Taxes and Divorce

What they say about death and taxes still rings true even if in divorce!  Even though the marriage is ending, both spouses are still legally responsible for any all tax liabilities incurred during the marriage and filed on a joint return.  This is true regardless of whether the divorce decree states one spouse is responsible for the taxes.

The hard reality is this:  the IRS does not care who the divorce decree says is responsible for those joint taxes from the marriage.  Neither does the state of Utah.  They hold both spouses jointly and severally liable.  This means they will go after one spouse for the full amount of taxes, and they will go after the other spouse for the full amount of taxes.  Now, they will credit all payments against both spouses so that overall no more is collected than is due.  But they will look to each individual spouse’s ability to pay, and they will ignore what the Decree says as to who is responsible.  The Decree merely gives one spouse the right to take the other back to court to “settle up” on what was paid to the IRS, or to Utah.

To avoid any potential pitfalls, make a rough estimate of your Federal and state taxes coming due for the present year.  Run the numbers two different ways: one set filing Married Filing Separately, and the other set filing Married Filing Jointly.  These estimates will help you decide which way to file will be most advantageous for the filing for the year of the divorce.  In addition, you should discuss this decision not only with your attorney or tax advisor, but also your spouse as well. If at all possible, try to reach an agreement with your spouse concerning this issue and document the result in writing.
 

Preparing Your Tax Estimates

The first step is to gather all the tax documents and relevant information to one folder. It is common for one spouse to have managed the family bookkeeping. If your spouse traditionally took care of that business and is uncooperative about sharing the information, you may have to employ the assistance of an attorney or even possibly the court. Before enacting these types of measures, however, you may wish to point out that the legal fees of both you and your spouse will rise dramatically should these avenues become necessary.

Another way of obtaining the relevant information would be to contact the family accountant for copies of previous years’ returns.  Additionally, you can find IRS Form 4506 online, fill it out, and contact the IRS.  By executing and submitting this form to the IRS, they will provide copies of all signed returns.  The IRS also makes several informational publications available that can provide key advice to persons going through a divorce.
 

The most significant of these publications would be:

• Publication 17, Your Federal Income Tax for Individuals
• Publication 501, Exemptions, Standard Deductions, and Filing Information
• Publication 504, Divorced or Separated Individuals
• Publication 505, Tax Withholding and Estimated Tax
• Publication 552, Record keeping For Individuals
• Publication 555, Community Property (for those living in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin)

Once the estimates are completed, it is time to make one of the most important decisions of the entire divorce: how will you file your taxes?
 

How Will You File Your Taxes?

• To file using “Married filing jointly” status, you and your spouse must be legally still married (even if you are living apart) as of the last day of the tax year, December 31.
• To file using “Married filing separately” status, you must still be legally married as of the last day of the tax year.
• To file using “Single” status, you must be legally unmarried or legally separated as of December 31 and not eligible for “Head of Household” status.
• Head of Household is more tricky.  You must be unmarried on the last day of the year, pay more than half the cost of keeping up a home for the year, and have a “qualifying person” live with you in the home for more than half the year.

Filing Separately

If agreement on the filing status cannot be reached, the proper thing to do is to file married filing separately. The reason for this would be two individual, separate returns can be amended to form a joint return anytime within three years. However, you cannot change a joint return into two separate individual returns at any time. Another advantage to filing separately is that you would not be held accountable should your spouse misrepresent any income or expenses on their tax return.

When filing a separate return, you report only your income, exemptions, credits, and deductions. If your spouse did not work, you may claim an exemption for him/her.

As to claiming children on your tax returns: the dependent credit for each child can only be claimed by one spouse or the other in any tax year.  You can agree to alternate years claiming each child, and make an agreement over who claims each child in which year.  Keep in mind, however, that in Utah should a spouse required to pay child support not be current on those child support payments, that spouse may not claim any of the kids on his tax return, even if the divorce decree allows him or her to do so.
 

Filing Jointly

Most often, filing jointly is the best way to go. A married taxpayer may claim the child and dependent care credits and, in the case of low-income taxpayers, the earned income credit. Also, some deductions, such as an dependency exemption for a non-working spouse or the deduction for a spouse’s contributions to an Individual Retirement Account, can only be employed on a joint return.

Other factors to bear in mind as you consult with your tax advisor with respect to filing status would be the resulting tax rate, deductions and credits to be lost or gained, tax losses from a partnership or business losses, as well as potential liability for any potential misrepresentations by your spouse on with respect to their income or expenses.
If you were to decide to file jointly, and then later the IRS assesses additional taxes, penalties, and interest based upon income not reported by your spouse on the joint return, you may be able at that point to qualify for  relief as “Innocent Spouse”.  Under these provisions you would not be held liable if you could prove the following:

• Your spouse seriously underreported substantial amounts of income
• You did not know of such misrepresentation and had no reason to know of such (which would actually be difficult since a spouse is supposed to read a joint return before signing it)
• It would be unfair to hold you accountable
• You did not receive any benefit from the unreported income

You could also qualify as an Innocent Spouse under either the Forgery Rule or the Duress Rule. Under the guidelines established by the Forgery rule, you would not be held accountable if you could prove that you had no income and therefore were not required to file a return. It would therefore be assumed that you gave no authorization for your spouse to sign your name to any joint return and you may be able to state that your spouse actually forged your name. However, if you DO have income and DO NOT file separately, the IRS will take it for granted that you intended to file jointly and therefore gave authorization for your spouse to sign for you. With respect to the Duress Rule, you must be able to prove that the pressures exerted upon you by your spouse were irresistible and that you would not have signed the return if these pressures were not exerted.

If one spouse has entered into an agreement to pay the IRS less than what is actually due (known as an offer in compromise) on any marital tax debt, the IRS will still go after the other spouse to collect the outstanding monies.  An indemnity clause in a divorce decree (where one spouse agrees to hold the other harmless for any tax liability) offers NO real protection from the IRS. In fact, the IRS can even seize a joint taxpayer’s assets or property even AFTER it has been divided in a divorce decree to satisfy an outstanding account. If you marriage is annulled, the IRS views this as if the marriage had never actually taken place. Therefore, if joint returns were filed, then corrected, separate returns will have to be re-filed.

Once the decision to file a joint return is made, it should also be collectively determined what to do with any refunds or additional taxes that may occur. This decision should also be documented in writing as well to avoid any future misunderstandings or hostility. A simple solution would be to agree to split any refund or share an equal burden of any additional tax that may come due.
 

Conclusion

The tax issues in a divorce are an excellent example how critical it is to put all details in writing.  During a divorce the spouses often reach understandings on alimony and child support but do not bother to get the details down in writing.  In the eyes of the IRS, word of mouth agreements are not enough to warrant a deduction.