How does changed income affect bankruptcy?

An answer to the question of how changes in income impact bankruptcy first requires some background.

One question posed in bankruptcy is how much, if anything, must a particular bankruptcy debtor repay unsecured creditors (such as medical bills and charge cards). The bankruptcy code reflects a rough attempt by Congress to legislate the notion that persons with "disposable" income should use chapter 13 to repay certain creditors with that disposable income. Hence, we have the statutory means test, used to determine chapter 7 eligibility as well as repayment requirements in chapter 13 bankruptcy.

At its most basic level, the means test is a comparison between income and a set of expenses/expense allowances. It follows that income is important as to whether the means test is favorable to a debtor or not.

The basic income figure used in the means test is the oddly named "current monthly income," which is an average of the prior six months of gross income. For example, the months of September through February are used in a case filed in March.

The mathematical consequence of an average being used in the means test is that changes in income do not immediately appear in the standard means test calculation. The practical impact will differ depending on chapter and direction of change.

Chapter 7, Increased Income

When chapter 7 bankruptcy is sought, a new increase in income causes concern that one might no longer be able to pass the means test. As a first step, analysis based on the new income figures should reveal if such concern is warranted. At the simplest level, the solution might be to file the case quickly before the six month average catches up to present. However, chapter 7 is also subject to a totality-of-the-circumstances based test that could result in dismissal even if the formulaic means test is passed. How to proceed in this situation requires careful analysis of all the facts and circumstances involved in the potential bankruptcy case.

Chapter 7, Decreased Income

In the converse of a increased income situation, one might have facts where old income is pushing up the six month average, leading to means test problems based on income that no longer exists. The simplest solution is to wait the case out until the average falls in line with reality. However, sometimes waiting might be ill-advised, and then one faces more particular inquiry into the implications of immediately filing a chapter 7 case.

Chapter 13, Changes in Income

The chapter 13 process is responsive to changes in income. Since the landmark 2009 Supreme Court case Hamilton v. Lanning, known or virtually certain changes in income are accounted for in the chapter 13 disposable income evaluation. The essence of the process is that when a change exists, the expected income replaces the six-month average income for determining what, if any, income should be paid to unsecured creditors.

Pre-filing income changes might still lead to some timing considerations, as both the minimum plan length and the applicability of the means test allowances are best viewed as mechanically determined based on six-month averages. Most basically, one might be able to propose a shorter plan if one waits after an income decline or hurries after an income increase.

Changes after Chapter 13 Filed

A related question to primary topic of this post is what happens if income changes after a chapter 13 case has been filed. Chapter 13 can be thought of as a fluid process. Confirmed chapter 13 plans can be modified to account for changed circumstances, both by the debtor and by the standing trustee, although such modifications must meet statutory standards and be approved by the bankruptcy judge for the case.