Guest post by Eva G. Bacevice, bankruptcy attorney and contributing writer at Upsolve
Divorce and bankruptcy often go together hand-in-hand. Financial strain can accelerate marital strife just as easily as pending separation can negatively impact your financial stability. While you may need to seek legal relief on both fronts, it is important to know how they impact one another, and that your personal circumstances will determine the best order to address them.
Types Of Bankruptcy
Chapter 7 is what you think of as a typical bankruptcy, also referred to as a liquidation. In Chapter 7, you can walk away from some (and possibly all) of your debt and get a fresh start. Even with a liquidation bankruptcy, you are likely able to keep most (or all) of your personal property. Chapter 7 will typically last between four and six months, and at the end when you receive your discharge you will no longer be obligated to pay the bulk of your debts. There are exceptions, however, we will discuss when we delve more deeply into the different types of debt.
Chapter 13, on the other hand, tends to be more complex. Chapter 13 involves a repayment plan (similar to a business Chapter 11) that will run between a minimum of three and a maximum of five years. You are most likely to consider Chapter 13 if you are behind on a secured debt, like your house or car, that you want to keep to have an opportunity to catch up on your obligations.
Types Of Debt
Different types of debt face different treatment in bankruptcy.
Secured Versus Unsecured
The first distinction to understand is secured versus unsecured debt. Secured debt is when your property is tied to a debt, for example, if you have a home with a mortgage the house is collateral on the mortgage. So if you are behind on your mortgage payments, you are at risk for foreclosure. Similarly, if you are behind on a car loan you are at risk of repossession. Unsecured debt, on the other hand, is not tied to any specific property. The most common examples of unsecured debts are medical bills and credit card bills. Unsecured debt is the main type of debt discharged in bankruptcy. You should also note that if you are behind on a secured debt at the time you file Chapter 7 there is no mechanism to catch up on those payments, so while you can walk away from the debt it also means you are walking away from the property, so letting a home go to foreclosure or surrendering a car.
There are additional categories of debt which are important to understand. Some debts are non-dischargeable, which means that despite filing for bankruptcy relief you are still obligated on these payments. Non-dischargeable debts are most often child support or alimony payments, which can be a large component in a divorce. These debts are non-dischargeable regardless of what type of bankruptcy you file and encompasses both the obligation for on-going payments as well as any arrearage (back payments.)
Priority debt is treated differently depending on the type of bankruptcy you file. In Chapter 7 priority debt (such as government debts like back taxes) is treated as non-dischargeable, whereas in Chapter 13 priority debt must be paid in a particular order in your repayment plan so that it is paid in full during your plan, whether it is back child support or back taxes.
For IRS debt, in particular, there is a scenario where that debt can be discharged in Chapter 7 but you need to meet very specific criteria. First, the taxes have to be at least three years old. Second, they need to have been filed timely, and at least two years before your bankruptcy filing. Third, they need to have been assessed within 240 days of filing Chapter 7. Also, if there is any evidence of fraud or tax evasion they revert to non-dischargeable status. In terms of tax debt and divorce, the vast majority of tax debt incurred during the marriage, whether you filed jointly or separately, can be a liability for either party as marital debt.
Which Type Of Bankruptcy Is Right For You?
When deciding between types of bankruptcy to file, one of the first issues you will need to address is whether you and your spouse intend to file bankruptcy or if you want to file bankruptcy without your spouse. Addressing marital debt before a divorce can make for a quicker divorce proceeding in many cases, but that is just one of a myriad of factors to consider that we will discuss in depth below.
The next threshold you will need to clear is whether you are eligible to file Chapter 7. To have Chapter 7 as an option you need to pass the Means Test to qualify to file. You can pass the Means Test in two ways. First, you may qualify simply based on your income. If your current monthly household income is less than the median income for your family size in your state then you will immediately qualify. Here it is important to pay attention to the word “household.” You may find that you do not qualify based on income cutoffs if you file jointly, however, if you divorce (or separate) first you might both individually qualify with your respective households for Chapter 7. The second way that you can pass this Means Test is to go through the full Means Test calculation, where you can qualify by showing that with a detailed look at your income and expenses for the month you have little to no money left over.
If you are not able to pass the Means Test under any of the above scenarios then you will only have the option to file Chapter 13. You might also choose to file Chapter 13 because you are behind on a secured debt that you want to keep.
What’s The Best Order? Bankruptcy First Or Divorce?
It truly depends on your circumstances. We will take a look at the different options below and discuss their pros and cons.
Filing A Joint Chapter 7 Before (Or During) A Divorce
If you do qualify to file jointly for Chapter 7 there can be several benefits to addressing your finances before your divorce. First, you can save on court fees by only filing one case, which will save on attorney fees as well as administrative fees from the court. Second, you will be able to discharge some (or all) “marital debt.” This can be key because marital debt refers to debts incurred during the period of the marriage. So if your spouse had a health crisis while you were married, you are likely still liable on those medical bills (similar to our IRS discussion above) even though you were not the one who was sick. Third, getting rid of your debts may make the division of assets in your divorce easier since you will not have to account for most (or all) of the debts. Finally, you might be able to protect more property by filing together. You can protect property in bankruptcy through using exemptions. Many states will allow a married couple filing jointly to double most of the exemptions which results in more property being protected overall.
There are also potential downsides to consider. Filing jointly can work if you have a decent relationship with your spouse since you will need to work together on your joint bankruptcy case. But to be fair, many couples who are considering or planning to divorce are making that choice precisely because they do not have a good relationship with one another. The other factor to consider is the automatic stay. When you file a bankruptcy case the automatic stay goes into effect as soon as you file and stops most other court proceedings. This can be great news in terms of avoiding foreclosure, repossession, or garnishment from a creditor, but it will also stop the divorce in its tracks until the bankruptcy case is over.
Filing An Individual Chapter 7 After Divorce
Filing on your own after the divorce is complete may be a better option if you and your spouse are not on good terms. This will allow you to put the marriage behind you as quickly as possible and then give you the chance to address your financial situation. It may also only be an option after a divorce in terms of qualifying to file Chapter 7 as we discussed above.
Filing Chapter 13
Chapter 13 is more complex, more expensive and will take much longer than Chapter 7. It might be the right solution for you based on your circumstances, but it will result in likely delaying your divorce for the period of the bankruptcy, which is at a minimum three years long. If your primary reason to file Chapter 13 is to protect an asset you may need to decide between the value (both monetary and emotional) of the asset and the delay of moving on with your life.
Making Your Decisions
The decisions that you make about when to file bankruptcy and whether to do so together are highly personal. There is no right or wrong answer, rather what is best for you under the current circumstances. Both types of relief are available for you to pursue, in whichever combination and order you choose. You are the best judge of your priorities and goals but you can always discuss your specific circumstances with an attorney, legal aid or non-profit like Upsolve to thoroughly explore all of your options and help make the right decision for you.
Bio: Eva G. Bacevice graduated from the University of Michigan Law School in 2001. She practiced law for close to a decade in the area of consumer bankruptcy. She now works in higher education as an Academic Advisor for undergraduate students at the Stephen M. Ross School of Business, University of Michigan in addition to working with Upsolve as a content writer. She is delighted to have the opportunity to share her knowledge of personal bankruptcy through the lens of her current work in and passion for education.