see if the debtor is manipulating income to qualify for Chapter 7 Bankruptcy.

1. What is Income?

So, what is the debtor’s income? Income includes Gross Wage, Salary, Tips, Bonuses, Overtime and Commissions. Included as well is any rent or other income derived from real estate property. Also included is Alimony and Maintenance payments (however payments from spouse are not included if that spouse’s income is included in the bankruptcy as income). If the debtor runs a business, then the debtor must report the Net Income received. A debtor’s spouse’s income is included as well unless they are legally separated. Of course, any former spouse’s income is not included. Pension and Retirement income is also included except Social Security which is not. Included as well are private disability insurance benefits.

It doesn’t matter when the work or services were performed for the income received. For example, if you worked in the two weeks prior to the start of the six-month period but paid within the six months prior to filing; that money is included.

Not included in income is Social Security and any compensation paid by the U.S. Government in connection with disability, combat-related injury or disability, or death of a member of the uniformed services.

2. What is the Means Test?

The Means Test is a threshold that either qualifies or disqualifies a debtor from Chapter 7 Bankruptcy. This test only applies when the debts are primarily consumer debts. If most of the debt is commercial debt, then the means test is not required. Consumer debt is defined as debt incurred “primarily for personal, family or household purposes.” This means, if you have incurred business debt and that makes up over 50% of your debt the means test is irrelevant. However, expect that the Bankruptcy Trustee will be asking about your debts to make sure you are not trying to pull a fast one.

The first step is to determine the debtor’s current monthly income. If the debtor’s monthly income exceeds a threshold amount the debtor must then complete a means test calculation. This calculation takes into consideration the average monthly income and then applies adjustments like tax, student loan payments, support obligations, the family size to determine the national standard deductions, food clothing, housekeeping, personal care and the like.

If the debtor flunks the means test, then there exists a presumption of abuse which is never good. This could cause the case to be dismissed or even converted to Chapter 11 or 13.

3. The Game!

So, because the means test looks at the debtor’s average monthly income for the six months prior to filing, timing is everything. If a debtor’s income is increasing, then filing sooner rather than later might just squeeze the debtor into meeting the means test threshold. On the flip side, if the debtor’s income is decreasing then waiting might be required so that the monthly average dips down below the means test threshold. Remember though, the Bankruptcy Trustee will be looking at all three snapshots of your income so trying to manipulate your income to qualify could result in questions about why your income has changed.

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