Everything You Need to Know About Divorce and Bankruptcy

Everything You Need to Know About Divorce and Bankruptcy

 

You have probably heard the commonly-cited statistic that about half of all marriages end in divorce. A sizable number of those whom have experienced divorce will also find themselves in need of bankruptcy protection. Family law and bankruptcy law intertwine in several ways. This post outlines some of the ways marriage, divorce, and bankruptcy laws are connected in Arizona.

 

Community Property Law in Arizona

Arizona is one of a handful of states with a community property law. Community property law affects both divorce and bankruptcy cases. Community property law considers all income and debt accumulated during a marriage to be marital property and requires it be split equally between the spouses during a divorce.

 

Distinguishing between community property and separate property can be quite important in bankruptcy cases. While community property is any income, assets, or debt acquired during the marriage (up until the time of separation), separate property includes property owned before the marriage, inheritance, and gifts given to only one spouse. Beware of “commingling,” or actions that cause separate property to transmute into community property. For example, depositing inheritance funds into a joint bank account and using some of it to remodel your marital home is considered commingling.

 

If you are married and filing for bankruptcy without your spouse, all of your community property (marital property) becomes part of the bankruptcy estate. This includes not only your spouse’s paycheck, but also real estate, cars, and other major purchases, even if it was bought and paid for in your spouse’s name only. Community property law works the same way for debt, too. If only one spouse files for bankruptcy, the other spouse will still be held responsible for the shared debt.

 

If you are filing for bankruptcy without your spouse, your spouse’s separate property does not need to be included in the bankruptcy proceedings. Keep in mind that it is considered fraud to transfer property out of your name to a family member to shield it from creditors in a bankruptcy case. If you have any questions about how Arizona’s community property law will affect your bankruptcy case, talk to an experienced Arizona bankruptcy attorney.

 

Timing Your Bankruptcy and Divorce Filings

 

It is not uncommon to realize that you are headed for divorce and bankruptcy at the same time. Financial hardships and tough economic times can take their toll on a marriage. The reverse is also common. Divorce is expensive and may leave one or both spouses saddled with debt. The old saying is true – when it rains, it pours!

 

So, if you think you may need to file for bankruptcy and divorce at the same time, which do you file first? The answer is complicated and depends on your individual situation, but an experienced Arizona bankruptcy lawyer can help.

 

Reasons You May Want to File for Divorce First

 

If divorce is inevitable, it may be a good idea to hold off on filing for bankruptcy until after the divorce is settled. To qualify for Chapter 7 bankruptcy in Arizona, you must not exceed the income limit for your family size. If you make significantly less money than your spouse, filing for bankruptcy after divorce may help you pass Arizona’s “means test” and income limits.

 

The Chapter 13 bankruptcy process takes three to five years to complete. The plan for jointly-filing married couples in Chapter 13 bankruptcy requires years of cooperation that may be unsustainable for couples headed for divorce. In the meantime, the divorce court will be unable to divide any marital assets that are subjected to an automatic stay in your bankruptcy case. Should you end up filing for divorce in the middle of Chapter 13 bankruptcy, a final order in the divorce case will be left pending until your bankruptcy case has been closed.

 

Reasons You Might Want to File for Bankruptcy First

 

Filing for Chapter 7 bankruptcy before an anticipated divorce may simplify marital property and debts. Chapter 7 bankruptcy is also a relatively quick process, so it will not hold up divorce proceedings for more than a few months.

 

Conversely, if your spouse is ordered to pay you alimony, this increase in income may put you over the limit to file for Chapter 7 bankruptcy. When filing Chapter 13 bankruptcy, spousal support payments count towards your disposable income, and you may see an increase in your plan payments.

 

However, if you do decide to file for bankruptcy while separated and/or planning a divorce, inform both your divorce and bankruptcy attorneys to avoid any potential conflict of interest.

 

Bankruptcy and Legal Separation in Arizona

 

Many families choose to legally separate while they get their affairs in order before obtaining a divorce. For others, legal separation is a way for couples to live separate lives if they object to divorce for personal, cultural, or religious reasons. Is bankruptcy an option for one or both spouses while legally separated?

 

You can file for bankruptcy while legally separated, either alone or as a couple. However, many implications of filing a bankruptcy petition during a divorce apply to legally separated couples, as well. Keep in mind that if you are not legally separated, both your and your spouse’s incomes will be included to determine your eligibility (for Chapter 7) or your monthly payment amounts (for Chapter 13). If you are already legally separated, your spouse’s income information will not be used for this purpose.

 

If you file for Chapter 7 bankruptcy individually while legally separated, your spouse’s credit will not be affected. However, only you will be discharged from marital debts. A Chapter 13 bankruptcy can be a little more complicated to manage for a separated couple. However, your spouse will receive “co-debtor” protection during the automatic stay, while you pay off the joint debt through your payment plan.

 

The decision to file for bankruptcy jointly or separately will depend on the individual circumstances of your case. An experienced Arizona bankruptcy attorney can recommend the best option for you, whether you should file separately, jointly, or wait until after your divorce is final to file for bankruptcy.

 

Child Support and Alimony: Nondischargeable Debts in Arizona Bankruptcy

 

There are certain debts that cannot be discharged in a bankruptcy. These include student loans, most kinds of taxes, and government fines/penalties. Support obligations, like child support and alimony, are also considered nondischargeable debts.

 

However, filing for bankruptcy may make it easier to meet your support obligations. If you owe any outstanding child support arrears and file for Chapter 13 bankruptcy, it is considered a priority debt. The debt you owe for child support will be paid in full through your monthly payment plan. This means less of your assets will be tied up by creditors, freeing up more money to support your children.

 

Only pre-bankruptcy debts are included in your Chapter 13 payment plan, so it is important to continue making timely child support payments as they become due. If you do not pay your current child support obligations during your Chapter 13 bankruptcy, the state can file for relief from the automatic stay, meaning they can go after your assets that would otherwise be protected. You will also be unable to receive a discharge from your bankruptcy until you are current on all child support arrears.

 

Like child support, alimony is also considered a “domestic support obligation” that is nondischargeable through bankruptcy. There are only rare exceptions to this rule, usually when a third party becomes involved in the support agreement. Agreements or orders in a divorce decree to pay for something other than domestic support may be dischargeable. Your bankruptcy lawyer will be able to advise you on which debts can be discharged through Chapter 7 or Chapter 13 bankruptcy.

 

If you are receiving child support and/or alimony from a former spouse, this will count as income in your bankruptcy case. For a Chapter 7 bankruptcy, your income (including spousal and child support) must meet the means test. Chapter 13 bankruptcy does not have an income limit. However, child support and alimony payments are considered part of your income and will be used to determine the amount of your monthly payments.

 

Pension and Retirement

 

One of the more common questions when approaching either bankruptcy or divorce is “Do I get to keep my retirement funds?” The good news is, whether filing for Chapter 7 or Chapter 13 bankruptcy, your individual retirement accounts such as IRAs and 401ks are generally left intact. Depending on the type of retirement account you have, there may be caps on the amount that can be protected. In certain circumstances, however, retirement funds may not be protected assets in a bankruptcy case.

 

Assets that we are not obligated to include as part of a bankruptcy estate are known as exemptions. The exemptions you are allowed to claim depend on your state and federal laws. While some states allow you to choose between federal or state exemptions, Arizona is considered an “opt-out” state, meaning we are only allowed to use our state exemptions, not the federal exemptions.

 

In most cases, your own ERISA-qualified retirement plans are scheduled exemptions under Arizona law. However, if you have a pension or retirement account that was transferred to you from a former spouse or anyone else, these funds might not be shielded. The exemptions for which you will qualify are highly dependent on the individual facts of your case. Only a knowledgeable Arizona bankruptcy attorney can give you legal advice on which exemptions you should claim.

 

If your ex-spouse was ordered to share his or her pension with you in the divorce decree, your share of the retirement funds will not be affected should he or she file for bankruptcy. When someone is ordered to give some or all of his or her pension to a former spouse, these future payments are usually issued through a Qualified Domestic Relations Order (QDRO). Bankruptcy law considers payments made through a QDRO to be immediately transferred and no longer the property of the supporting spouse. In cases in which a pension is designated to be transferred through a QDRO, you do not need to worry about your share of the pension becoming part of the bankruptcy estate.

 

Marriage and Remarriage

 

If your finances are a wreck after a divorce or other hardship, it is highly recommended you take steps to get your financial situation in order before entering into a new marriage. Although your new spouse will not be on the hook for the debts you accumulated before the marriage, getting married or remarried can make it harder for you to get out of debt.

 

If you are filing Chapter 7 bankruptcy, your spouse’s income will be considered as part of the means test to qualify. If your new spouse makes too much money, you will be disqualified from filing Chapter 7, even though he or she has nothing to do with your old debts.

 

If you are disqualified from filing Chapter 7 bankruptcy, you have the option to reorganize under Chapter 13. However, your spouse’s income will be factored into your monthly payment plan, meaning that he or she will need to contribute towards paying off your debt.

 

Fortunately, even if you should decide to file for bankruptcy after getting married, your spouse’s credit score will not be affected by your bankruptcy or debt. Some people find it is to their advantage to rely on the good credit of a non-filing spouse to secure loans for the family’s mortgage, car, and other major purchases until their post-bankruptcy credit can be repaired. However, keep in mind your shared marital property will become part of the bankruptcy estate if you file for bankruptcy after you are married. If you do anticipate filing for bankruptcy after getting married, be mindful of commingling assets to allow your spouse to hold onto his or her separate property.

 

Talk to an Arizona Bankruptcy Attorney

 

Like marriage and divorce, filing for bankruptcy is a major life decision that can have a big impact on other areas of your life. If you and/or your spouse have questions about how bankruptcy might affect your marital situation (or vice versa), speak with an experienced Arizona bankruptcy attorney right away. Tucson bankruptcy lawyer Stephen Trezza has been helping families achieve financial freedom for over 25 years. Contact us today to set up a no-cost, no-obligation consultation.