How Are Business Income and Expenses Used on the Bankruptcy Means Test for Chapter 7 and Chapter 13?
In the context of U.S. bankruptcy law, the "means test" is a critical tool used to determine eligibility for Chapter 7 bankruptcy and to calculate the repayment plan under Chapter 13. For individuals who own or operate a business, business income and expenses play a significant role in this process. Here's how they are handled under each chapter:
Chapter 7 Bankruptcy Means Test
Chapter 7 is designed to provide a fresh start by discharging most unsecured debts. The means test determines whether your income is low enough to qualify or if you have sufficient disposable income to repay creditors (in which case you might be pushed toward Chapter 13).
Business Income: If you're a sole proprietor or self-employed, your business income is considered part of your personal income because there’s no legal separation between you and your business. Gross business income (revenue before expenses) is not used directly. Instead, you subtract ordinary and necessary business expenses to determine your net business income. This net income is then included in your "current monthly income" (CMI) for the means test. CMI is calculated as the average monthly income over the six months prior to filing, including net business income, wages, or other sources.
Business Expenses: Ordinary and necessary business expenses (e.g., rent, utilities, supplies, employee wages) are deducted from your gross business income to calculate net income. These expenses must be reasonable and documented. Personal expenses disguised as business expenses (e.g., lavish personal travel) may be scrutinized by the bankruptcy trustee. The net income after these deductions is what flows into the means test to assess your disposable income.
Means Test Application: If your CMI (including net business income) is below your state’s median income for a household of your size, you generally pass the means test and qualify for Chapter 7. If it’s above the median, you proceed to the second part of the means test, where allowable expenses (based on IRS standards and some actual expenses) are subtracted from CMI to determine disposable income. If your disposable income is too high, you may not qualify for Chapter 7.
Chapter 13 Bankruptcy Means Test
Chapter 13 involves a repayment plan over 3-5 years, and the means test helps determine how much you must repay creditors through the plan. Business income and expenses are treated similarly to Chapter 7 but with a focus on funding the repayment plan.
Business Income: As with Chapter 7, net business income (gross revenue minus ordinary and necessary expenses) is included in your CMI. This net income contributes to the pool of disposable income available to pay creditors over the life of the repayment plan.
Business Expenses: You can deduct ordinary and necessary business expenses from your gross income, just like in Chapter 7.
These deductions reduce your net income, which in turn affects how much disposable income you have to commit to the Chapter 13 plan. The bankruptcy trustee will review these expenses to ensure they’re legitimate and not inflated to reduce your repayment obligation.
Means Test Application: In Chapter 13, the means test calculates your disposable income to determine the monthly payment under the repayment plan. Unlike Chapter 7, passing or failing the means test doesn’t determine eligibility (since Chapter 13 is available to those with regular income, including business income). Instead, it sets the minimum amount unsecured creditors must receive. If your CMI is above the state median, your plan typically lasts 5 years; if below, it may be 3 years.
Key Differences
Chapter 7: The focus is on qualifying for discharge. Business income and expenses affect whether you pass the means test to file under this chapter.
Chapter 13: The focus is on repayment. Business income and expenses determine how much you can afford to pay creditors through the plan.
Additional Considerations:
Documentation: You’ll need detailed records (e.g., profit-and-loss statements, tax returns) to substantiate business income and expenses.
Trustee Oversight: The bankruptcy trustee may challenge deductions if they seem unreasonable or if they suspect you’re hiding income.
Separate Entities: If your business is a corporation or LLC, its income and expenses are generally separate from your personal bankruptcy unless you’ve commingled funds or personally guaranteed debts.