Property and Debt in a Divorce

Liability for a spouse’s debts depends on whether the divorce happens in a community property or equitable distribution state. In the ten states with community property rules, both spouses are responsible for most debts incurred by one spouse during the marriage; in the other jurisdictions, the common law property states, debts incurred by one spouse are usually his or her debts alone, unless the obligation paid for a family necessity, such as food or shelter for the family or tuition for the kids.

Some states have subtle variations about treating joint and separate debts. The rules also apply to same-sex marriages and to same-sex domestic partnerships and civil unions when these are the equivalent of marriage, but not in jurisdictions where the relationship does not confer all the rights of marriage.

Community Property States

In community property states, a couple’s income is shared as well. All income earned by either spouse during marriage, as well as property bought with that income, is community property, owned equally by husband and wife. Gifts and inheritances to one spouse, however, as well as separate property owned before marriage, remain the separate property of that spouse. All income or property acquired before or after a divorce or permanent separation is also separate.

The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, and Alaska, (where spouses can make assets and liabilities community property).

In community property states, most debts incurred by either spouse during the marriage are owed by the couple, which is the community, even if only one spouse signed for a debt. A debt incurred before marriage, such as a student loan, does not automatically become a joint debt. However, when a person signs on as a joint account holder after getting married, that party becomes responsible for the account.

After a legal separation or divorce, however, a debt is generally owed only by the spouse who incurred it unless it was incurred for family necessities, to maintain jointly owned assets (for example, to fix a leaking roof), or if the spouses maintain a joint account.

In a community property state, creditors of one spouse can go after the assets and income of the married couple to make good on joint debts because in these jurisdictions, most debts incurred during marriage are considered joint debts. Some states consider debt in more nuanced ways, analyzing who owes what debts, the purpose of the obligation, and when it was contracted.

Community property can have profound implications for debtor’s spouse. For example, when Susan’s cosmetics business capsizes, she owes $45,000 to suppliers. Because Susan and her husband Conrad live in a community property state, her creditors can sue both of them to collect the money she owes. Susan is unemployed and penniless, but Conrad’s powerhouse position pays nicely, so Susan’s creditors can garnish $3,000 of Conrad’s income per month until her debts are paid.

Property that has a title and was acquired during the marriage is at risk. Bill’s Dry Cleaner is going down the tubes. Bill’s name may not be on the title to his spouse’s boat, but in most community property states, the creditor can sue to take the boat, assuming the boat was purchased with community funds, not separate funds.

In a community property state, a creditor can go after only half of the community property to repay the debt one spouse’s separate debt, such as his child support obligation from a marriage, or a debt his name only where he hid the fact that he had been married.

Couples in community property states can agree with each other to have their debts and income treated separately by entering into a pre- or postnuptial agreement. These agreements make sense for a couple before one spouse goes into business. However, agreement now does not protect a spouse from liability for existing business debts, only from liability for future ones.

A party can enter into an agreement with a particular store, lender, or supplier, by which the creditor agrees to look solely his or her separate property for repayment of any debt, which removes a spouse’s liability for a debt.

In a community property state when one spouse files for Chapter 7 bankruptcy, all of the eligible community debts of both spouses are discharged.

Common Law Property States

By comparison with a community property state, in a common law property state, debts incurred by one spouse are his and her debts alone, and income earned by one party does not automatically become jointly owned.

Both spouses are responsible for a debt only if it benefits the marriage, for example, the debt for food, clothing, childcare, shelter, or necessary household items, or the debt was jointly undertaken. This means, for example, that both spouses signed a contract requiring them to make payments, that both spouses’ names were on an account or title, or that a creditor considered both spouses’ credit history before making the sale or loan. The same rules hold true after permanent separation but before divorce.

All other debts, such as a business debt from one spouse’s business or a car loan for a car whose title is in one spouse’s name, are considered a spouse’s separate debts.

In most common law states, income earned by one spouse and kept separate during the marriage belongs to that spouse alone. Property bought with separate income during the marriage is also separate property unless they jointly title it. In addition, gifts and inheritances received by one spouse, as well as property owned by one spouse before marriage and kept separate are the separate property of that spouse.

However, income earned by one spouse put into a joint bank account becomes joint property, and when joint funds are used to buy property, the property is also owned jointly unless title is taken in the name of one spouse only. Jointly owned property can include equity in a jointly owned house, household goods, jointly owned vehicles, and jointly owned bank accounts, retirement plans, and stocks or mutual funds.

The party on the title owns property that has a title document, such as real estate and vehicles. For instance, if a car is in only one spouse’s name is that spouse’s separate property. If a house is in both spouses’ names, the house is joint property, even if one spouse doesn’t contribute anything toward the mortgage payments.

In a common law state, creditors of one spouse can go after the income or property of the other spouse or joint property only when the debt was incurred for joint purchases or for purchases that were made for family necessities. In some common law states, a creditor can also go after joint property to pay the separate debts of one spouse (even if the debt was not family-related), but in most states a creditor can take only half of the money in a joint account.

For example, Hector’s auto supply business fails owing $30,000 to suppliers and other creditors. Hector runs the business by himself, without the help wife, so the business debts are considered his separate debts. Because Hector lives in a state with common law property rules, the creditors cannot garnish his wife’s income or take her separate property, though they may be able to sue to take money from the joint bank account Hector maintains with his wife. Whether the creditors can go after other property held jointly by Hector and his wife, such as a jointly owned house, depends on the state they live in and how they hold title to the house.

In about half of the common law property states, a creditor cannot go after certain joint property to pay the separate debts of one spouse when a couple holds property in tenancy by the entirety. The creditor can go after the property to pay only joint debts, not separate debts of either spouse. And in some states, such as Florida, most joint property is automatically held in tenancy by the entirety and so is immune from being taken to pay one spouse’s separate debt.

For example, Maxwell Sharp rents supplies and construction equipment in   New York, but his business is struggling to stay above water. Maxwell’s wife Desdemona owns a beauty salon and makes a good living. When Max fails to pay his debts, the creditor threatens to sue the Sharps. Because the Sharps hold title to their house in tenancy by the entirety, a creditor cannot put a lien on the house and force its sale as long as Desdemona is alive. If Maxwell and Desdemona sell the house, however, the creditor could go after Max’s half of the proceeds.

Creditors of one spouse cannot legally reach the other spouse’s separate money, property, or wages to repay the first spouse’s separate debt.

Inheritance or gifts to one spouse are beyond the reach of creditors. Poindexter owes $53,000 to vendors and his office supply business just went under. Because Poindexter and his wife Gladys live in a state with common law property rules, these creditors can sue Poindexter, but cannot go after his wife’s inheritance. In some states, however, the creditors can go after a joint bank account.

A spouse should not guarantee his or her partner’s business debts.   In a common law state a party who owns business independently of his or her spouse does not want him or her to personally guarantee any   business debts. Unless a spouse cosigns a loan or personal guarantee, he or she is   not liable for a husband or wife’s business debts.

In a common law property state, if only one spouse files for Chapter 7 bankruptcy, only that’s spouse’s joint and separate debts would be discharged; the other spouse’s separate debts would not be discharged.

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