Bankruptcy and Divorce in Maryland

The question about how a bankruptcy affects a divorce and vice versa touches upon many considerations in both divorce and bankruptcy planning, and both spouses can benefit from taking time to plan for these contingencies. Also, the timing of when to file bankruptcy – whether to file 1) bankruptcy in divorce; 2) can you get a bankruptcy while in Chapter 13 bankruptcy; or 3) bankruptcy after divorce – is a very important consideration that spouses should take into account.

Protecting the Marital Home

There are several factors a couple should consider when planning for bankruptcy in divorce, whether one or both spouses is thinking about filing for Chapter 7 or Chapter 13 bankruptcy. The first factor is treatment of the marital home. Often, married couples own a home that is titled as tenancy by the entirety, which can protect the equity in the home from certain categories of creditors in bankruptcy. A tenancy by the entirety property is protected from debts that only one spouse holds, except for tax debt. However, the tenancy by the entirety is severed when the court enters the divorce decree, at which point the property reverts to tenants in common, which does not offer the same protections as tenancy by the entirety.

If a couple gets divorced within 6 months after a Chapter 7 bankruptcy is filed by one or both spouses, even though the property may be titled as tenancy by the entirety when the bankruptcy case is filed, since the divorce decree severs the tenancy by the entirety, equity in the marital home that may have been protected from creditors because of the entireties exemption can be considered part of the bankruptcy estate which brings it into the reach of the chapter 7 trustee who has the ability to sell the home and distribute proceeds to creditors. A couple should factor protecting any equity in the marital home when thinking about bankruptcy and divorce.

Bankruptcy Means Test While Going Through Divorce

Another consideration when filing for bankruptcy and divorce is how income calculations affect bankruptcy. In bankruptcy, income affects the Means Test in a chapter 7 bankruptcy and is an important factor in the bankruptcy filer’s budget to determine whether they can afford to pay back some of their creditors in a chapter 13 bankruptcy repayment plan. A chapter 7 bankruptcy is a 4 to 6-month process in which the bankruptcy filer – the “debtor” – does not repay any of their creditors, and a chapter 13 bankruptcy is a 3 to 5-year repayment plan in which part or all of the debts are paid over time.

In 2005, the bankruptcy code was amended to prevent people that could afford to pay their creditors in a chapter 13 bankruptcy repayment plan from filing under chapter 7 if their income is above the median income for their household size unless they overcome a presumption of abuse.

If a couple is married and living together, even if only one spouse files for bankruptcy, both spouses’ income must be used in the Means Test calculations, as well as calculating the bankruptcy budget. However, if the couple is separated, one spouse’s income may be used, which could result in qualification for chapter 7 under the Means Test. Additionally, if children live with one spouse 51% or more of the time, the household size can be increased for Means Test calculations for that couple if they file for bankruptcy.

When considering whether to file bankruptcy after divorce or bankruptcy in divorce, a couple should consider how their income will be affected by the divorce.

Property Transfers and Marital Debt

The next consideration of going through bankruptcy in divorce is how marital debt and transfers of property are treated. In a bankruptcy, certain debts that are considered “domestic support obligations” are not dischargeable in bankruptcy. However, Maryland courts have drawn a distinction between a domestic support obligation, which is not dischargeable in chapter 7 or chapter 13 bankruptcy, and a “property settlement,” which is only dischargeable in chapter 13. The difference between a domestic support obligation and property settlement often revolves around the parties’ intent and how the payout is structured in a marital settlement agreement.

Property transfers between spouses are also considered “insider” transfers, and a Chapter 7 trustee can undo transfers made 1 year before filing for Chapter 7 bankruptcy. For example, if a debtor transferred a home without a mortgage to their spouse in a divorce, this transfer would be subject to scrutiny in a Chapter 7 bankruptcy and could be undone by a Chapter 7 trustee.

The timing of when to file a bankruptcy should take into account martial debts and property transfers between spouses.

Divorce Affects Bankruptcy Income and Expenses

When thinking about bankruptcy and divorce, a couple should understand how income and expenses are used in bankruptcy. In a Chapter 13 bankruptcy, disposable income is calculated by first determining all sources of income earned by the debtor 6 months prior to filing the bankruptcy, and then deducting expenses for the support of the debtor or debtor’s dependents, deducting charitable contributions, and if the debtor has its own business, deducting expenses of the business.

It is important to understand that if a married couple both file a joint Chapter 13 bankruptcy, or if only one spouse files a Chapter 13 bankruptcy, while married and living together, both spouse’s income and expenses are used to calculate disposable monthly income, which is the amount that is paid under the Chapter 13 plan to unsecured creditors such as credit cards and personal loans.

If a couple in a Chapter 13 bankruptcy gets divorced, the income and expenses of each spouse must be recalculated and should each couple decide to proceed with their cases, new Chapter 13 repayment plans must be structured.

Chapter 13 Debt Limits and Maximizing Exemptions

Some other considerations a couple going through a divorce while planning for bankruptcy should consider are the Chapter 13 debt limits and maximizing exemptions to protect property in bankruptcy. To file under chapter 13, the debtor must have less than $1,257,850 in secured debts and $419,275 in unsecured debts. If the debtor is over these limits, they must either dismiss their chapter 13 case or convert to the more complex chapter 11. Fashioning a division of these debts between spouses may allow one spouse to file under chapter 13 instead of chapter 11.

Finally, if the couple has value in any of their property, such as equity in a home, jewelry, or several cars, it is important to plan for exempting that property in bankruptcy. Bankruptcy exemptions are generally doubled for married spouses, and therefore can be used to protect more property in bankruptcy.

Severing a Joint Bankruptcy Case

When answering the question of can you get a bankruptcy while in chapter 13, the couple should consider how the divorce affects the ongoing Chapter 13 case. A conflict of interest will arise for the couple’s bankruptcy attorney, and the couple has the option to sever the joint bankruptcy cases into two separate bankruptcy cases. Upon severing the joint case, each spouse can then decide if they choose to dismiss the Chapter 13 case, convert to a Chapter 7, or amend or modify their now individual Chapter 13 repayment plan.

Planning for bankruptcy in divorce, getting a divorce while in Chapter 13 bankruptcy or bankruptcy after divorce can be done, but it is important to understand how the divorce affects a bankruptcy and vice versa. If you have questions about bankruptcy and divorce, call Steiner Law Group at (410) 670-7060.