What do you do in a divorce when your spouse is a tax cheat?
Many Spouses Denied Relief
Unfortunately, even with the current “innocent spouse” IRS rule, many spouses are not granted relief for unpaid taxes because they did not apply for relief within the two-year period. Lawmakers, IRS taxpayer advocates and legal aid attorneys have argued that this two-year deadline is especially unfair to victims of domestic abuse, who may have been kept in the dark for years about their marital finances. Some spouses may have even had their own mail hidden from them by their husband or wife, preventing them from seeing IRS notifications.
Divorce Does Not Relieve a Spouse from Liability for a Joint Tax Return
Other spouses are unaware that a refund offset (when the IRS withholds a taxpayer’s refund to cover any unpaid taxes) starts the clock on money owed to the IRS. In some cases, a spouse convicted of criminal behavior also has problems with the IRS. Once that spouse is sentenced to jail, the husband or wife may not learn about the unpaid taxes until it is too late to gain relief under innocent spouse relief. The primary takeaway for anyone going through a divorce, is that divorce does not automatically relieve you from liability for a joint tax return filed while you were married, even if you truly had no idea what was in the document, and even if your divorce decree states otherwise.
Consider these very frightening stories of spouses who were unaware of their husband’s tax problems:
- Arrested on charges of Medicare fraud in 2000, Richard Chentnik, a dentist, had racked up more than $900,000 in taxes, interest and penalties. Chentnik assured his wife, Cathy Marie Lantz, he would do the right thing by filing an innocent-spouse claim on her behalf. Unfortunately, Chentnik died before the claim was submitted, and by the time Lantz filed her own claim, the two-year deadline had passed, and the IRS denied her claim. An appeals court upheld the IRS decision.
- In 2005, Joanne Payne’s husband died, leaving her with unpaid tax bills which went back as far as 2000. Payne and her husband had been married for 53 years, however Payne says her husband handled all the financial details. Because of this, Joanne Payne, by then in her 70’s, struggled after her husband’s death to cope with even the most routine financial issues. She paid some of the taxes owed, but now, in poor health, living on a fixed income, and upside down on her mortgage, she still owes the IRS $4,000. Payne’s application for innocent-spouse relief was turned down by the IRS because she also missed the two-year deadline.
- Howard Joynt owned a bar and restaurant in the Georgetown neighborhood of Washington. When Howard died in 1997, his wife, Carol, found out he owed the IRS a staggering $3 million. Carol claimed her husband’s attorneys warned him not to discuss the matter with his wife. Carol had the means to fight back, hiring a team of high-powered lawyers who advocated on her behalf until she was awarded innocent-spouse status. Carol Joynt later published a memoir titled Innocent Spouse. In the book she says the two-year deadline is particularly unrealistic for the women who were never involved with the marital finances until death or divorce forced them to be.
Obtaining Innocent-Spouse Relief Is Not Easy
Even for those taxpaying spouses who file for relief within the two-year allowed period, it can be a rocky road to actually getting that relief. The IRS says they receive more than 50,000 innocent-spouse claims each year, but grants less than half of those. Denials of more than 1,500 claims each year are directly related to the two-year deadline. The taxpayer is required to show the IRS they did not know, and/or had no reason to know that their spouse was not paying or was underpaying their taxes; the claim will be rejected if the agency believes the taxpayer benefitted from the tax avoidance.
While the IRS says they consider factors such as the education of the taxpayer as well as the overall financial situation, they may overlook these issues if they believe the other spouse gained benefits from the husband or wife’s tax avoidance. As an example, if a husband was only making $40,000 a year, but the wife always drove an expensive car, the IRS may conclude the wife knew, or should have known, that taxes were not being properly paid.
Types of Relief You May Be Entitled To
There are two different types of relief you can apply for as soon as you realize your ex owed the IRS money. These are:
- Discharge of liability in the form of Innocent Spouse Relief, and
- Separate Tax Liability (a complete separation of finances and taxation)
For many divorcing couples, taxes are the very last thing on their mind during the divorce. There are so many other issues to deal with, such as asset division, child custody, child support and spousal support, that taxes may seem like a much less pressing issue, until it takes one spouse completely unaware, leaving them shocked by the amount of money the IRS now says they owe. Failure to consider tax issue can result in fines, penalties, outstanding tax bills, or even worse consequences.
Consequences of Being Granted Innocent Spouse Relief
If you file for and are granted Innocent Spouse Relief, your tax debt will be either totally wiped out, or partially wiped out, providing you had no knowledge of fraudulent or incorrectly prepared tax returns. You must also not have benefitted from the hidden income. Separate Tax Liability relief is somewhat easier to get; if you qualify for Separate Tax Liability, the IRS will separate the tax liability of your own income from your spouse’s hidden income. Before filing for any type of relief, you must know how your marital taxes were filed.
Married Filing Jointly
Most often, married couples file their taxes as “married filing jointly,” in order to garner certain tax benefits. Unfortunately, “married filing jointly” also brings the most liability to the spouse who was unaware of the hidden income. But suppose a couple have been married thirty-five years, and the husband has always taken care of the finances and taxes. The wife has a good job, making $250,000 per year as a W-2 employee, while the husband is self-employed. Because the couple has few itemized deductions, they end up paying the maximum tax rate of about 50 percent.
A few years back, the husband decides to try and lower that tax burden by creating a phantom business on paper, deducting his personal expenses as business expenses. The husband uses his phantom “consulting” business to pay for a new car as well as week spent golfing with friends, claiming the expenses are proper, deductible business expenses. The couple divorces, with the wife having no idea of her husband’s IRS tax evasions. The IRS will hold the wife just as liable, since she signed the returns, and since she is higher wage-earner, it is likely her wages will be garnished to satisfy the tax debt. In this case, the wife should speak to an experienced tax attorney as soon as possible, filing both for innocent-spouse relief as well as possibly injured spouse.
Should You File for Innocent Spouse Relief, Separation of Liability or Equitable Relief?
If you request innocent spouse relief and it is granted, you may not be liable for the taxes, interest or penalties incurred by your spouse, and the IRS will not attempt to collect these amounts from you. All the following provisions must be met to qualify for innocent spouse relief:
- A joint tax return was filed with your ex and that return understated the taxes owed as a result of erroneous items placed on the return by your ex.
- You swear that at the time you signed the joint tax form, you did not know—and could not have known—that your spouse had misstated or understated the amount of taxes owed.
- The IRS must determine that when the facts of your particular case are taken into consideration, it would not be fair to make you accountable for the debt.
If the IRS finds you and your ex transferred property to one another fraudulently, your request for this type of relief will not be granted.
Under Relief by Separation of Liability, the understated taxes, along with any owed interest or penalties, will be separated on a joint return, with the understated taxes allocated to you, being the amount you are liable for. Separation of Liability is available only for unpaid liabilities which resulted from an understatement of taxes. You must meet the following requirements to be eligible for Relief by Separation of Liability:
- You are either legally separated from your spouse, or your divorce is final from the spouse you filed a joint tax return with, and
- You did not live with the spouse you filed the joint tax return with at any time during the year ending when you file Form 8857.
- You do not qualify for innocent spouse relief;
- You do not qualify for separation of liability relief;
- You do not qualify for relief from liability arising from community property laws;
- There was no fraudulent transfer of assets between you and your ex;
- You did not file your taxes with the intent to commit fraud;
- You did not fail to file your taxes with the intent to commit fraud;
- You failed to pay the taxes owed;
- You have established that considering the circumstances of your case, it would not be fair to assign liability to you for unpaid taxes, and
- The liability for the taxes you are seeking relief from must be attributed to your ex.
If your name is on the title of an item, the tax liability for that item will be attributed to you unless:
- You had no knowledge that the money intended for tax payments was taken fraudulently by your ex for his or her benefit;
- You establish you were abused by your spouse, therefore you failed to contest any questionable items on your joint tax return, or
- You establish that the fraud perpetrated by your ex is the sole reason for the erroneous item which resulted in a tax understatement.
Factors the IRS May Consider When Deciding on Your Bid for Relief
The IRS will consider the following issues when making a decision regarding whether you should be relieved of the liability for tax debt, tax understatement or tax misstatement:
- Were you a victim of domestic violence or spousal abuse prior to signing the joint tax return?
- Was your physical health impaired when you placed your signature on the joint tax return or when you requested relief from the IRS?
- Was your mental health impaired when you placed your signature on the joint tax return or when you requested relief from the IRS?
- Will you suffer substantial financial difficulties if the IRS does not grant relief?
- Does your divorce decree provide that you will pay the unpaid taxes?
- Were you aware of the times which caused the understated tax?
- Have you received any type of substantial benefit from underpaid taxes or the item which caused understated taxes, or
- Did you attempt, in good faith, to comply with the IRS tax laws for the years you are asking for relief?
Your Responsibility During a Divorce to Disclose Financial Information
In the state of Florida, properly disclosing financial information by both sides is a mandatory requirement. A detailed, sworn financial affidavit will be filed in court during your divorce, and if you believe there is any tax fraud on the part of your spouse, it would be wise to speak to a tax attorney early on in the divorce to ensure no tax crimes have been committed, or to lessen your exposure to criminal charges if a tax crime has occurred. Once you file a claim for relief, the IRS will contact your ex, so that he or she may participate in the process. Divorce can be contentious enough without the added stress of tax evasion on the part of your ex. Speak to your family law attorney as soon as you have any inkling that your spouse was less than honest when filing your joint tax returns. Your attorney will ensure your rights are protected while helping you decide the best course of action.