Self-Employed Debtors and Good Faith Bankruptcy Filing
Self-employed or business-owning prospective clients will occasionally ask whether they might lower wages to pass the means test qualifying them for a Chapter 7 bankruptcy. That is, they are curious as to whether they can, since the means calculates income and Chapter 7 eligibility based upon a specific 6-month period of time, simply pay themselves less money for 6 months in order to slide through the test.
The question they are asking when they ask me if they can lower their wages or salary to pass the Chapter 7 bankruptcy means test is actually, “Can I fudge my numbers so that it looks like I make less money than I do?”
The Bankruptcy Means Test: Pre-Bankruptcy Planning vs. Lying & Fraud
If your instinctual response to that question is “No,” then you are producing the safe as well as honest response. But let’s pull it apart.
You run your own business, your business has expenses, you may or may not take an actual paycheck on a regular basis depending on what those expenses are. Perhaps you have employees, and your obligation to see that they receive the paycheck that they expect is a priority at times over your own self-interest. This is a very common situation with small-business or self-employed individuals, in or out of bankruptcy. It’s a way of life for most small business owners.
So what if it happens that, in the 6 months prior to filing your bankruptcy petition, which is the period of time that the Chapter 7 means test examines to compute your household income, you happen to experience high business expenditures and a reduced opportunity to pay yourself a salary? It is, after all, a common practice for Chapter 7 petitions to be filed, where circumstances allow for it, at times when the means test produces a better result than it might at other times (for example, 7 months after a debtor receives a one-time, non-regular annual wage bonus that throws the means test income average off in an unfair manner). That is sometimes called “pre-bankruptcy planning,” and a certain, “good faith” amount of it has been determined to be legitimate.
So the question of whether it would be “good faith” or “bad faith” is a very fact-specific inquiry that will be different for each person asking the question.
First, the concept of “good faith” plays a large role in the bankruptcy process. “Good faith” can also be viewed as “honesty” for general purposes, or, at the least, “non-fraudulence.” Provisions of the US Bankruptcy Code allows for a case to be dismissed where there is a lack of good faith, and a separate Federal statute, Section 152(2) of Title 18 of the US Code, provides that knowingly and fraudulently making a false oath in bankruptcy is a crime. You are required to report your gross income from all sources other than Social Security for each of the 6 months prior to filing on the means test Form B22—period.
If you don’t pay yourself a paycheck but still need groceries and gasoline for the personal use of your case, who is paying it? The business? Those debits for personal expenses with the company debit card are income that must be reported.
Second, however, there is a practical reason for not refraining from paying yourself a wage or salary: increased cash reserves increase the liquidation value of the business. Your ownership interests in a corporation are an asset of the bankruptcy estate that is created upon filing of the petition just as your car, your jewelry, your cash on hand, your guitars, and your comic-book collection are. The question with business ownership interests in Chapter 7 is always, “What is it really worth?”
A business in Chapter 7 is worth the difference between its assets and its debts. A business with a lot of cash in a business bank account is worth more than a business without a lot cash in its bank account—and is therefore more difficult to protect from the liquidation power of the Chapter 7 Bankruptcy Trustee.
Non-Means Test Income Analysis: Beyond the Six-Month Look-Back
Furthermore, the Means Test is not the only part of the bankruptcy petition that examines your income.
In your bankruptcy schedules, you will also disclose your monthly average income as of the date of filing & prospectively looking forward (as opposed to the backward-looking Means Test analysis), as well as your monthly average household expenses. Your monthly average income is to be premised upon your annual income—not a single six-month period. It is possible to pass the Means Test and still be required to file a Chapter 13 bankruptcy.
That is, if you have “too much” net income left after your average household expenses are deducted from your monthly average income, you will not be able to file a Chapter 7 bankruptcy without meeting potential resistance by way of a motion to dismiss your case from the US Trustee (the division of the US Department of Justice overseeing the bankruptcy process and watch-dogging Chapter 7 eligibility).
For some debtors who own businesses and have a large amount of business or “non-consumer” debt, this question may not apply. But, for others, what is “too much” net income? This question will have highly variable answers depending upon your household, your district, your judges, and your Trustees.
The long story short is that you can work hard to pass the means test but still be required to file a Chapter 13 bankruptcy once you honestly report your average monthly income based upon your annual total.
The good news is that, if this is the case, your business and your assets will be totally safe from liquidation in a Chapter 13 bankruptcy.
Lower Wages to Pass the Means Test: The Bottom Line
There are occasions in which pre-bankruptcy planning in this manner may be legitimate, the outcome of which might be means test passage and Chapter 7 eligibility, but it is not an analysis that you can successfully run without the assistance of an experienced bankruptcy attorney.
An experienced bankruptcy attorney can assist you in balancing these complex considerations, maximizing the benefits and cost-effectiveness of the bankruptcy process while also maximizing the protection of your assets. If you are a small business owner, it is inadvisable to attempt a bankruptcy without counsel.
If you are a Michigan resident and would like to explore your options for a Chapter 7 or Chapter 13 bankruptcy with an experienced Michigan bankruptcy attorney, please contact us at (866) 674-2317 or click the button below to schedule a free, initial consultation.
If you enjoyed reading “Can I Lower Wages to Pass the Means Test in Bankruptcy?,” please browse our other articles on our main Michigan Bankruptcy Blog.Tags: chapter 7, detroit bankruptcy lawyer, Income in Bankruptcy, means test, Michigan bankruptcy attorney
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