Tax law plays a very important role in a divorce settlement, especially when your ex-spouse had a business you didn’t know about. And if payroll taxes weren’t paid, watch out! Your divorce papers won’t save you.
This may come to some of you as a real “Shocker Bob,” but not all marriages survive the test of time and even fewer end in an amicable, cordial, courteous, polite or even civil manner (yes, I did use a thesaurus). As I have written about many times, marital tax matters do not always end when the marriage is finalized, and a family court judge drops the hammer—I mean gavel. Since this is an article about taxes and tax topics, I will focus strictly on how matters of tax law play a very important role in a divorce settlement.
A Common Case-In-Point
You and your spouse file a joint return for tax years 2000 thru 2005. In 2006 you file for divorce which is granted. Great, now the two you can go your own separate merry ways and live happily ever after. Dream on. Then the friendly folk at the IRS decide to audit your joint return for 2004 (those meanies). Because your ex-spouse was the first name on the return, the Taxpayer, and Spouse is the second name, he/she received one of those nasty notices from the IRS stating that your return has been selected for review. Since the two of you are not on—let’s just say—friendly speaking terms, the ex-spouse goes ahead and has his/her CPA handle the audit. There may be hidden reasons for not informing you of the audit, as you will see. During this, what I would assume, is a friendly exchange of information and dialogue, it is discovered that there are some significant irregularities. The IRS discovers that your ex-spouse has under-reported a few million dollars in income and failed to remit to the government a large sum of payroll taxes. This is happening all whilst you are sleeping blissfully and completely unaware of the freight train headed directly toward you.
It Doesn’t Matter What Your Divorce Papers Say
Since you are really smart, and you had a real good family law attorney who—in an effort to protect you from just such a situation—included a clause in the martial separation agreement that indemnifies (that means you are not responsible) you against all future community property tax assessments (both federal and state). Great, you keep on sleeping sound as a baby.
Finally, Friday night has arrived. You’ve had a long day at the coal mines toiling away and come home drop dead exhausted. You are ready for a quiet dinner and a great bottle of vintage wine all to yourself. As you open your front door, you pause to pick up the mail and set it down next to your keys on that incredible antique table so skillfully rescued from the evil clutches of your ex-spouse. You let out a sigh of relief. Peace at last. Great, now it’s Miller Time! You change, slip into something warm and comfortable, poor yourself that large glass of wine and pick up the mail. To your amazement, there, just after the sweepstakes letter guaranteeing you are a million-dollar winner, is a certified letter from the Internal Revenue Service. Your heart starts to race, you quickly—but carefully—put down the glass of wine and begin to open that certified envelope. Your palms grow sweaty as you begin to read the first page, and then true unadulterated panic begins to set in. On the first page of the letter, it says that as a result of an audit, you owe the government $377,845.15. First thought, HOW MUCH and what audit are they talking about? The second thought is of various ways to harm your ex-spouse.
Now the question is, where do you go from here. First you scream. Wait, first you finish the wine then scream (watch Netflix, everybody is always drinking during a crisis.) Next you call your ex, and finally you call your attorney. They all tell you the same thing. Talk to your CPA. Come Monday morning, you are on the horn first thing looking for answers and a plan.
A Plan with Possible Solutions
A plan is nothing but a series of solutions. If you do them carefully and in the correct order, you most likely will end up with a positive outcome. One possible solution for you, the surprised spouse, is to file for Innocent Spouse Relief. After all, you are completely innocent and definitely need some relief.
But First, A History Lesson
A brief but important tax lesson about 26 U.S. Code § 6015—Relief from joint and several liability on joint return. In less technical jargon, here how this works. Believe it or not, between 1913 and 1918, couples were not permitted to file jointly. There was no such concept of a marriage as a single economic unit. It all changed in 1948 when Congress finally recognized that married couples should be treated as a single unit. In 1971, Congress decided that under certain circumstances, there are times when you must ignore the economic unit of marriage and unwind the joint liability of the tax return. That provision was improved (I mean modified) in 1984 and then again in 1998 (it is Congress, nothing happens quickly.) Ultimately, the code section was finalized with three main parts allowing some form of relief. That means that the surprised spouse has three different ways to obtain partial or complete relief. To avoid the gory details of this provision, I will give a quick and way over-the-top summary of the three sections granting relief:
6015(b)—Requesting spouse was both (a) innocent of knowledge of the facts of the omission and (b) innocent of benefit from the income.
6015(c)—On the date the request is filed, the taxpayer is no longer married to the non-requesting spouse, and the request is made within two years of when the IRS first initiates collection action and the requesting spouse had no actual knowledge of the transactions that gave rise to the erroneous items.
6015(f) – provides simply that “if…taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency…and…relief is not available to such individual under subsection (b) or (c).”
To request relief under (b), (c) or (f), the surprised spouse must file Form 8857, Request for Innocent Spouse Relief.
Back To the Solution Plan
So, off to the CPA’s office you go to get some relief. The two of you fill out the form with all the torrid details of how you were deceived by your ex-spouse. You claim you never signed the return and was basically clueless and so on. For now, I am going to make simple assumptions; that the surprised spouse did not review or sign the tax return, had no knowledge of the business affairs of the ex-spouse and did not benefit in any meaningful way (e.g. ex-spouse bought the surprised spouse a Royals Royce, diamonds or designer clothing.) Remember, for the most part, this is a test of facts and circumstances, and the initial judge and jury is the IRS.
The certified letter is now in the mail on its way to the IRS. You wait and wait for answer. Then, on another Friday night you get the answer you have been waiting for and the IRS grants you relief from the income tax liability on the 2004 tax return. Once again it is “Miller Time” or at least back to the expensive bottle of wine.
But wait, in that stack of letters is another certified letter from the IRS. What could it be? You open in and to your aghast and amazed, you still have a large balance due to the IRS. Not only that, this neatly folded letter goes on with the words “Intent to Levy” and “File a federal tax lien.” What the hell!
The Hits Just Keep on Coming
Earlier in this story, I said that the IRS determined that the ex-spouse failed to remit a large sum of payroll taxes (e.g., trust fund monies.) What is the difference you may ask. Well, especially for purposes of Innocent Spouse Relief, payroll taxes are not considered income taxes. Wait a minute, aren’t taxes “taxes”? (Thank you Yogi Berra).
Again, it is off to see the Wizard, I mean the CPA (same thing.) After some simple Google search, the CPA prints out the following for your reading displeasure: Section 6672 imposes joint and several liability on each responsible person, and each responsible person can be held for the total amount of withholding not paid.” Wait there is more: 6672 also provides that if any “person required to collect, truthfully account for, and pay over any tax imposed by this title…willfully fails to collect such tax, or truthfully account for and pay over such tax” then that person is “liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.” This means that for every dollar of tax not collected and remitted to the government, there is a dollar of penalty. Oh yes, don’t forget about the interest.
You all have heard of traffic court, criminal court, family law court and obviously, the Supreme Court. Well guess what—there is a Tax Court. Since the majority of you reading this are not tax nerds, this may come as a surprise, but “Yes, Virginia, there is a Santa Claus.”
Though I changed the names to protect the innocent (sort of), this is an actual case that worked its way up to the Tax Court. Quick note, in order to get to Tax Court, you have to jump through many hoops involving various levels of review by the IRS. In fact, cases like this can take years to adjudicate. It started in 2014 and was finished June 22, 2022.
The Bottom Line
Let’s get right to the bottom line, and this bottom line is very important. It’s important not just for divorced couples, but for anybody that is in a business that has payroll, even if the payroll is just for the owners (no actual employees.) If your name is on the payroll bank account—even though you never wrote a check, made a deposit or have anything to do with it—the IRS will just assume you are a responsible party and send the IRS hounds after you. It will be up to you to prove you were not part of your ex-spouses failure to do the right thing. This is the only solution, besides suing your ex-spouse and hopefully getting, at least, a judgment to protect you (better than nothing.)
Bottom line here is that the requesting spouse was denied relief under any section of 6015, Innocent Spouse, because, according to the interpretation of the Tax Court, payroll taxes are not income taxes and only income taxes are on a personal return (that 1040 thing you fill out once a year, maybe.) And that is the only type of tax that the joint liability 6015 attempts to unwind. Therefore, requesting spouse is out of luck on this one.
The Only Thing To Do
While you cannot easily discover if your spouse has obsconded with company payroll taxes, you can take note of your income taxes. If your spouse or partner is involved with any form of business that you know nothing about, it is your responsibility to review your tax return before it is submitted. In today’s world for most of us, we do not sign the actual return but Forms 8879 “IRS e-file Signature Authorization.” Once a jointly filed return is accepted by the IRS, both of you are on the hook for whatever is represented on that return. Remember you are signing under penalty of perjury. So, you better pay attention, because when it come to these type of matters, it is everything, everything, everything that matters.
One final note, I would like to personally thank Bryan Camp who is a George H. Mahon professor of law at Texas Tech University School of Law. It is his weekly, and very technical blog that has inspired me to write this article for you. Thank you, Bryan.