Within this article we will discuss what you need to do if:
The IRS has notified you of an outstanding tax debt
You perceive you should not be personally responsible for the IRS debt and
You just started, or are in the middle of, a divorce process
There are a series of steps you have to take to manage the potential tax exposure as well as your divorcing risks at the same time. What you want to achieve is to gain relief from the IRS and simultaneously not get financially harmed in you divorce process. This is a delicate balancing act.
The very first question you have to know is whether you are 100% responsible for the IRS debt or not. If you are not 100% responsible, then you have an opportunity to reduce or completely remove the IRS debt from your name and potentially assign it to your spouse.
First, let’s talk about the IRS debt that may not be your your responsibility and how to manage your financial exposure. There are 4 ways which we have summarized in the next 2 sections.
Seek (Financially) “Injured Spouse” Relief from the IRS
The word Injured refers to financial injury, not physical injury. This is where the IRS has taken money from you as a result of a tax debt that was never your financial responsibility. The IRS inappropriately assigned a portion of, or all of, the tax debt to you, identified you as being a culpable party and then found a way to place a lien on your property, garnish your wages, seize your assets, or otherwise, yet you were never associated to the situation in any way whatsoever. This is the pure definition of Injured Spouse. In other words, you were financially injured from the actions of the IRS yet were not supposed to be harmed in any way. You want to rectify the situation. The process to do that is called Injured Spouse Relief.
It is important to know, some people think they are not “involved” yet are actually involved as a result of signing and then filing a tax return. If you sign a joint tax return the IRS deems that you are jointly and severally liable for anything that was reported on the tax return, including any misstatements, and any tax liability that is still outstanding. So, even though you were not the source of the problem, if you signed and filed a joint return you would not qualify to classify yourself as an “injured spouse”. The IRS ignores that reality and focuses on your involvement where you signed and filed a joint return with your spouse.
If you do not qualify as an injured spouse not all is lost. There is another classification called “innocent spouse relief”. Read on to learn more.
Seek Innocent Spouse Relief, Separation of Liability or Equitable Relief from the IRS
If you have an understated (not underpaid) tax liability and the understatement was not a result of any of your behaviors or any of your knowledge (i.e. you were 100% innocent), you may be eligible for 100% innocent spouse relief. You have to be truly separated from the entire process and be able to claim 100% innocence. If you were not 100% innocent and could be associated to the underreporting of information, then you could be eligible for what is known as separation of liability where the tax liability is separated between you and your spouse. If you don’t fall into either of those categories, you could potentially seek equitable relief. Equitable relief is where the tax was underpaid (not understated) and you want to apportion the tax liability to you and your spouse.
How does all of this impact a divorce process?
You may or may not be successful with the IRS. You have to plan for both financial outcomes, the financial outcome with the IRS and the financial outcome from your divorce. Once you file the required paperwork around innocent spouse, separation of liability or equitable relief, the IRS is obligated to notify your spouse to respond accordingly. You nor the IRS will know ahead of time how your spouse will respond to your claims on the forms you submit. It will be unclear how your spouse responds and whether the IRS will award you the monies you seek.
Questions that often arise in context to the IRS and divorce together are:
What happens if you do not receive the full award of innocent spouse? How do you address that so you can gain the credit in your divorce process?
How do you recoup advisory fees you may have paid and get repaid those monies in you divorce as your spouse should have not placed you in this position in the first place?
Will the information you provide to the IRS expose you in your divorce process? How do you mitigate those risks?
What happens if your spouse responds to the IRS follow-on inquiry in a way that limits your ability to gain the tax relief you are seeking? What do you do then?
Can the tax debt be moved from your side of the ledger to your spouse’s side of the ledger in your divorce? If so, how do you make that happen?
What happens if your divorce is nearly finalized and the IRS has not yet made a decision? What do you do in that situation? How do you handle that uncertainty in your divorce process?
Could an opposing counsel, mediator or Judge use the IRS documents against you?
How do you limit the exposure to your financial record (tax record, credit report, etc.)?
Could the IRS continue to pursue you even though you are innocent?
How do you put an end to your IRS issues and your divorce?
There are numerous questions that often arise when IRS issues intersect the divorce process. All of this is sensitive stuff which needs to be diligently managed to best manage the financial pain you could experience from the IRS and/or from your spouse in your divorce. Both impact your financial future.
So, what can you do?
Like everything else in the world, the quality of your story impacts your outcomes. Yet, your story depends on the quality of the evidence you use in your story. You need to prepare a cogent story that does not place you in harm’s way with the IRS and in context to your divorce so it is not used against you. Some additional questions that often arise in these intersecting processes are:
Even if you have the facts straight, how will you write your logic in a hierarchical manner?
Have you asked the right questions in context to all of the perspectives at hand: the IRS, your spouse, the opposing counsel, your own counsel, the mediator, the Judge or others too?
Will your story comply with what the IRS wants and needs to hear?
Could the IRS read between the lines and not award you relief?
These are all important questions to make sure you do this right. This is not just about a calculation or filling out some forms. It is about your positioning statements, how you manage your collective risks, getting the IRS to understand as well as having the participants in your divorce process interpret the information correctly.
We record that you seek out a financial divorce risk manager who can gain a strong handle around your tax related matters as well as your divorce matters. It is the intersection of these skills that is important to have on your team. One skill without the other could create unintended consequences.
It is important to be aware there are technical tax matters and technical divorce matters that often have to be addressed which often require more specialized skills. If you are not going through a divorce, you might be able to have a traditional technical CPA who specializes in IRS conflicts to help you through this process. If you are going through a divorce, then the risks of the divorce can enter the equation and you need to make sure you plan and manage those aspects of the IRS issues along with your divorce at the same time. If this is your situation, we would recommend you gain the help of a divorce risk manager, not just a traditional CPA or a tax attorney. The point is to choose your advisor wisely.
If you need help, feel free to reach out for a free consult. My name is Larry Smith, CPA MBA. I have been practicing as a CPA since 1990 and working in the divorce space as a technical divorce risk manager since 2003. I will provide you a free 30-60 minute consult. You will have no obligation to move forward with our services. My direct number is 617-680-5222. My email is [email protected]