Today we’re talking about divorce and taxes. Taxes usually come into play within a major life transition issue. Divorce is one of those issues. When two people are separating, there’s often some questions that come up. I want to talk a little bit about frequently asked questions. Then I want to talk about what to do if you are a spouse and you feel you’re being unfairly stuck with a tax liability.
The first thing I want to talk about is joint returns and separation of those returns. When you get divorced, most likely you’ve been filing a married filing joint return. In the divorce process, you need to make sure that you’re aware of what your filing obligation is and make sure you complete that filing obligation even if your ex-spouse is not being particularly cooperative. The way that you do that is until your marriage is formally dissolved, you need to file a married filing separate return. Once there is a legal separation in place or once there is a full dissolution of the marriage, then you can go back to filing single or filing head of household.
In the meantime, you do want to make sure that you file married filing separate and that you continue to file. Married filing separate, although there is a little bit of a tax penalty associated, the benefit with married filing separate is that you can separate the income out from one spouse to another. One spouse’s income is calculated on one return and the other spouse’s income is calculated on the other return.
The one thing you need to be aware of when doing a married filing separate return is if you live in a community property state, then technically half the income that is going into the marital economic community can be treated as community property. This includes for divorcing spouses in certain situations. Just because you are not working as a spouse, doesn’t mean that you’re not going to have an income tax filing and paying requirement as it relates to the other spouse’s income.
Now, there are ways to go about that in terms of separating that out. I do want you to make you aware from a filing perspective, you are going to have to pick up community income if you do live in a community income state. Now, when you file a married filing joint return, if there is a liability that is due on that return, both spouses are considered jointly and severally liable for the liability. If you file a tax return and you owe 100 grand just for mathematical purposes. If you owe 100 grand, then both husband and wife owes 100 grand.
If the husband makes a $5,000 payment, then husband and wife both owe 95 grand. If the wife makes a $2,000 payment, then husband and wife owe 93 grand and so on and so forth until it gets paid down. Now, the IRS is not bound by third-party agreements in terms of who picks up responsibility for taxes. Keep that in mind that when you file a joint return, even if you and your ex-spouse come to an agreement on who’s going to pay the taxes, if that person doesn’t live up to the obligation, that agreement is not a valid defense for the IRS.
You’re still going to be considered jointly and severally liable. It’s important that you realize this because the IRS can take collection action against one or both of you. They can levy paychecks. They can levy bank accounts. They can file a liens against you. You want to make sure that you’re in compliance and have an appropriate resolution with collections if you do owe money and you go through a divorce. That’s really important. It’s something that most spouses don’t really think about in the context of the divorce because they’re like, “Wow, it’s his income, or it’s her income. It should be her liability. They need to take care of it and not me.” No, that’s not actually correct.
You actually need to protect yourself going into a divorce for looking at situations like that. Obviously, during the divorce process, although we would hope that it would be amicable, there are situations where conflict tends to escalate. Having a very clear and level-headed plan is certainly important. Here’s what you do if you don’t think that you are being fairly pegged with a tax liability.
I want you to keep in mind this, if two people are earning income and contributing to a marriage, and there is a certain lifestyle based on that marriage, whether or not those two people are contributing equally, and if somebody appears to have benefited from a certain lifestyle, it is not necessarily fair or the IRS won’t necessarily deem it fair to relieve them of tax liability. There are exceptions to this. Number one, file a settlement with the government which is called doing an offer in compromise. There are two grounds for doing an offer in compromise, well, there’s three grounds technically, but we’re only going to talk about two of them.
The first one we’re going to talk about is doubt as to collectibility and the second one is doubt as to liability. From the doubt as to collectibility standpoint, doubt as to collectibility is fairly easy. You owe a large tax liability, you cannot pay it and your financials will support that you cannot pay. You submit an offer in compromise, you submit a financial statement, that’s doubt as to collectibility.
Doubt as to liability is that you don’t necessarily owe the tax that is due. Typically in situations where you’re either going to do a doubt as to liability offer in compromise or you’re going to file a formal innocent spouse petition with the IRS, we recommend going the formal innocent spouse petition side of things first. If that breaks down, you could always file a doubt as to liability offer in compromise on the same grounds.
It’s generally easier to get an innocent spouse designation pushed through because the IRS is very familiar with the innocent spouse process. They get a lot of innocent spouse requests and it’s typically easier if you want a reduction, you have already get an innocent spouse designation pushed through. Again, if you have a tax liability, if you feel you’re unfairly assessed and you can’t pay it, you’re going to want to file a doubt as to collectibility offer in compromise.