Disposable income affects bankruptcy cases in two ways. First, it affects eligibility for a discharge in Chapter 7 bankruptcy cases. Disposable income is calculated using a means test. The means test uses the average income for the last six months, excluding social security income, in order to calculate the debtor’s current monthly income. Standard IRS deductions are subtracted from the current monthly income, and the remaining number represents monthly disposable income. Too much disposable income and a presumption of abuse exists.
Debtors whose means test states there is a presumption of abuse are not eligible for a discharge under Chapter 7 because they have too much disposable income and can make meaningful payments to their creditors. The presumption of abuse can be rebutted by showing that the debtor’s current financial situation is not accurately represented by the means test, and in fact the debtor does not have disposable income. The bottom line is that if the debtor has too much disposable income then he may not qualify to receive a discharge under Chapter 7.
Second, disposable income affects the amount that the debtor must pay to unsecured creditors in Chapter 13 bankruptcy cases. Basically, the debtor must dedicate at least an amount equal to his monthly disposable income to the unsecured creditors listed in the schedules. However, if the debtor has proposed a plan that pays all unsecured creditors then it may not be necessary to dedicate all disposable income in the plan. Also, if the debtor has nonexempt property then he has to pay an amount equal to the value of the nonexempt property to the unsecured creditors. This may cause the debtor to have to pay back some or all of the unsecured creditors even though he doesn’t have disposable income on the means test. Debtors who have both disposable income and nonexempt property pay the unsecured creditors according to whichever method of measurement, either value of nonexempt property or disposable income, provides the greatest payment to the unsecured creditors.