Picture this: Your spouse’s small business goes bankrupt, and your spouse along with it. (Or worse: You go bankrupt, and you have to tell your spouse about it.) You hang on to the house and some other assets that are in your name, but even so, your financial picture isn’t pretty. The sizeable tax refund you receive is more than happily received — it’s a lifeline.
Then an overzealous bankruptcy trustee tries to take it away.
That’s exactly the situation a client of mine was in recently. When they called me, they thought they had already lost. What happened next shows how important it is for business owners to know and advocate for their rights, and how helpful an experienced bankruptcy lawyer can be.
Federal Bankruptcy Law Protects A Spouse’s Assets
Crucial to this case was understanding the difference between the debtor spouse’s obligations during bankruptcy and the voluntary contributions a non-debtor spouse may have made to the bankruptcy plan. In other words, the spouse who goes bankrupt may be required to fork over their entire tax refund (if they haven’t properly separated their personal assets from the finances of their bankrupt business), but the spouse who isn’t bankrupt gets to keep theirs.
For married couples filing a joint federal tax return, this means the non-bankrupt spouse gets to keep 50% of the total refund.
This is true no matter what proportion of income each spouse earned. Even if the non-debtor spouse earned no income at all during a given year, they’re entitled to half the refund from a joint return.
In my client’s case, Mr. B went bankrupt, along with his business, but Mrs. B didn’t. Mrs. B did, however, agree to contribute her income to Mr. B’s bankruptcy plan — a decision that was 100% voluntary. Bankruptcy is one of the most stressful events a marriage can undergo. Mrs. B wanted to help her husband move past his bankruptcy, which is a natural inclination the law ought to reward, not punish.
But here, the bankruptcy trustee decided Mrs. B’s voluntary contribution of her income meant the trustee was entitled to every cent of the couple’s tax refund, including Mrs. B’s share.
Fortunately for Mrs. B, bankruptcy law, when properly interpreted and applied, doesn’t punish voluntary spousal cooperation with forced contributions. Even more fortunately, Mrs. B came to see me before forking over thousands of dollars to the trustee.
Bankruptcy Law Protects More Than A Spouse’s Tax Refund
It isn’t just your tax refund you can protect from a spouse’s bankruptcy. Any asset or income owned or received by the non-debtor spouse can be kept out of a bankruptcy plan. This often includes an asset owned by a spouse prior to marriage, inheritances and property purchased only in one spouse’s name.
State laws can vary when it comes to what is considered jointly owned property and what qualifies as property owned by only one spouse, however. And of course, trying to shift assets into the non-debtor spouse’s name in order to shield them from bankruptcy is a shenanigan the law doesn’t look on too favorably.
All business owners should protect themselves by understanding what assets might be subject to bankruptcy before bankruptcy is even on the horizon.
Proper bankruptcy planning all but requires consulting with a knowledgeable bankruptcy lawyer in your state, but you can do plenty of planning and preparation on your own. Learn the laws in your state and plan your business so it properly protects and separates your personal assets — and especially your spouse’s assets.
With the law on our side, Mrs. B and I went to court and won because we had taken the proper care beforehand and knew how to move forward effectively. In bankruptcy, it often feels like the deck is stacked against you in a game where your entire financial future is on the line. Having someone on your team who knows the rules and knows how to play them to your best advantage is often the difference between a win and a loss.
Take Charge Of Your Bankruptcy Plan (Or It Will Take Charge Of You)
The important lessons here?
1. Your bankruptcy planning needs to start long before your bankruptcy, and every business should have a bankruptcy plan from the very beginning. How you structure your business will determine what you can protect if it goes bankrupt, so plan ahead.
2. Remember that a non-debtor spouse’s assets can’t be forced into the debtor spouse’s bankruptcy plan, and this includes tax refunds.
3. You have to advocate for your rights (or partner with someone who will advocate on your behalf), or you’ll lose them.
Finally, and most importantly, control your bankruptcy, or it will control you.
Don’t blindly follow everything your bankruptcy trustee tells you to do. Take an active role in learning about your rights and discussing options and special circumstances with your trustee (or have your attorney do that for you).
Proper planning and careful execution are the ways to come through bankruptcy intact and ready to start anew. The alternative is a lot of extra stress, a lot of wasted time and money and all too often a repeat of the bankruptcy cycle.
That’s not what I want for my clients, or for any of you.
This article does not, and is not intended to, constitute legal advice. The information contained here may be out of date or otherwise inaccurate for a particular jurisdiction, and no one should rely on this information when making legal decisions or taking any action. For advice concerning specific legal matters, readers should contact a licensed attorney in their state.