Divorce, Taxes, and the IRS

Copyright 2006 The Divorce Center P.A. In Divorce, potential tax liability can frequently become the tool for one spouse to use against the other spouse. If improperly used, this tool can destroy all of the marital assets. In the worst case, tax liability can seriously impact the future financial security of either spouse and subject them to criminal sanctions. Situation 1 - Your Spouse Owns a Business The most common situation where taxes become an issue in a divorce is they there is a family business. The owner - spouse may have hidden cash receipts or engage in a practice of recording inflated expenses. This common practice by many business owners is a fraudulent attempt to minimize taxes. The other spouse is often aware of and approves of this practice. During the marriage, minimization of taxes results in higher household income and a better lifestyle for the couple. This practice is illegal or borders on illegal. During the marriage it is a secret between the married couple. But during a divorce each spouse may try to use past tax behavior to gain an advantage. The owner - spouse wants to minimize past income in an effort to lower child support, alimony, or division of marital property. Of course the other spouse wants to prove the opposite. The result is a game of chicken - with one spouse threatening to turn the other spouse in to the IRS. This is a dangerous game for all involved. Do it yourselfers will find the situation blowing up in their face. People with attorneys may find the attorney reluctant to deal with the situation. The Potential Problems: * Your Attorney cannot assist the owner/spouse commit the crime of tax evasion. * The non-owner spouse may end up liable for half of the back taxes, penalties, and fines. * The divorce court Judge may decide to turn everyone in. * In an extreme situation, everyone can go to jail. Situation 2 - You Make a Surprise Discovery: Your Spouse is a Tax Cheat Another common situation in divorce: the sudden realization that a spouse is a tax cheat - and you were completely unaware until the divorce. The Potential Problems: * You may end up owing the IRS half the overdue taxes. * You may end up owing the IRS the ENTIRE tax bill. * The overdue tax bill may be double the actual unpaid taxes, due to penalties, fines, and interest. The Potential Solution: The IRS has a provision called Innocent Spouse Relief. This provision gives complete or partial tax forgiveness to an innocent spouse. But be aware - the definition of "innocent" is technical, elusive, and difficult to understand. Two available forms of tax relief: * Innocent Spouse Relief - Discharge of Liability * Separate Tax Liability for Each Spouse The first form of relief wipes out your tax debt in part or full. You must have not had any knowledge of the incorrect or fraudulently prepared tax returns. That means you cannot look like you were aware of any part of the return. Also, you must not have benefited from the hidden income. That means you cannot be driving a Mercedes and at the same time signing a tax return that show $200/week in income. The second form of relief is slightly easier to get. If you qualify, the IRS will separate out the tax liability of your income from your spouse's hidden income. This type of relief may have the effect of wiping out extreme tax bills and penalties. The Bottom Line: Always be aware of these types of tax situations. The financial effect can be far worse than the divorce. If you believe this type of problem is in your future, start preparing immediately. Do not sign a joint tax return for your upcoming tax filing. File married-filing-separately. The moment you suspect a potential tax liability, begin to separate your financial life from your spouse's financial life and then promptly file for divorce.