What Happens to Disposable Income in Bankruptcy?

The amount and timing of your income is a key factor in a bankruptcy case.
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It's important to understand how disposable income is treated during bankruptcy. In a Chapter 13 bankruptcy, the amount of your disposable income helps determine how much you have to pay your creditors. For Chapter 7 cases, disposable income can be important in determining if you even qualify for bankruptcy relief. The state you live in plays a role in determining the wages you may keep or lose when you file Chapter 7 bankruptcy.

The Means Test

If your gross annual household income is below your state's median, you qualify for Chapter 7 bankruptcy. However, if your annual income is above the median, you must qualify with your disposable income on the so-called "means test" if you want to file Chapter 7. For means test purposes, your disposable income is defined as your gross income minus your expenses and allowable deductions. If your disposable income shows that you can afford to pay back at least some of your debts, you may be disqualified from a Chapter 7 filing.

Actual Income and Expenses Test

Even if you pass the means test, it's possible you still won't qualify for Chapter 7 bankruptcy. The actual income and expenses test is a projection of your disposable income looking forward, whereas the means test is a backwards-looking test that uses information from the six months before you file bankruptcy. If the court sees that your disposable income going forward will exceed about $200 per month, you may not qualify for Chapter 7.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy, also referred to as a wage earner's bankruptcy or an individual debt adjustment, is the most common alternative to Chapter 7 bankruptcy. In Chapter 13, you work out a payment plan for your debts over a three- or five-year period, with the court's approval. You are expected to pay your creditors back the amount of your disposable income over the period of your bankruptcy. Any debts remain above and beyond your disposable income are discharged by the court.

Income Exemptions

In a Chapter 7 bankruptcy, you are liable to lose income you have earned but not yet received as of the day you filed. By filing Chapter 7, you avoid the monthly payments required in Chapter 13, but in exchange, you have to give up "non-exempt" assets. A non-exempt asset in bankruptcy is one that is worth more than its applicable bankruptcy exemption. Each state determines which assets are exempt in a bankruptcy case, so where you live is the determining factor in what you can keep. While most states exempt 75 percent of earned but unpaid wages, the amount can vary dramatically. For example, as of the time of publication, Pennsylvania exempted all unpaid wages for debtors. However, if you weren't the head of a household in Michigan, you only qualified for an exemption of 40 percent of wages.

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