One of the most painful experiences in life is a divorce. There are so many important decisions that have to be made about children and finances, not to mention the emotional and spiritual costs to both spouses.
Today, I want to talk about the tax cost of a divorce, specifically the continuation of tax liabilities after the marriage.
The vast majority of couples today file joint tax returns. By doing so each becomes personally liable for the entire amount of taxes that are owed on the return. Each also becomes personally liable for any and all taxes that may arise in a future audit of that return.
Some couples file separate returns, called married filing separately. This does not avoid much of the problem, in part because many states have community property laws which generally require each spouse to report half of the other spouse’s earnings regardless of who actually earned the income.
If you are legally married, or if your significant other may be able to claim there is a common law marriage under state law, then the determination of what type of return to file may be critical. If there are potential issues in the marriage, I would urge you to consult with an expert to help make the right election.
The tax liability incurred in a prior marriage can and will follow each of the parties after they separate and divorce.
The IRS can seize and sell any property that either spouse owns. This includes any property you receive in the divorce proceeding. Remember that both of you are generally personally liable for the full amount of the taxes, penalties and interest that are reflected on the return or arise in a future audit.
Those tax liabilities may also affect the next spouse as well. This is especially difficult where one spouse remarries and his or her old tax liability attaches to the new community property acquired in the new marriage.
I am often told by new clients that the divorce decree provides that the prior spouse has the duty to pay the taxes and the IRS is bound by that ruling. Unfortunately, divorce is a state court proceeding and does not bind the IRS. The IRS can and will pursue both parties, especially whichever party has the most liquid assets (cash in checking and savings accounts, wages, etc.) that are the easiest to seize.
Some taxes are not joint obligations — only one spouse may be liable. For example, some income taxes from a married filing separately return as well as certain penalties arising from unpaid payroll taxes may be the responsibility of only one spouse. However, the IRS can and will sell community property of both spouses at liquidation value and pay the other spouse half of what is received after expenses (which can be substantial).
Unfortunately, the primary claim in the state court proceeding merely allows one spouse to sue the other spouse for their property losses. This is hardly satisfying considering the loss of the property and especially the time and expense of another lawsuit.
The federal tax law creates an exception to avoid some of the hardships all of this can create. This exception was typically known as the “innocent spouse” law — which has been replaced by several relief provisions in different statutes that are often very different and may offer several different kinds of relief.
We will address these provisions in the next article.
If your marriage is in trouble, or you are about to be married to someone who has old tax liabilities, you really need to see a tax specialist. And find a good one. Very few people know anything about these laws.