As a Texas family attorney, it's crucial to understand the implications of our state's community property laws. While these laws were designed decades ago to ensure a fair distribution of assets acquired during a marriage, they can sometimes lead to unintended consequences that couples may not have considered. This is especially true in a world in which spouses are getting married later in life, both spouses are working, and both spouses may be entering the marriage with a significant amount of separate property, including retirement accounts, residences and businesses owned prior to marriage.
In this blog post, we'll a few of these surprising and often unintended consequences and how they can impact divorcing couples, as well as a few steps you can take to avoid them.
Commingling of separate and community property
One unintended consequence of community property laws is the potential for separate property to become commingled with community property. If a spouse fails to keep their separate property (such as an inheritance or property owned before marriage) distinct from the community estate, it may be subject to division during a divorce. This can lead to disputes and unintended loss of assets.
There are a couple very important points here:
First, at the time of the divorce, all property owned by each spouse is presumed to be community property. The spouse claiming that property is separate has the significant burden of proving it. This can be complicated by the lack of records, especially records dating back to the time of marriage, and by commingling or mixing separate and community property.
Second, income on separate property is community property under Texas family law. This means that interest or cash dividends in bank, investment and retirement accounts is community, even if the underlying funds or assets in the account is separate. This often creates unintended commingling when those interest or dividends hit the account each month. Further, income from a separate property business, like, for example, a dental practice one spouse owned before marriage, is also community property. Once again, this can cause significantly commingling if the income from the business is deposited into accounts intended to remain separate.
Liability for debts
Under Texas community property laws, both spouses may be held liable for debts incurred during the marriage, even if only one spouse was responsible for acquiring the debt. This means that if one spouse racks up significant credit card debt or takes out a loan without the other's knowledge, both spouses could be on the hook for repayment, even after a divorce.
Business ownership complications
If one or both spouses own a business, community property laws can create unintended consequences during a divorce. The value of the business and its assets may be subject to division, even if only one spouse was actively involved in running the company. This can lead to complex valuation issues and potential disruption to the business's operations.
And, as mentioned above, if the business was owned prior to marriage, many spouses assume that the income and assets of the business are automatically separate. Under Texas law, the income is community property. Further, if community property, like the income from the business or other community assets, is put back into the separate property business, there can be issues regarding the characterization – separate or community – of those assets. This, like other commingling discussed above, can trigger the need to spend thousands of dollars on an expert to trace the true character of the assets, resulting in unanticipated, and often unfair, outcomes during the property division in the divorce.
Finally, many business owners decide at some point to change the structure of their business by either incorporating a sole proprietorship or by creating new entities that work in conjunction with the original business. In most cases, the new businesses, or the reorganized business, are going to be considered community property if the new entities were formed during marriage.
Retirement account divisions
Retirement accounts, such as 401(k)s and pensions, are considered community property if contributions were made during the marriage. Dividing these accounts during a divorce can have unintended tax consequences and may impact each spouse's long-term financial security if not handled properly.
Further, if a portion of the retirement account is separate because it was earned prior to marriage, it will be the burden of the spouse claiming the account as separate to prove it by producing detailed records and, possibly, hiring an expert to trace the separate portion of the account. It is very common for financial institutions to destroy statements after a period of time. If this occurs, so that it’s not possible to obtain accurate records back to the time of marriage, the result could be the entire account being considered community property.
Intellectual property rights
If one spouse creates intellectual property, such as patents, copyrights, or trademarks, during the marriage, the other spouse may have a claim to a portion of the value under community property laws. This can lead to disputes over ownership rights and royalties, even if the non-creating spouse had no direct involvement in the development of the intellectual property.
Avoiding unintended consequences
To mitigate these unintended consequences, it's essential for couples to:
- Have open and honest discussions about their finances and how assets should be treated during marriage.
- Consider creating a prenuptial or postnuptial agreement prior to marriage.
Couples in Texas can completely control whether different types of property during marriage are considered community or separate. With a good premarital agreement, a couple can even decide that there will be no community property automatically created during marriage, making the issues of commingling or unintended enrichment from one spouse’s labors completely a thing of the past.
With these agreements, a couple can still have jointly-owned assets, but they will get decide how and when this occurs. These agreements can help clarify each spouse's rights and obligations regarding property division in the event of a divorce.
- Seek the guidance of an experienced family law attorney prior to marriage, or during marriage if there are significant financial changes or questions, to navigate the complexities of Texas' community property laws and make informed decisions to protect their assets and interests.
- Keep good records of assets and accounts during marriage. Because banks and other financial institutions only maintain records for set periods of time, our attorneys at Coker, Robb & Cannon, Family Lawyers recommend that our clients calendar one day each year on which they save a copy of the previous year’s statements in a safe and secure cloud location like Dropbox or OneDrive. This will assure that, should they ever need to document their separate property, they have the records necessary to do so.