Confusing Income : Taxable Income Is Different From Means Test Income

Whether or not you qualify to file Chapter 7 bankruptcy depends on your income level relative to applicable median income where you live. The term “income” has special meaning in bankruptcy law, and many people reach incorrect conclusions about their bankruptcy eligibility because they do not understand how bankruptcy defines their ”income” for purposes of the bankruptcy means test.

A couple made an appointment earlier this week to discuss asset protection as an alternative to bankruptcy. The couple had over $150,000 of unsecured debts. The wife was unemployed and the husband worked in sales. They told me at the beginning of their story that they were ineligible to file bankruptcy because the husband made too much money. They wanted to know what creditors would do to collect money and if they could protect their salary and their few remaining assets.

After listening to their description of their situation I pressed them to explain to me in more detail why they were ineligible to file Chapter 7 bankruptcy. They explained that the husband’s 2009 income was $100,000 and that they knew this income level was too high to qualify their three person household for Chapter 7 bankruptcy. It turns out that the husband earned most of his taxable income in the first half of 2009. He lost his job in October, 2009. He just found a new job this February that paid a base salary of $50,000 plus commissions. He expected that 2010 commissions at his new job would match his 2009 salary by the end of this year so he was still “too rich” to file Chapter 7 bankruptcy. I told the couple that in my opinion they were in fact eligible to file Chapter 7 bankruptcy based on their income history.

Many people confuse the concept of gross income for tax purposes with deemed income for bankruptcy purposes. When I asked prospective debtors what their income is they frequently give me their IRS annual income instead of their current monthly income. Bankruptcy’s means test considers actual household income only in the six months immediately preceding bankruptcy. Annual income on your tax return is not important in most cases. Reasonably guaranteed future income may be a factor in some cases. Because this husband was not working from October, 2009, through January, 2010, his income for bankruptcy purposes would be below median income assuming he filed in April, 2010. He is “poor enough” to file Chapter 7 bankruptcy even though his IRS taxable income was about $100,000 in 2009 and may be the same in 2010.

The man’s commission income is uncertain. He expects to earn a comparable income in his new position, but his future actual income is speculative above his base salary in a new job. His commissions in months immediately subsequent to his bankruptcy filing date probably will not yet reach his goals. Based on what I know initially about this couple I do not think the U.S. Trustee would consider the filing to be an abuse.