Chapter 7 versus Chapter 13

Dear Bankruptcy Adviser,
I filed Chapter 7 and then I received a presumption of abuse letter from the U.S. Trustee’s office. I have not been told whether my case will be dismissed or converted to a Chapter 13 repayment plan bankruptcy. If my case is dismissed under a presumption of abuse, when will I be able to refile Chapter 7 bankruptcy?
— Lisa

Dear Lisa,
For those unfamiliar with the bankruptcy process, a presumption of abuse typically arises when a debtor’s income exceeds the median income of all individuals in the debtor’s state. Or the debtor lists expenses that exceed permissible expenses. The United States Bankruptcy Trustee presumes that the debtor is trying to abuse the bankruptcy system and notifies the debtor by sending a presumption of abuse letter.

When you have income above the median income for the state you live in, you must pass the “means test.” In general, this test is used to see if your income available for debt repayment over that five-year period is $10,000 or more, then Chapter 13 will be required. In other words, anyone earning above the state median, and with at least $166.67 per month of available income, will automatically be denied Chapter 7. So, for example, if the court determines that you have $200 per month income above living expenses, $200 times 60 is $12,000. Because $12,000 is above $10,000, you’re stuck with Chapter 13.

Additionally, a debtor is only allowed to list expenses that are “reasonable and necessary.” Who determines the amount of “reasonable and necessary” expenses? The Internal Revenue Service determines it, with statistics gathered over the years to determine what the “average” American should be paying for goods and services. In reality, most people spend well above those amounts.

For example, the debtor may truthfully list monthly expenses of $500 for food and $300 for recreation and entertainment. However, according to the Bankruptcy Code, it is “reasonable and necessary” (code words for “only permissible”) for a single individual, with no kids and no dietary issues, to spend only $250 per month on food and $75 per month on entertainment and recreation. In the eyes of the bankruptcy trustee, that remaining $475 can be used to pay off creditors, which is why a debtor in that situation would not qualify for complete relief from her debts under Chapter 7, but would instead qualify under Chapter 13 with a repayment plan.

However, a presumption of abuse does not always mean the bankruptcy petition will be dismissed. If a debtor has special dietary needs, or works in a profession that requires special purchases, such as an actress who has to buy clothing for auditions, then it may be possible to show the trustee that certain higher expenses are necessary for that particular debtor. Detailed documentation will be required.

Lisa, in your case, the bankruptcy trustee has notified you that, according to your income or listed expenses, it appears you can afford to pay something to your creditors. Chapter 7 relief is only granted when you have no assets that can be used to repay your creditors, which is why you may have to oppose the trustee’s motion to dismiss your Chapter 7 case, either by convincing him or her that your particular expenses should be allowed, or instead converting your case to Chapter 13.

You asked when you will be able to file for bankruptcy protection under Chapter 7 again. If your financial circumstances take a turn for the worse that could make it possible for you to legitimately qualify for a Chapter 7 bankruptcy, and there is no waiting period once a case has been dismissed. The question you should be asking, however, is: Why did you not know the rules before you filed? I assume you did not hire a bankruptcy attorney, because a competent attorney would have told you that you did not qualify for Chapter 7 bankruptcy relief. At this point, your situation has become a bit more complicated, and your best bet would be to find a bankruptcy attorney who can advise you on your best course of action.

Justin Harelik is a practicing attorney in Los Angeles. To ask a question of the Bankruptcy Adviser go to the “Ask the Experts” page, and select “bankruptcy” as the topic.