Student loans have become a familiar discussion among families and, more recently, a subject for debate between the federal government and the Courts.
Knowing how student loans will be treated in the event of a divorce is more critical now than ever, given the increasing cost of college over the past 30 years, as well as the growing number of students taking out student loans to pay for college and beyond.
Let's consider the following example. Husband and Wife are married when the parties decide the Wife should leave her current job and go to medical school. The couple agrees that the Wife's higher education would lead to a better quality of life for their family, including their three children. Wife takes out student loans to pay for tuition and books, as well as to offset the decrease in the family's income while she is in school and to pay for living expenses, such as housing, food, childcare, and transportation costs. Wife deposits the disbursement check from her student loan into a checking account, held in her individual name, prior to paying the living expenses. Wife graduated from medical school and works as a physician, while Husband works from home and is the caregiver for the children during the day. The parties were together for two years after graduation and until they separated. Wife wants to know who is responsible for the massive loans she incurred to attend medical school and how that will be treated in the divorce. What she is really asking is whether this is a marital debt.
What Is “Marital Debt”?
When addressing the division of assets and debts in the event of divorce, a determination has to be made as to whether each asset or debt is marital, what the value of the asset or debt is, and how the asset or debt should be divided. If a determination is made that a debt is not marital, the debt cannot be divided between the parties. For more on the classification, valuation, and distribution of marital property, see our prior article. Debt is subject to the same procedures as marital property. Marital debt is one incurred, during the marriage and before the date of separation, by either or both spouses for the joint benefit of the parties. The debt does not need to be held in the name of both spouses to be considered "marital," so long as the debt was incurred for the joint benefit of the parties.
In order for the Court to classify student loan debt as marital, the party claiming that the debt is marital must present evidence regarding whether the marriage lasted long enough after incurring the debt and receiving the degree for the married couple to substantially enjoy the benefits of the degree or higher earnings. So exactly how long does a marriage have to benefit from the higher earning capacity for the loans to be considered marital? There is no specific formula, and the answer is very fact specific. However, the North Carolina Court of Appeals found that a twenty-month benefit period prior to the separation of the parties was sufficient to find that the loans were marital debt.
In our example, the student loans would be classified as marital. The fact that Wife deposited the money received from the loan into her personal checking account before paying the expenses would not change this determination. Additionally, the parties enjoyed the benefit of the higher earnings for two years prior to the date of separation, which would arguably be sufficient time for the family to enjoy the benefits of the degree.
Now let's consider a variation of this example. The parties met in college while obtaining their undergraduate degree. Wife gets accepted into medical school, and the parties move in together. Wife takes out student loans to pay for tuition, books, and living expenses, such as rent, food, transportation, and gas. The parties get married after Wife's first year of medical school. Under these circumstances, loans that were incurred after the date of marriage would be considered marital. The loans incurred prior to the date of marriage would not be marital and would be the Wife's sole responsibility.
The Classification of Martial Debt
The determination of whether student loans should be classified as marital debt is fact specific and should be analyzed on a case-by-case basis. Below are some factors that may support a conclusion that the loans should be classified as martial:
- Did both parties expect to share in the rewards of the education?
- Were portions of the loans used to pay the general living expenses of the parties, such as housing, groceries, childcare, family medical expenses, clothing for the family, family vacations, gas, and transportation?
- Did the parties agree that the student-spouse should obtain a degree, and was the non-student spouse aware that student loans would be incurred to obtain the degree?
- Did the student-spouse open a business after graduation and employ their spouse to where the non-student spouse benefited from the employment?
- Did the marriage last long enough for the parties to enjoy the benefits of the degree?
Factors that may tend to prove that the debt should be classified as the separate debt of the student-spouse.
- Were the loans used solely to pay educational expenses such as tuition and books? If loans were used solely for the educational expenses of the student-spouse, then the loans will likely be considered the separate debt of that spouse.
- Did the student-spouse ultimately graduate with the degree, obtain employment, and increase their earning capacity as a result of the degree? If the spouse did not obtain relevant employment and/or increase their income as a result of obtaining the degree, then the loans will likely be considered the separate debt of that spouse.
- Were the parties maintaining separate residences when the loans were incurred? In the case where the student-spouse moves away to obtain their degree, and the other spouse remains in a separate residence, a portion of the student loans that were used to pay the student-spouse's living expenses may be considered the separate debt of the student-spouse.
- Is there a premarital or post-marital agreement in place that defines student loan debt as the separate property of the student-spouse. A premarital or post-marital agreement is the surest way to control how student loans will be divided upon a potential divorce.
Student Loans Incurred for the Benefit of a Child May Be Considered Marital Debt
In addition to student loans incurred by one party to a divorce proceeding, parents often incur student loans for the benefit of an adult child. These loans are often called "Parent PLUS Loans." The Court of Appeals has determined that these loans, if incurred during the marriage, are properly classified as marital debt, so long as the parties made a joint decision to incur the debt.
Distribution of Student Loans in a Divorce
Once we determine the student loans are marital, how do we divide the student loans between the parties? Until recently, we have had very little guidance on how student loans were actually distributed between the parties in an equitable distribution action. In April of this year, the North Carolina Court of Appeals rendered a decision offering a roadmap to distributing student loans, Read v. Read, No. COA22-782 (N.C. Ct. App. Apr. 18, 2023).
A trial court will equally divide marital property and debt between the parties, unless the Court determines that such an equal distribution would render an inequitable result. N.C. Gen. Stat. § 50-20(c) enumerates certain factors that a court shall consider when determining whether an unequal division of the marital estate is appropriate. Specifically, section 7 of this statute provides that a Court shall consider "any direct or indirect contribution made by one spouse to help educate or develop the career potential of the other spouse." Courts can apply 50-20(c)(7) to award a greater share of the student loans to one spouse.
In Read, the Court distinguished between student loans that were applied towards tuition and supplies, from those that were applied to living expense for the parties and their family. In this case, the loans associated with tuition and supplies were distributed to the student-spouse. The loans that were used for living expenses were divided and distributed between the parties. In this particular case, this assignment resulted in a 70% distribution of the loans to the student-spouse and a 30% distribution to the other spouse.
Student Loan Forgiveness and the Tax Implications of Student Loan Forgiveness
In late February, the United States Supreme Court heard oral arguments in two cases challenging President Joe Biden's student debt relief plan in which the Biden Administration is seeking to cancel $10,000 in federal loans issued to qualified recipients ($20,000 for Pell Grant recipients) for individuals who make less than $125,000, or married couples filing jointly who make less than $250,000. The Court is expected to render a decision later this year. For parties anticipating or actively engaging in divorce proceedings, special considerations should be taken regarding the potential outcome of the Supreme Court's ruling. For instance, it is worth considering what would happen if a resolution was reached based on one party assuming responsibility for all student loans, and then those loans are forgiven. If the non-student spouse is distributed a portion of the student loan through an equitable distribution judgment and then some of the loans are forgiven, how is the forgiveness of the loan distributed between the parties?
The future of student loan forgiveness, and the tax implications of such a discharge of debt at the federal and state level, is uncertain. Consider the scenario wherein you have taken on student loan debts that have been forgiven, resulting in substantial tax consequences that were not foreseen when addressing financial matters related to your divorce. Even more concerning, think about the scenario where the non-student-spouse agrees to assume student loans that are forgiven, and now the student-spouse has an unexpected tax obligation. Under the Biden Administration's plan, discharged student loans may not be taxed at the federal level, but North Carolina state income taxes could be assessed.
On June 30th, the Supreme Court ruled that President Joe Biden's student debt relief plan was unconstitutional. While student loan forgiveness is off the table for now, the Biden Administration is rolling out a new income-based repayment plan – Savings on Valuable Education (SAVE). SAVE Repayment Plan Offers Lower Monthly Loan Payments | Federal Student Aid. This plan will accelerate student loan forgiveness after 120 payments for borrowers with initial balances of $12,000 or less, with an additional 12 payments required for each additional $1,000 in loans, up to a maximum of 25 years (300 payments) for full loan forgiveness for all other borrowers on the plan. SAVE also eliminates the remaining monthly interest on the loan after a scheduled payment is made pursuant to the repayment plan. This means that if your minimum payment does not cover the interest charged on the loan each month, the interest not covered by your payment will be eliminated, and your loan balance will not grow due to unpaid interest. These are important considerations when addressing the division of student loans in the event of a divorce.
The attorneys at Ward and Smith will continue to monitor the evolving issue of student loan forgiveness.
Student loan debt often represents the greatest financial burden for many borrowers, sometimes even surpassing the amount owed on their home. With so much at stake, proper classification, valuation, and distribution of student loan debt is vital. Ward and Smith Family Law attorneys are rooted in experience and eager to provide your best footing for successfully tackling this complex issue. Contact us to learn how you can position yourself to properly account for your student loans, or the student loans incurred by your spouse, in a divorce or premarital/post-marital agreement.
[Editor's note: Article was updated on July 13, 2023, to reflect the US Supreme Court decision on student loan forgiveness.]
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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.