Handling Debt in Divorce
There are many types of debt that occur in the marital estate and when there is a divorce, these debts need to be assigned to one or both spouses. In California, a community property state, most debt is divided equally.
For example, there is debt brought into the marriage for education. Oftentimes, this debt is assigned entirely to the spouse who incurred the debt. However, if the debt was incurred during the marriage and the parties benefitted from the degree or training, then there are nuances that may equally apportion the debt. Timing of the encumbrance, years of benefit and number of years to the date of separation are all factors that are considered. Any outstanding education debt at the time of divorce may or may not be assigned to the spouse who incurred the debt. It is a legal question that will be argued according to the case law and statutes that apply.
Similarly, if a debt was incurred and community funds were used to service the debt for a separate property asset of one spouse, the courts could potentially consider how this debt now affects the community interest in the separate property asset. Again, this is a legal issue and involves financial analysis.
Key to the assignment of debt is the timing of the demarcation between what is marital versus separate property. The date of separation is especially important in California divorce. Debt incurred after the date of separation is typically assigned to the spouse who incurred it. Usually this pertains to credit card debt or the purchase of a car with loan or lease. Of course, community funds cannot be used for the purchases, so that will be the first item of concern in determining the nature of the debt and if any reimbursements are owed. Credit card debt incurred after the date of separation is typically assigned to the spouse who incurred it, but there are legal questions about the fact set regarding temporary support and the availability of access to marital funds by both parties.
Working closely with an attorney and financial advisor will help clarify the facts and the application of the law.
One concern is who is responsible for the debt outside of the divorce rules. If both names are on a debt (e.g. joint credit card) the issuing bank has legal recourse to both parties even if it is determined in family law that the debt is assigned only one spouse. If that spouse does not pay the credit card with both names, both credit scores will be impacted and the bank could still pursue payment from either spouse for payment, penalties and interest. It is important to address these issues as soon as possible around the date of separation. This avoids potential problems and post-separation accounting issues that concern the purchases made after the date of separation.
If joint debt was acquired during the marriage, if the financial situation allows for paying off the debt, it should be a priority. This alleviates the carryforward of debt and the possibility that if a party defaults on the debt, the other party will not be responsible. Even though the Marital Settlement Agreement may include language that would indemnify the party who eventually pays for the other, there is always the issue of enforcement and collection from the defaulting party post-divorce. This is especially critical for IRS and state tax back payments.
It is important to note that just because one party is listed on the debt, if incurred during the marriage, it would not necessarily be separate property. Both parties may still be responsible for the debt and it should be dealt with either through pay off, equal division or assignment with offset in the divorce.
If one party assumes the entire marital debt, then an offset of another asset would usually be awarded to that party to cover the additional debt assumed. It is considered a trade-off—one party assumes the entire debt but receives an additional percentage of assets to offset the assumption of the debt. The assets, then, would not be divided equally to account for this. Provisions need to be included in the Marital Settlement Agreement language to ensure that that party actually makes the payments, with built-in repercussions if a payment is missed. If the other party’s name is still on the debt that is being assumed only by one spouse, the creditors will disregard the divorce agreement and pursue the spouse who was not assigned the debt.
It is imperative that the parties minimize the liability post-divorce. Whenever possible, use proceeds from the sale of a house or other assets to eliminate any debt that would otherwise need to be divided or carried over post-divorce. This simplifies the process and alleviates problems in the future with non-payment, late payment, credit score impacts, and other concerns.
This article does NOT constitute legal or tax advice and is for general information purposes ONLY. Prior to making any decisions, seek legal counsel from a licensed attorney or CPA.
