Bankruptcy often gets a bum rap here in the United States, making those who could truly use its benefits hesitant to pursue that option.  But the U.S. government established bankruptcy laws in order to help debtors and creditors alike.  It assists debtors by allowing them to either liquidate their assets to pay off as much of their debt as possible–forgiving the rest–via Chapter 7 bankruptcy, OR by allowing them to reorganize their debts into a re-payment plan via Chapter 11 or 13 bankruptcy.

Our U.S. Constitution–in Article I, Section 8–gives Congress the right to “establish…uniform laws on the subject of Bankruptcy throughout the United States”.  Title 11 of the U.S. Code governs the ins and outs of bankruptcy law and is usually referred to as the “Bankruptcy Code.”  States also have the power to pass laws governing some aspects of relationships between debtors and creditors, though the power to regulate bankruptcy remains vested in the federal government.

Chapter 7 bankruptcy is often also known as liquidation bankruptcy.  If you file for this type of bankruptcy protection, you must first pass a two-part means test in order to determine that you qualify for liquidation as opposed to reorganization bankruptcy.  The means test is a formula meant to prevent higher-income individuals from filing for Chapter 7 bankruptcy in order to wipe out debts that they could actually afford to re-pay.

The first step of the means test compares your current monthly income to the median income of similarly-sized households in your state.  If your income is below that median income amount, you pass the first step of the means test and will automatically qualify to file for Chapter 7 protection.  If it falls above that median income amount, however, you must proceed to the second step of the means test.

The second step of the means test determines whether or not you have enough monthly income left over after paying your allowed monthly expenses (such as car and house loans and utilities) to pay off at least a portion of your outstanding unsecured debt (such as credit cards).  If your disposable income reaches a certain level, you will fail the Chapter 7 means test and will need to file for reorganization bankruptcy instead.