Individuals considering both bankruptcy and divorce have additional planning issues to consider. Which should be done first? Can we arrange our asset division to protect assets following divorce? Which assets can be discharged and which must be paid? Can income taxes be discharged?
There are two ways for individuals to file for bankruptcy: Chapter 7 or Chapter 13.
Chapter 7 requires liquidation of assets to pay off debts, after which remaining debts are discharged. Chapter 13 requires creation of a plan for repayment over 3 to 5 years, with eventual discharge of the remainder. However, certain debts cannot be discharged and certain assets are “exempt” from liquidation.
With either method, an “automatic stay” stops creditors from any collection efforts or court proceedings. However, if you are in the process of divorce, it also stops the divorce court from doing anything with debts. You cannot divide property if bankruptcy is in process. Usually, a decree cannot be granted either. Some people may see bankruptcy as a strategic tool to delay the divorce process.
A crucial consideration of filing bankruptcy is in determining whose name is on the debt. If the debt is all in the name of the person filing, then it may be discharged. However, if the debt is in joint names, both parties would have to file bankruptcy in order to discharge the debt. Support obligations (child support, spousal maintenance, alimony) are not affected.
For example, in Chapter 7, with credit cards in one name, the obligation is discharged. If the debts were jointly incurred, the balances would not be discharged. Any non-exempt assets, even separate property, are subject to being liquidated. The following assets are “exempt” from bankruptcy liquidation:
- 401ks, 403bs, and other defined contribution plans
- IRAs, including ROTHs and SIMPLE IRAs
- Home equity
- Life insurance cash value
- Household furnishings
- One automobile per person
- $30,000 for individual
- Jewelry up to 25% of the above exemption limit
Assuming that all income taxes have been properly filed (including extensions through October of each year), past due taxes older than 3 years can be discharged. Thus, 2008 and prior years can be discharged; while 2009 through 2011 cannot. As far as going to jail for non-payment of taxes, it is NOT a criminal offense to NOT pay taxes. It IS a criminal offense to cheat on taxes.
If divorcing prior to filing for bankruptcy, can one party be awarded exempt assets along with the debt in his name, while the other party receives the non-exempt accounts like brokerage accounts and the debt in her name? According to one attorney, this “scheme” usually works; however, courts could find that they had engaged in fraud. Activities to get ready for bankruptcy may be suspect.
One must go through a qualification process to use Chapter 13, which requires a “best effort” to repay debts over 5 years. After that time period, the debts are discharged. Note that you don’t lose the assets, but are required to pay as much as possible. This is determined through a carefully created budget for basic needs and any support obligations required by law. There is a “credit meeting” and the plan is filed with the bankruptcy court to pay off debts in 3 to 5 years. If you default on payments, the creditors can once again proceed with collection efforts. Support payments are scrutinized, but still required to be paid off the top. These must be disclosed during the qualification process.
If a property settlement note is used to equalize the estates of the divorcing individuals, that note can also be discharged. Often, attorneys draft language trying to protect their client from discharge of a property settlement note by requiring that the payments become alimony in case of default. Alimony payments are not dischargeable.
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This paper is based on a continuing education presentation by Bart Balis, attorney with Balis and Barrett in Boulder, Colorado. It summarizes the key points of the talk and should not be considered legal advice.
According to Mr. Balis, coordinating divorce and bankruptcy proceedings can be a valuable way to reduce loss. Chapter 13 can be very useful in property division and may permit one to avoid paying off credit cards following divorce. But the reader should bear in mind that jointly held debts require that both parties file. And, of course, competent legal advice is vital.