Means Test Pitfalls for Self‑Employed Californians — What to Know and How to Prepare

Introduction — Why the Means Test Matters to Self‑Employed Californians

The federal means test determines whether an individual consumer can file a Chapter 7 bankruptcy (a discharge) or must move to Chapter 13 (a repayment plan). For self‑employed filers the test is often more complex: it examines your averaged income over the applicable period, allowable living and business expense standards, and state exemptions that affect what you can keep. Because the numbers and standards change based on filing date and household size, planning matters—timing, documentation, and correct accounting often decide whether you "pass" the means test.

Check the U.S. Trustee (DOJ) median‑income and expense pages before filing—those official tables are the starting point for the means test and are updated periodically (by filing date).

Common Pitfalls for the Self‑Employed

Below are the mistakes we see most often among freelancers, contractors, and small business owners in California.

1. Miscomputing "current monthly income" (CMI). The means test uses the average of income received during the six full calendar months before the filing month. Self‑employed debtors often use annual tax figures or year‑to‑date numbers incorrectly instead of the precise six‑month average.
2. Mixing personal and business accounts. Debtors who pay personal expenses from business accounts (or vice versa) struggle to produce verifiable profit & loss statements; courts scrutinize undocumented draws and transfers.
3. Over‑ or under‑reporting business expenses. The means test counts business net income (gross receipts minus ordinary and necessary business expenses). Failing to document legitimate business expenses or claiming non‑business items as deductions can produce audit flags or an inflated disposable income calculation.
4. Ignoring IRS/U.S. Trustee expense standards. Part two of the means test applies national and local expense standards (food, housing, transportation, etc.). Many self‑employed filers either neglect allowable business‑related expenses (like vehicle operating costs) or assume personal choices will be accepted as necessary living expenses without documentation. Use the IRS national/local standards as incorporated into the U.S. Trustee guidance when completing Forms 122A‑1 / 122C‑1/2.
5. Timing the filing without planning. Because the six‑month averaging window can work for or against you, an unplanned filing after a single high‑income month can bump you over the median income threshold. Conversely, a deliberate delay after a sustained income drop may help you pass — but intentional manipulation (transfers to avoid reporting) can lead to challenges.
6. Misunderstanding California exemptions (homestead & other protections). Some self‑employed filers overestimate protection from a homestead or other state exemptions. California's homestead exemption now uses county median sale price subject to statutory caps/floors and is adjusted for inflation—know the rules that apply to your county and the date you claim the exemption.

How to Prepare — Practical Checklist for Self‑Employed Filers

Preparation reduces surprises at filing and increases the chances of a favorable outcome. Use this checklist and keep clear records you can supply to counsel or the trustee.

Documentation & Accounting

• Assemble detailed profit & loss statements for the last 6–12 months and reconcile them to bank statements and 1099s. Courts expect contemporaneous records, not handwritten after‑the‑fact summaries.
• Separate personal and business finances going forward. If you haven’t done so already, open dedicated business accounts and stop commingling funds.
• Collect substantiation for regular expenses (receipts, lease agreements, vehicle logs). If you rely on IRS national/local standards for allowances, be ready to show why actual expenses differ and why deviations are reasonable.

Timing & Income Strategy

• Calculate several "what‑if" scenarios using the six‑month average rule: compute CMI using different possible filing dates to see whether timing changes your result. Document seasonal or one‑time income spikes so your attorney can argue volatility if needed.
• Avoid suspicious transfers or paper reductions of income just before filing. Courts scrutinize recent transfers, related‑party payments, and rapid changes in compensation to determine intent to manipulate the means test.

Exemptions & Asset Protection

• Review California exemptions with counsel: homestead rules now use county median sale prices with a cap (statutory changes include annual CPI adjustments). Don’t assume a single statewide number — county figures and the cap/floor rules apply when you claim the exemption.
• Identify retirement accounts, business tools, vehicles, and inventory; many retirement accounts are federally or state‑protected, but documentation is necessary.

Where to Get Help

• Work with a bankruptcy attorney experienced with self‑employment cases — they can prepare Forms 122A/B, analyze CMI and disposable income, and advise whether Chapter 7, Chapter 13, or an out‑of‑court solution is best.
• If you cannot afford counsel, the Central District of California maintains self‑help resources and intake options at the Roybal courthouse and online. Plan to bring organized P&L statements and bank records to any free clinic or consultation.