People who are concerned their spouse has (or will) understate income or overstate deductions question whether they should file their tax return as MFS instead of MFJ. When a return is filed as MFJ and the IRS identifies misreported information, the IRS holds each spouse jointly and severally liable for the outstanding tax liability, regardless who misreported the information. In other words, when spouses file as MFJ, they are united in their filing process and both spouses are held financially liable up to the total amount of the tax lability due to the government, plus any interest and penalties which may accumulate over time.
Filing as MFS shields each spouse from each other’s potential tax liability as a result of any misreported activity. Yet, at the same time, filing as MFS significantly increases the tax burden to each spouse who is involved in a divorce proceeding. A tax return filed as MFS is imposed a much higher tax bracket than a tax return filed as MFJ, Single or Head of Household.
How a taxpayer arrives at the decision to file MFS or MFJ is usually based on the person’s perception of risk to future liability. It may also be based on the perception of the current obligation due to the government.
If a Spouse perceives the future risk of an audit is minimal (i.e. a third party reports all of the information to the government such as W-2 information), then that Spouse may choose to file as MFJ even though they are going through a divorce. With the understanding the marital estate will experience a lower tax liability filing the tax return as MFJ, the spouses would then negotiate how to divide up any tax payments due, or refund owed, to the marital estate which would later be distributed through the agreed upon settlement structure. Filing as MFJ usually:
- eliminates an extra variable from entering a divorce proceeding which can be difficult to untangle
- reduces the risk of paying additional money to the IRS which could be avoided, assuming the perceived risk is manageable
Even if the risk of a future tax audit remains of concern there are ways to still file as MFJ and incorporate language into the divorce decree to mitigate the future risk to one or both spouses.
Where the concern is focused on the current reporting year, then those issues need to be brought forth and incorporated into the settlement structure assuming an MFJ filing is still a concern.
People usually choose to file as MFS when one of the spouses:
- owns a business and/or rental property (i.e. a third party is not reporting the information on behalf of the taxpayer)
- has a history of inaccurately reporting tax information to the government which may trigger future financial obligations of the other spouse
When one spouse files the tax return as MFS, the other spouse is forced to file as MFS too. Again, both spouses are subject to higher tax burdens as a result of filing in this manner.
Where information is accurately reported from a third party the audit risk is much lower. This tends to reduce the risk for either spouse being required to file as MFS. Yet, where Spouse 1 voluntarily files as MFS, forcing Spouse 2 to file as MFS too, one must question why Spouse 1 initiated an MFS filing instead of an MFJ filing. These situations typically arise when Spouse 1:
- Did not arrive at an agreement how to best allocate the tax liability with Spouse 2
- Perceives the risk of MFJ is high no matter what and may need to be educated about the low risk of a future audit
- Has determined the amount of money that needs to be paid out (e.g. an amount due to the IRS) will be lower for Spouse 1 individually under an MFS tax filing status as compared to a MFJ tax filing status (i.e the current year tax liability)
- Focuses on the short term cash outlay as a more attractive option than protecting the marital estate from a higher cash outlay overall
- Intentionally seeks to impose financial harm (i.e. engages in a financial assault) to Spouse 2, where Spouse 2 would be subject to a higher tax burden when filing as MFS
The question that arises in these situations is whether Spouse 1 has “a perception of a future audit risk” or is more geared towards a “willful intention to cause financial harm” towards Spouse 2. Where Spouse 2 is forced to file as MFS, Spouse 2 does not have many options to avoid the tax liability with the IRS. The IRS views this issue as beyond their scope of control. The IRS recommends the “injured spouse” seek relief through a civil court action, not a tax court. Spouse 1 could eliminate the additional tax liability by simply amending a prior tax return filed as MFS to MFJ. Yet, both spouses would have to sign the tax return reflecting the MFJ tax filing status. The Parties would also have to arrive at an agreement how the remaining liability would be settled between the Parties.
About the Author
Larry Smith is a Founding Partner of Divorce Outcomes, a specialized professional services firm that manages all of the financial aspects in a divorce process. Since 2003 he has worked as a trusted financial advisor, financial advocate, divorce architect and technical financial expert; he is not an attorney. He is an alumni of KPMG and Andersen with expertise in technical accounting, forensics, sophisticated taxation, management consulting, risk management, advanced process engineering, business combinations, divorce management, multi-party negotiations, advanced quality analytics and cognitive performance technologies. Since 1986 Larry has been advising individuals and organizations about innovative financial solutions to resolve complex financial challenges that arise in life and in business.
For both personal and business divorces, Larry is considered an expert in divorce strategies, divorce process management, financial divorce architecture, financial risk management, taxation for divorces, financial divorce forensics, advanced divorce analytics, financial divorce negotiations and mediation, business valuations and sophisticated equity structures. He helps clients shape complex financial decisions, manage communication risks and ever-changing negotiating positions to strategically preserve or grow wealth from these types of transactions.
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in their divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients manage their divorce process, uncover hidden financial risks, architect divorce solutions, manage ever-changing negotiating positions, communicate complex financial matters and close the divorce process as soon as possible with a goal to arrive at the best outcomes possible. Throughout the process we evaluate the current state of our clients’ financial lives with an objective to best reposition their future. We do not sell any products. We simply raise issues that are in our clients best interest. Our clients share with us we:
- unfold, analyze and repackage their financial life so they are well positioned after their divorce
- preserve the value of their business or marital estate
- continuously strive to provide a return on our services
- build balanced financial solutions grounded in evidence
- find ways to make our client, and at times both parties, money through the process
- design their divorce to work for them and their family’s life
- provide mental clarity to make decisions
- reduce the total process time from start to close
- minimize the stress and unpleasant memories that can last a lifetime
As we reach an agreed upon settlement structure, we help our clients identify a fitting attorney who can leverage the financial solution to draft and record the requisite legal documents. Where outcomes are at risk from a traditional process, we function as expert financial negotiators or financial mediators to turn around the situation and achieve our client’s desired outcomes.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.