Financial Impacts Of Divorce in Scottsdale, Arizona

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Financial Impacts Of Divorce

Existing Contracts. The Court can and will assign to each party their share of the assets and liabilities. What the Court cannot do, however, is rewrite existing contracts. It can order one party to be responsible for the debt. It can include a “hold harmless” and “indemnify” provisions that require the spouse awarded the debt to pay back the other spouse if creditors of that debt come after them.

But at the end of the day, the contract signed when the parties were married is still intact. And a creditor can go after either party, regardless of what the divorce court.

This is important because there are usually two contracts in almost every marriage that can have a major financial impact on the parties: A mortgage and a vehicle loan. It’s also common to see HELOC loans. So, what can be done to protect the party who is not taking the house or the car?

Here are a few options:

  1. The decree should set deadlines for when certain things need to happen by, such as a deadline for refinancing the house or vehicle, removing the other spouse’s name from the title for the house or vehicle, taking their name off the insurance. Otherwise, the spouse who is not awarded the property remains on the loan and can be potentially liable in the event someone is injured on the marital residence property or in a car accident. That is a major risk financially.
  2. The Decree should set a consequence if these deadlines are not met (usually requiring the asset be sold and the equity divided).
  3. In the event a home or other major community asset is sold, the parties can agree that the funds gained from the sale are first applied to existing debts, such as credit card debts.

Refinancing. The easiest way to remove names from loans is for the spouse who is keeping the home, vehicle, or other property on which the community has a loan. The biggest question is always—does the person who wants to keep qualify to refinance it. This needs to be known before a divorce agreement is made. The best thing to do is to have that person prequalify. If the prequalification is conditional, then those conditions need to be known and so the parties either negotiate to meet those conditions or abandon the idea of refinancing. As mentioned above, whenever parties agree to a refinancing, there should be a deadline for when it occurs and a consequence if it is not met (usually listing the home, vehicle, or other asset for sale).

Taxes. Divorce has a tremendous impact on taxes from how you file to what you pay to who claims the child in what year. Here are some ways a divorce may impact your taxes:

  • Filing Status. “Married filing jointly” is often the most desirable way to file your taxes because it generally contains the lowest liability of the all the filing statuses. Once divorced, you obviously can no longer file as married. You will, as part of the divorce decree, determine whether you will file jointly or separately for the last tax year in which you are married. Be aware that if filing jointly, you are responsible for all representations made on that return—in other words, if you file jointly, and your spouse lies about their income, you are also responsible for the fraudulent tax return.
  • Name on Your Filing. It is common for people to change their last name as part of the divorce process. The name of your tax return must match the name on file with the Social Security Administration. Therefore, if your name changes as part of the divorce, you need to contact the Social Security Administration and update your name.
  • Prior Tax Liability. If you owe taxes from any year in which you were married, both spouses could be liable on the marriage. For people who have failed to file tax returns during the marriage, this is the time to get caught up, so that the two of you can split any liability within the Decree.
  • Child Support Payments. Child support payments are tax neutral. The person paying them cannot deduct them; the person receiving them does not need to report them.
  • Child Tax Credit. The Parenting Plan will make orders regarding in what tax year each parent may claim each child. The ability to claim the child is usually dependent on a parent being up to date on child support.
  • Child Support Arrearages. If a parent has been found by a Court to owe child support arrearages, the state of Arizona will intercept any tax return or stimulus paid that parent and apply it toward their child support obligation. Arrearages are different than the ongoing child support obligation. Arrearages mean that you have not paid prior child support amounts.
  • Spousal Maintenance. Under the Trump tax law, the person paying spousal maintenance pays income taxes on the amount they pay to their former spouse. The receiving spouse does not pay income tax on what they receive in spousal maintenance.
  • Qualified Domestic Relations Orders. Retirement accounts must be divided at the time of the divorce. To avoid tax penalties, spouses must use a Qualified Domestic Relations Order (QDRO) to divide any retirement asset. The QDRO must comply with federal ERISA regulations to be recognized. Those requirements are highly technical. For this reason, most people use specialized QDRO attorneys to prepare their QDRO.
  • Basis of Assets. When you buy an asset, what you paid for it is your “basis” for tax purposes. When you sell it, the sell price minus the basis is your profit or loss. Profits can be taxed. Let’s give an example of how that works. Let’s say you buy your house for $300,000.00 and sell it for $500,000.00. Your basis is the $300,000.00 purchase price. Since you sold the home for $200,000.00 above your basis, you have $200,000.00 in taxable income. The value of assets on divorce is not a taxable event, meaning you don’t have to pay taxes on assets you receive in the Decree. But the divorce also does not reset the basis. Additionally, while assets are divided equally, there may be an inequitable distribution of the basis of the assets, meaning one of you could pay substantially more in taxes when selling the assets awarded to you than the other spouse.

Social Security. Many people will need to rely on their spouse’s Social Security benefits in order to meet their needs in their old age. While Social Security is not divided in a divorce, a divorce will impact your ability to draw on your spouse’s Social Security. Here’s what you need to know about social security and divorce:

  • The length of marriage matters. The marriage has to have lasted at least 10 years for you to be eligible to draw on your spouse’s social security.
  • Eligibility. In addition to the 10-year rule, to draw on an ex-spouse’s social security, you need to be at least 62 years old at the time you start drawing on the benefits (you can be under 62 at the time of the divorce), you cannot be remarried, their benefit must be greater than the benefit you would otherwise be entitled to, and you must be entitled to Social Security retirement or disability benefits.
  • Remarriage. If the spouse receiving benefits from the ex-spouse remarries, they can no longer receive Social Security benefits from the ex-spouse. If the spouse whose benefits are being draw remarries, it does not affect their ex-spouse’s ability to draw on their benefits.
  • Amount of Benefit. An ex-spouse is entitled to up to 50% of their ex-spouse’s benefit.
  • Ex-Spouse’s Benefit Not Affected. Benefits paid to a divorced spouse do not reduce the amount their ex-spouse receives in social security.
  • When Entitled to Two Benefits. Some spouses may be entitled to two benefits: Their own benefit or their spouses. In that case, they get the benefit that is the higher amount, but they do not get both benefits.
  • Disclaiming Social Security. Divorces occur in state court. Social security is a federal benefit that is governed exclusively by federal law. While rare in Arizona, some Divorce Decrees may include a clause where one spouse gives up their interest in the other spouse’s social security. Such clauses are unenforceable. A divorce decree cannot divide social security benefits. State courts simply lack the jurisdiction to do so.
  • Widow’s Benefit. If eligible for an ex-spouse’s Social Security benefits, a spouse may be eligible for a widow or widower’s benefit should the spouse die.

Health Insurance. If you are on your spouse’s health insurance, your health insurance is going to be affected by divorce. During the divorce proceedings, your spouse will be prevented from removing you from their insurance under the Preliminary Injunction, a court order that, under Arizona law, goes immediately into effect when the Petitioner (aka the person who starts the divorce in the Court) files for divorce (It is binding on the Petitioner at the time of filing, and binding on the Respondent at the time of service).

But once divorced, health insurance is something you will be responsible for. Fortunately, federal and state laws offer a stepping-stone approach to people who have recently been divorced. Whether you qualify really depends on the status of your spouse’s employer.

The federal law, known as COBRA, requires employers of 20 or more employees to offer their employees and their families a temporary extension of health coverage (18 months) under certain circumstances, including divorce. The state law, known as mini-COBRA, extends the eligible businesses who must offer this insurance to a divorced spouse to include small businesses of less than twenty (20) employees who offer health insurance as a benefit.

Here is what to know about this coverage:

  • People going through divorce are given the right to continue or convert their health insurance. Information regarding this option is provided in the Notice to Convert Health Insurance, which is one of the documents filed to start a divorce.
  • But if you are Medicare eligible or eligible for disability benefits, your spouse’s employer will not be required to convert or continue your insurance.
  • The spouse being insured is responsible for premiums and may include to include the children.
  • If you want to continue or convert your health insurance following the divorce, you must contact the insurance company ASAP and start paying the premiums within 31 days of when the insurance would otherwise stop.
  • If continued, the insurance company may choose to keep them on the same plan as their former spouse or convert them to a new policy.
  • If converted, the new policy must be the one most similar to their old coverage unless the insured chooses a lesser policy.
  • You can’t be denied a continuing or converted policy because of a pre-existing condition.

If you are not extended health insurance through one of the COBRA laws or if you want to consider a different plan, you should be aware that divorce is one of the “life-changing events” that allows a person to obtain insurance outside the Open Enrollment Period.

Life Insurance. If you designated your spouse as a beneficiary of your life insurance policy and you are now divorcing your spouse, you may need to revisit your beneficiary designation on the life insurance.

In 1995, the Arizona state legislature adopted a revocation-upon-divorce law that, among other things, automatically revokes your spouse  as the beneficiary of the life insurance policy at the time of divorce. So if your spouse has been the beneficiary, and you are getting divorced, you now have no beneficiary for your life insurance policy.

So once your divorce is final, one of the first things you should do is call your life insurance company and designate your beneficiary. It can be your ex-spouse or it can be someone else. This change should be made in writing.  If you choose to keep your ex-spouse as a beneficiary, the revocation-upon-divorce law will not apply to your situation so long as you re-designated your spouse as the beneficiary after the divorce became final (that means you’ve received the Divorce Decree, signed by the judge, divorcing the two of you).

Be aware that this law does not apply to employer-provided life insurance policies. Those employer-provided benefits are governed by a federal law called ERISA, and it keeps the beneficiary you designate intact, regardless of whether you are divorced or married. This federal law overrides state law. If you have one of these plans, and you do not want your spouse to receive the proceeds, you must change the beneficiary. We recommend you contact your plan administrator ASAP to make that change.

Also be aware that in cases of spousal maintenance and child support, your spouse may require you to keep life insurance designating them as the beneficiary for the remaining amount owed for support. This is quite common. If it’s required of you, then, again, you should re-designate your spouse as the beneficiary once the divorce is finalized.

Children’s college funds. A divorce can affect the finances available for your child’s college education. Here’s what you need to know about how divorce might affect your child’s educational funding:

Arizona law does not require a parent pay for a child’s college education, but the parents can agree that they will pay for it. The duty to pay child support terminates either when the child turns 19 or when the child is 18 and graduates high school. Arizona law does not require a parent pay child support beyond that point, except where a child has severe disabilities.

Further, Arizona law does not require a parent fund a child’s education. Putting this altogether, if you try to get the Court to order that the other parent funds your child’s education, you will lose that case in Court.

But if you want such an agreement, an option is available to you—reach an agreement in writing with the other parent that they will fund the child’s education. If you make this agreement and put in the Divorce Decree, the Court will enforce it.

But be aware that to enforce it, you will need to file in civil court, not family court, to enforce that provision.

If a 529 savings plan was started during the marriage, the 529 savings plan needs to be determined in the Divorce Decree. A 529 plan has many advantages for parents looking to save for their child’s education. But despite being for the child, the 529 actually belongs to the parents. That makes it a marital asset.

The 529 will need to be divided as part of the Decree. This is usually done by designating one parent as being in control of the account and including language within the decree requiring that parent to maintain the 529 savings plan for the benefit of the child.

Inheritance. If your spouse is named as a beneficiary in your will or trust, that is revoked upon divorce, although you can execute a new will renaming your spouse as  a beneficiary in a will or a trust. For more information on this, see our tab on “Spouse as a Beneficiary.”

But how does divorce affect what you inherit? First, divorce should not affect what you inherit. Inheritances are exempt from the community property laws in Arizona, so when it comes to your inheritance, it should not matter whether you are married or not.

Divorce can impact your inheritance, though, if you “commingle” your inheritance with community funds. Let’s say, for example, you inherited $10,000.00 from your grandmother and you put that money into the account where your money and your spouse’s paycheck goes, that $10,000 is going to be considered community property.

Spouse as a Beneficiary. During a marriage, spouses commonly list each other as beneficiaries on various financial instruments, including wills, trusts, IRAs, 401(k)’s, etc. Upon a divorce, a law may or may not automatically change the beneficiary on these financial documents. Here’s how those various financial instruments are treated during a divorce:

  • Wills. Ex-spouse is automatically removed as a beneficiary but will remains valid. Ex-spouse is automatically disqualified from being a personal representative, guardian, or trustee. To add ex-spouse back into a will or into a fiduciary position, a new will must be executed.
  • Living Trust-Marital Property Trust. Each spouse is considered to have predeceased the other. If a spouse dies before trust is dissolved, their one-half share of community property (and any of their separate property) is distributed as if there was no surviving spouse.
  • Living Trust-Separate Property Trust. Ex-spouse disqualified as a beneficiary and as acting as a trustee. Like a will, if the person wants their   ex-spouse to remain a beneficiary or trustee, they must re-execute the trust.
  • Estates without Wills or Trusts. Many people die without either a will or a trust. The legal term for this is that they died “intestate.” Who receives their estate follows state law on intestate succession. An ex-spouse does not receive anything under the state’s intestacy laws.
  • Power of Attorney. Ex-spouse automatically removed as an agent. Power of Attorney may remain intact if another person is designated as alternate agent.
  • IRA’s. Under Arizona law, the divorce disqualifies ex-spouse as a beneficiary. But there can be some gray areas here if the IRA administrator is never informed of the divorce, and if a long period of time has passed since the divorce and death, permitting an argument the IRA owner intended to keep ex-spouse as beneficiary.
  • 401(k). A 401(k) falls under ERISA, a federal law that trumps state laws. Unlike Arizona’s law that removes an ex-spouse as a beneficiary, ERISA has no such law. Therefore, an ex-spouse remains the 401(k)’s beneficiary. The beneficiary designation must be changed if the 401(k) owner wants a different result.
  • Pension. Pensions also fall under ERISA. Therefore, if an ex-spouse is designated as the beneficiary, they remain the beneficiary.
  • Federal Retirement Plans. Again, these fall under ERISA. Therefore, if an ex-spouse is designated as the beneficiary, they remain the beneficiary.
  • Life Insurance. An ex-spouse is automatically removed as the beneficiary of a life insurance plan unless it’s employer-provided insurance in which case the beneficiary remains. The Court can, however, order that one spouse maintain a life insurance for the benefit of the other spouse, particularly if there’s spousal maintenance or child support award that may be owed.

Remember this is contingent on there being a divorce. If a spouse dies before the divorce is finalized, the beneficiary designations remain unchanged. If a couple is legally separated, the beneficiary designations remain unchanged.

But what about an annulment? When it comes to changing the beneficiary designation, Arizona law treats an annulment like a divorce, so the beneficiary does change just as it would in a divorce.

Bankruptcy. Divorce and bankruptcy proceedings should not coincide with each other. Either wait to divorce until after the bankruptcy is complete or wait to file bankruptcy after the divorce is complete. Be aware that there are risks associated with both options.

For example, let’s say Spouse A and Spouse B owe $100,000.00 on a loan. If they file for bankruptcy together before the divorce, this debt can be discharged for both of them, but both of them also have a bankruptcy on their record.

So let’s say they opt to wait until after the divorce. The divorce court orders Spouse B to be solely responsible for the $100,000 debt. After the divorce, Spouse B files for bankruptcy, and the debt is discharged. What do the creditors do? They come after Spouse A for the full $100,000.00. They can do so even though the divorce court assigned the debt to Spouse B and the debt was discharged. This is because the Courts cannot change the terms of existing contracts.

If you are considering a bankruptcy and a divorce, this is something that should be discussed with a bankruptcy attorney.

You should also be aware that some debts cannot be discharged in a bankruptcy. These include spousal maintenance, child support, and attorney’s fees owed from a child custody matter.

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