What Are Living Costs in Chapter 7?

By John Green

Not everyone qualifies for a complete discharge of indebtedness under Chapter 7 of the federal bankruptcy law. An individual whose monthly income is too high will have to file instead under Chapter 13, which requires making payments for several years. However, even if a person fails the means test at first, it may still be possible to qualify for Chapter 7 debt relief after deducting certain living expenses.

Not everyone qualifies for a complete discharge of indebtedness under Chapter 7 of the federal bankruptcy law. An individual whose monthly income is too high will have to file instead under Chapter 13, which requires making payments for several years. However, even if a person fails the means test at first, it may still be possible to qualify for Chapter 7 debt relief after deducting certain living expenses.

Chapter 7

Filing for debt relief under Chapter 7 of the federal bankruptcy law makes it possible to obtain a total discharge of outstanding debt, with exceptions for such debts as student loans, child support, recent taxes and credit charges made for nonessential items within 90 days of filing. Under Chapter 7, the debtor's possessions are sold to pay creditors, although the law exempts certain assets from liquidation, such as retirement funds, veteran benefits, life insurance and personal property up to a specified value, depending on the item.

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The Means Test

Generally, if the debtor's income is sufficient to repay at least 25 percent of his outstanding consumer debt over five years and exceeds the annual median family income in his state, the bankruptcy filing must be made instead under Chapter 13, which requires the debtor to follow a payment plan for three to five years. According to the Department of Justice's Trustee Program, the median income is based on U.S. Census data and number of individuals in the debtor's family. In calculating monthly income in connection with the means test, the amount can be reduced for certain expenses.

Standard Expense Exceptions

Under Chapter 7, the amount of the filer's deductible monthly living costs is generally determined by the national and local standards set each year by the Internal Revenue Service. These standard amounts can be included for the debtor, dependents and, in the case of joint filing, non-dependent spouse. The national standard includes such expenses as food, clothing, household supplies, personal care products and out-of-pocket health care costs. State standards cover such costs as utilities, rent, cable television, phone and Internet. In reducing monthly income to reflect living costs, these national and local standard amounts are used even if they are substantially less than the filer's actual expenses, although Chapter 7 does give the judge discretion to make an upward adjustment for expenses for food, clothing, housing and utilities if reasonable and necessary.

Actual and Reasonable Expense Exceptions

In addition to the national and local standard expense levels set by the IRS, Chapter 7 also establishes several categories in which expenses can be deducted from the monthly income amount. For example, monthly income can be reduced by actual and reasonable expenses for health insurance, disability insurance and health savings accounts for the filer, filer's spouse and any dependents. Other categories include care for elderly or disabled family members, expenses connected with protection from domestic violence, school-related expenses for dependent children, tax obligations, payments for secured debts, bankruptcy administration costs and involuntary payments related to employment, such as union dues or uniform expenses.

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If you're facing serious financial difficulties, you may consider filing for bankruptcy protection under federal law. The bankruptcy process is designed to give you a fresh financial start, discharging certain debts while allowing you to keep some "exempt" property. However, if you owe less than you earn, a new bankruptcy law passed in 2005 will make it difficult for you to qualify for a Chapter 7 bankruptcy, which involves liquidation of your assets and discharge of your debts. Instead, you may have to file for Chapter 13 bankruptcy, which requires partial or full repayment to your creditors.

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In Chapter 7 bankruptcy, also called liquidation bankruptcy, your assets -- unless they are specifically protected or "exempt" from liquidation -- are sold to pay your debts. If your non-exempt assets do not have enough value to fully pay your outstanding debts, the bankruptcy court issues a discharge of many of your unpaid debts, erasing your obligation to pay them. However, not everyone qualifies to file under Chapter 7. You should be sure that you meet certain income guidelines and other requirements before filing your case.

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