Getting Divorced? What You Need to Know About Your Unpaid Tax Liabilities.
Getting divorced is unpleasant, even in the best of situations, and nothing can make it more unpleasant than when issues from the marriage continue to haunt the former couple after the marriage is ended. Unpaid taxes is just one of those issues. I am talking specifically about unpaid Federal and state income and the reason the problem persists past the end of the marriage is something called called joint and several liability.
What is Joint and Several Liability?
Joint and several liability is just a fancy way of saying both spouses are on the hook for the whole amount of any income tax liability, regardless of whose income it is. The IRS and state tax authorities can collect such taxes from one or both spouses in pretty much any manner they choose. Let me illustrate this with a simple example:
Tom and Sue are married. Tom works from home (he is self-employed) while Sue is employed at a bank and is paid a wage. Tom is less than diligent about paying his estimated taxes while Sue has her income taxes withheld from her paycheck. At tax time, the couple files a joint return which results in a balance due because Tom did not pay anything towards his taxes (to keep things simple lets just assume the taxes are due on just the Federal return).
Once the return is filed and the IRS is made aware of the unpaid taxes, the IRS has almost absolute discretion to collect from the couple in any manner it chooses. It can collect just from Tom or Sue or from them both. The IRS is not required to attempt first to collect from Tom, the person whose tax liability caused the shortfall. The IRS doesn’t even have to try to collect from the spouse who earns the most or who has more assets! There is absolutely no requirement that the IRS ever try to collect from Tom. Practically speaking, that means that the IRS could levy a bank account held in Sue’s name or garnish her paycheck without attempting to collect from Tom first.
I think this example explains how joint and several liability operates. For that reason you can see why a couple should understand the concept of joint and several liability, especially if you are in the process of getting divorced. In all likelihood, under my example, the IRS will try to collect from both Tom and Sue equally but if Tom stops working and goes on unemployment then the burden will fall on Sue to pay the taxes due. Even if Tom and Sue later get divorced this joint and several liability will continue to exist until it is paid, compromised or the statute for collections pass. So what can the divorcing couple do to deal with a joint tax liability?
First, understand that the IRS is not bound by any agreements or the divorce judgment.
The hardest thing to explain to a divorcing couple is that the IRS is not bound by a state court divorce judgment or settlement agreement. The reason is that Federal law trumps state law – it’s as simple as that. As unfair as that may seem, that is the law. If the court assigns the repayment of a joint tax debt to a party (or the parties agree to divide the debts among them) then that is binding only on the couple but not the IRS. What ends up happening is that if the IRS collects unpaid taxes from a spouse who is not obligated to pay such liability then the non-liable spouse will need to go back to family court to try and collect the difference from the liable spouse. This result can be particularly galling when the liable spouse has no assets or earnings or who actively fights attempts to pay the other spouse under the divorce judgment or settlement agreement.
Second, consider married filing separate for any current year returns.
While this is not helpful when a joint return has been filed, it is important to understand that there is no requirement to file a joint tax return. If the other spouse is habitually behind in paying his or her taxes then you may want to consider filing a separate return to only be liable on your portion of taxes. Be careful though! While the IRS may not be able to collect your spouse’s tax liability from you (whether by garnishing your wages or seizing your assets) that doesn’t mean it cannot seize your spouse’s share of any joint assets. It is not unheard of for the IRS to foreclose on the marital home.
Before moving on I want to add that even if the joint return shows a refund that doesn’t protect you 100%. If the joint return is later audited and additional taxes are assessed then you will be on the hook, jointly and severally, for the additional amount due. So the lesson here is to be careful about signing a joint return if you suspect your spouse may be playing fast and loose with the tax rules.
Third, you may be able to sever joint liability through innocent spouse relief.
All hope is not lost if you have a joint tax debt. The IRS has a process called innocent spouse relief which provides a means of severing a couple’s joint and several liability for taxes. This relief is available often where there is some inequity in holding you liable for the whole tax liability – usually where there is some bad behavior on the part of the other spouse. If you qualify, innocent spouse relief will de-couple your tax liability (in whole or in part) from your spouse or ex-spouse. Innocent spouse relief comes in three “flavors” as it were:
General Relief – relief is available where there is a tax understatement that results from an “erroneous item” solely attributable to your spouse (erroneous items are things such as unreported income or claiming non-deductible/fictitious expenses). Beyond the requirement of the erroneous item solely attributable to your spouse or ex-spouse, you must also show that: one, had no actual or constructive (meaning that someone in your shoes should have known) knowledge of the erroneous items; and two, it would be inequitable to hold you responsible for the understatement, considering all of the facts and circumstances.
Separate Liability – relief can be granted up to your share of the tax liability (based on what your liability would have been if you had filed separately). Separate liability relief will not be granted if: one, the IRS can show that assets were transferred between you and your ex-spouse as part of a fraudulent scheme; or two, you signed the joint tax return with actual knowledge of the item giving rise to the tax understatement, unless the return was signed under duress.
Equitable Relief – this is a catch-all if you do not qualify for relief under innocent spouse or separate liability relief. To qualify for equitable relief, you must show that under the facts and circumstances of your situation that it would be inequitable to hold you liable. In this case, the IRS will consider a series of factors that point to whether or not relief should be granted. Factors that indicate relief should be granted are: taxpayer would suffer an economic hardship if relief is not granted, taxpayer was abused by the spouse, the other spouse has a legal obligation, such as in a divorce decree, to pay the tax liability, and the liability is solely attributable to the other spouse. Factors that indicate that relief should not be granted are: the taxpayer had reason to know or knew of the tax liability, the taxpayer benefited significantly (beyond normal support) from the understatement, and the taxpayer has not made a good faith effort to comply with the tax laws during the year the tax liability arose and thereafter.
Finally, you do have options even if you are jointly and severally liable and there is no way to obtain innocent spouse relief.
Even if you cannot obtain relief or avoid joint liability you can still work with the IRS to reduce or remove the unpaid tax liability. Installment agreements, offers-in-compromise, currently not collectible status and penalty abatement are all tools to obtain relief from your tax liabilities and you may be able to use these tools to handle your tax debts.
In summary, be aware of the rules regarding joint and several liability as it may have an impact on your divorce. I hope you found this information useful and if you have any questions about what I have written feel free to call or email me.
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