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Bank Account Blues - Debt, Credit, and Bankruptcy

By: Carol Ann Wilson

 

We have referred to property as either marital or separate. The same classifications apply to debt. In general, both you and your spouse are responsible for any debts incurred during the marriage - it does not matter who really spent the money. When the property is divided up during the divorce, the person who gets the asset usually also gets the responsibility for any loans against it.

Itís in both of your best interests to pay off as many debts as possible before or at the time of the final decree. To do so, use whatever liquid assets you have - bank accounts, money market funds, stocks, bonds, or cash values from life insurance. It may make sense to sell assets to accumulate some extra cash. The most easily sold assets include extra cars, vacation homes, and excess furniture. (Donít expect to get much for used furniture unless it has value as an antique or collectorís piece.)

If you ! canít pay off the debts, then the decree must state who will pay which debt and within what period of time. There are generally four types of debt to consider: secured debt, unsecured debt, tax debt, and divorce expense debt.

Secured debt includes the mortgage on the house or other real estate, and loans on cars, trucks, and other vehicles. It should be made very clear in the separation agreement who will pay which debt. If one spouse fails to make a payment on a debt that is secured by an asset, the creditor can pursue the other spouse.

Unsecured Debt

Unsecured debt includes credit cards, personal bank loans, lines of credit, and loans from parents and friends. These debts may be divided equitably. The court also considers who is better able to pay the debt.

For unsecured debt, any separation agreement needs to include a
hold-harmless clause. This will indemnify the nonpaying spouse, which means that the paying spo! use gives nonpaying spouse the right to collect not only all missed payments, but also damages, interest, and attorneyís fees if payments are not made. Without a hold-harmless clause, the nonpaying spouse has the right to collect only the missed payments.

Often, the legal decision and the financial outcome are very different things. This is a lesson Paul learned the hard way. Tracy and Paul were married eight years, during which time Tracy ran her credit cards to the limit with her compulsive spending. The court held Tracy solely responsible for paying the $12,000 in credit card debt. After the divorce, however, Tracy didnít change her ways and was unable to pay off her debt. The credit card companies came after Paul, who ended up paying them off.

In a case like this, one solution would have been to pay off the credit cards with assets at the time of divorce or for Paul to have received more property to offset this possibility.

Tax Debt

Just because the divorce settlement is final doesnít mean you ! are exempt from possible future tax debt. For three years after the divorce, the IRS can perform a random audit of your last joint tax return. In addition, the IRS can question a joint return - if it has good cause to do so - for seven years. It can also audit a return whenever it believes fraud is involved.

To avoid surprises, the divorce agreement should spell out what happens if any additional interest, penalties, or taxes are found, as well as where the money comes from to pay for defending an audit. We know of countless horror stories where the unsuspecting spouse (usually the ex-wife) is all of a sudden obligated for a huge tax bill and doesnít have a clue how it happened.

Divorce Expense Debt

Although it isnít always clear who is liable for debts incurred during the separation, typically these debts are the responsibility of the person who incurred them. An exception would be if one spouse runs up debts he or she is unable to pay! to buy food, clothing, shelter, or medical care for the kids. The other spouse is probably obliged to pay those expenses.

You will accrue other costs during the divorce process, including court filing fees, appraisals, mediation, and attorneys. Other less obvious expenses are accounting, financial planning, and counseling. The separation agreement needs language that states who is responsible for these expenses.

Divorce expenses may accrue after the decree, such as attorney fees for doing QDROs, title transfers, and tax preparation for the final joint tax return, mediation fees, and long-term divorce counseling for the parents or the kids. Who pays? You do, unless it is spelled out clearly so there are no disputes at a later date.

Dividing Marital Property and Debts

Many people try to divide each asset as they discuss it - your half of the house is $4,000, my half of the house is $4,000. Since you will rarely divide the house like this, this may not be the most useful way to go about it. It may be ! more practical to list each asset as a whole item under the name of the person who will keep it.

For example, in the wifeís column, list the marital equity in the house if she is thinking of continuing to live there. List the entire value of the husbandís retirement in his column, if that is your initial inclination. An advantage to this method is that it allows you to see the balance, or lack of it, of your initial plan as you develop it. If you want to know dollar values, you may need a third party, such as an appraiser, to help you determine them.

This is the time to have a real heart-to-heart discussion with your about-to-be-ex about the range of his or her sense of fairness. Ask:

  • Is the only possibility for a 50-50 division of things by value? By number?

  • Are you more interested in cash than in things?

  • Will you take less than 50 percent if your share is all cash?

  • Are you more interested in future security than in present assets?

  • Are you willing to wait for a buyout of your share, such as house selling or retirement, and are you looking for more than 50 percent to compensate you for waiting?



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