If you are getting divorced or you are recently divorced, and you owe back taxes, there are some little-known tax hazards that, for the unaware, can lead to devastating effects. The question of “who pays the back taxes?” isn’t nearly as simple as you might think. If you think that you’re in the clear because the divorce decree orders your ex-spouse to pay the back taxes on a joint tax liability, I’ve got some bad news for you.
There is widespread confusion among the public–and even among divorce and tax professionals–about the effect of a divorce on a joint tax liability. If you’re caught unaware, you could end up being a sitting duck to some of the most brutal collection practices the IRS employs. The good news is that there are a few simple steps you can take to avoid the worst possible outcome. To learn how to identify and avoid the biggest traps, read on.
About half of U.S. marriages end in divorce. One of the main relationship issues that often leads to divorce is financial struggles. As an attorney who specializes in helping clients with financial difficulties related to tax liabilities, I often deal with clients who are recently divorced, and, on a few occasions, I have represented a husband and wife who go through a divorce during my representation. Sometimes the underlying financial problems that led to the tax debt are the root cause of the divorce. Other times, the tax liabilities themselves place enough strain on the marriage to lead to divorce. Either way, there are some very important things to understand about how a tax liability changes the landscape of divorce.
In most marriages, spouses combine their income, assets, bank accounts, and other financial affairs. Most married couples also file joint income tax returns. That combination of financial lives can be very difficult to untangle when spouses part ways, whether amicable or acrimonious.
There are often disagreements over which spouse is entitled to keep what parts of the jointly owned property and assets, as well as disputes regarding spousal and child support. Adding a joint tax liability to this mix only serves to increase the stress and disagreement between the divorcing couple. In most cases, these issues are eventually resolved, sometimes with the involvement of the court system, and a final agreement is reached between the former couple.
The most important thing to understand about tax collections after a divorce is that the divorce decree, or any agreement between the ex-spouses, has no bearing on the taxing authorities’ approach to collecting the debt. You heard that right. The IRS and state taxing authorities do not care what your divorce decree says.
I have seen many cases wherein the divorced couple made an agreement in the divorce decree that one of the spouses was responsible for resolving the couples’ tax liabilities, and the spouse who was left without the responsibility assumes that the taxing authorities will leave them alone. This is not the case.
A joint tax return gives rise to a joint tax obligation. Further, that joint obligation is known legally as a joint and several liability. That means that the entire debt can legally be collected from both spouses together or either spouse individually. The taxing authorities may only collect the debt once, but they can collect as much or as little of it from either spouse as they see fit. Simply put, the IRS wants its money, and it is going to try to collect it as quickly as it can without regard to which spouse it collects from.
Again, the divorce decree does not change the joint and several nature of the tax debt, so the taxing authorities will continue collection activities against both jointly liable taxpayers, and will collect according to the individuals’ abilities to pay. The joint nature of the liability does prevent the authorities from collecting more than the assessed balance from both ex-spouses, put together.
As an example, let’s assume that a husband and wife divorce. In the divorce decree, the husband is named as the ex-spouse who is responsible for resolving the tax liabilities. Naturally, the wife assumes that she’s off the hook and that the husband will take care of the problem. In our hypothetical divorce decree, the wife is also awarded the family home, which has equity, and spousal support. The loss of the home, and the obligation to pay spousal support leave the husband without sufficient net monthly income to pay the tax debt, and, since he lost his ownership interest in the house, he has no equity in assets (assume that the couple had no major assets other than their home).
Basically, the husband is now uncollectible. The ex-spouses assume that the taxing authorities will honor the divorce decree, and that the wife will be left alone. Then, the authorities begin garnishing the wife, and place a tax lien on the family home now titled to the wife. This causes problems for the couple, obviously, but it is completely legal for the authorities to do.
The joint nature of the tax debt allows the taxing authorities to collect the entire balance due from both spouses, and the several nature allows them to collect the entire balance due from either spouse. Contrary to the divorce decree, the wife is now left paying the entire tax liability, because none of it can be collected from the husband. The wife has no legitimate legal recourse to challenge the taxing authorities’ action, because the divorce decree is binding only on the spouses—not the IRS or state taxing authority.
Another tactic the authorities use to collect from divorced couples who owe joint liabilities is called “account mirroring.” Again, due to the joint and several tax liabilities, the authorities can open a separate collections case against both ex-spouses. Then, each ex-spouse is responsible for making arrangements to resolve the tax liabilities, according to their ability to pay, but neither can totally assign the liability to the other.
Payments made by both ex-spouses are credited to the liability, and the joint debt is decreased by each ex-spouse’s payments. The debt is resolved when the total payments received from both ex-spouses pay off the entire joint liability. If the accounts are mirrored, and one ex-spouse sets up an Installment Agreement, but the other ex-spouse does not, the authorities are legally entitled to enforce involuntary collections on the ex-spouse who has not made arrangements to resolve the account. The non-compliant ex-spouse can be garnished and levied, and have assets seized for payment toward the joint debt.
To illustrate, we’ll return to our hypothetical husband and wife. Husband, knowing he has the obligation to resolve the tax liabilities, as ordered in the divorce decree, sets up an Installment Agreement. In setting that Installment Agreement up, the authorities become aware of the divorce, and mirror the accounts. Wife begins receiving collection notices without husband’s name on them, but she disregards them. After all, husband is responsible for the debt according to the decree.
Then, wife’s employer receives a garnishment order on her wages. Wife fights it, and insists that husband is responsible, and she has no obligation to pay toward the debt. Wife can continue to fight about it, but she will never win, and her failure to recognize the nature of the debt can ultimately result in the taxing authorities seizing the house that she was awarded in the divorce. The only way to have avoided the outcome was for the wife to have made her own arrangements to voluntarily resolve the debt.
One way that ex-spouses attempt to defeat the authorities’ ability to collect from both joint taxpayers is to file a petition for Innocent Spouse relief. The reasoning is often that one spouse’s income, failure to ensure sufficient withholding, or other tax mistake was the root cause of the debt in the first place, so the other spouse is innocent of failing to pay the taxes on their income.
It is important to understand that the threshold for Innocent Spouse relief is quite high. Typically, Innocent Spouse relief is only granted when the petitioning spouse was abused or otherwise coerced into filing the joint return without paying the taxes. Also, if the petitioning spouse received a benefit from the income or the failure to pay the taxes (like buying groceries or enjoying a vacation), an Innocent Spouse petition will usually be denied. If a spouse signed joint tax returns, received a benefit from the income or the unpaid taxes, and was not coerced into those acts, the authorities will not grant a petition, and both ex-spouses will remain jointly and severally liable for the tax debt.
Filing an Offer in Compromise (tax settlement) might be another seemingly attractive strategy. An Offer is based on verification that a taxpayer cannot pay the entire liability without experiencing a financial hardship. In a divorced couple’s situation, there are double the expenses, but usually the same income as during the marriage, which makes an Offer look very appealing.
However, if the accounts are mirrored, then the taxing authorities will look at each ex-spouse’s finances separately, requiring two Offers be filed. Similarly, if one spouse files a successful Offer, the other spouse does not receive the benefit of the reduction of the debt, except to the extent that the funding of the accepted Offer is mirrored to the other ex-spouse’s liability. To resolve a divorced couple’s joint tax liability with an Offer requires two Offers to both be successful, and funded, separately.
With an understanding of tax collection practices for debts owed by divorced couples, there are a few strategies to prepare for the collections process during the divorce. First, do not rely on the divorce decree to protect one of the spouses from the collection of the debt. A better idea would be to establish a joint Installment Agreement before the divorce is final, and then assign those monthly payments to the ex-spouse who remains responsible for taxes in the decree.
Assuming that Installment Agreement is sufficient to pay the liability off in full, and the chosen ex-spouse adheres to the terms of the agreement, the authorities will probably never look at the case again. Similarly, it might be a good idea to file an Offer in Compromise prior to the divorce becoming final, so that a single Offer can resolve the joint liability.
Since tax debts and divorce form a volatile combination, do yourself a favor and hire an experienced tax relief professional to represent you before the authorities, especially when dealing with a joint liability, prior to the divorce (if you’re already divorced, get someone good on board ASAP). A good tax relief pro will understand how the collection process can impact you, and how the situation changes after the divorce.
Keep in mind that the authorities cannot collect more than the total joint liabilities from both taxpayers together. That means that, the less you pay, the more your ex-spouse is likely to have to pay to resolve the debt. Having a knowledgeable representative in your corner for those negotiations can easily make the difference between continuing to support your ex-spouse for many more years and taking care of your liabilities without paying more than your share of the balance owed.
Going back to our hypothetical couple. Let’s assume that husband hires an effective tax relief professional who gets his case into Currently Not Collectible (CNC) status, meaning that while the debt still exists, the IRS has agreed that any action to collect will cause him a financial hardship, and agrees to halt collections for a year or two. Then, husband files an Offer in Compromise, knowing he is safe from Collections, due to his Currently not Collectible status, and has the time to prepare a very solid Offer. Husband’s Offer is accepted. Husband’s mirrored liability is resolved for a fraction of the total joint liability, and he no longer has to worry about any collections, by virtue of his approved and funded Offer in Compromise.
Wife decides to ignore the problem. After all, husband is responsible according to the divorce decree, so why should she even pay attention to the taxes? All of a sudden wife’s wages are levied, and her bank account is cleaned out. It is a disaster scenario that wife could have avoided, had she understood the true nature of collection of joint tax debts, and gotten herself some help.
Instead, she files an unsuccessful Innocent Spouse Petition, continued to fight with the authorities, using the divorce decree that says husband is responsible for resolving the tax debt, loses at every turn, and can’t fathom how the authorities can be so cruel to her. Finally, the tax collector shows up to seize the house that she won in the divorce and she is ruined. It is a very sad situation, which could have been avoided, had she had someone with the knowledge and skill to avoid such an outcome on her side.
It’s imperative to keep in mind that few divorce attorneys have much experience resolving tax liabilities. And though I realize that the last thing someone going through a divorce wants is yet another attorney, having an attorney experienced at navigating the tax aspect of the divorce is a heck of a lot better—and a lot less expensive–than the alternative.
If you owe taxes and you are dealing with or have dealt with a divorce, you would be well advised to consult with a tax relief professional. Fortress Tax Relief has caring and knowledgeable professionals on staff who can answer any questions that you might have, and who can provide you with a solution tailored to your specific needs and circumstances. There’s no charge for a telephone consultation, so pick up the phone and give us a call today!
