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When ‘I Do’ Becomes ‘Tax Due': Marital Tax Debts

Oct. 28, 2021, 8:46 AM

She knew her husband liked to gamble, she told me. But she didn’t know how much, nor that he had been draining his retirement account for years to pay for his habit. The overwhelmed wife of many years found these things out when her husband landed in the hospital, and she discovered the statements and tax bills in papers in his desk.

It was a familiar story. Sometimes, the details changed a little—a husband instead of a wife, an addiction to drugs or alcohol instead of gambling, or a legal/business development instead of a medical emergency—but the outcome was inevitably the same. Spouses that weren’t fully informed about their partner’s financial habits were left with mountains of debt, including tax bills.

There’s a common misperception that tax liabilities accrued during a marriage will disappear after a separation, divorce, or death. But that’s not true.

When you file a joint income tax return with your spouse, the law holds each of you jointly and severally responsible for the entire tax liability under tax code Section 6013(d)(3). This means that the IRS holds each of you responsible for 100% of the tax debt and may collect the tax due from either one or both of you.

There is no forgiveness of a federal tax debt at death: The tax debt does not simply disappear. If the tax debt was solely the responsibility of the decedent, the IRS may pursue an action against the estate. And if the tax debts were accrued during the marriage due to a jointly filed return, the surviving spouse remains liable for them.

Similarly, there is no statutory forgiveness of a federal tax debt at divorce. Many taxpayers believe that the debt is automatically bifurcated, but that’s not true: Jointly accrued tax debt remains joint debt. This is true even if one spouse agrees to pay, or is ordered to pay, the balance as part of the divorce settlement. If the liability isn’t paid, the IRS may pursue the other spouse for the balance. That’s why it’s important to timely address any outstanding tax liabilities in a divorce proceeding, including ensuring that the bill gets paid promptly. A promise to pay isn’t the same as a resolution.

While these are general rules, don’t forget that there are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. The rules in these states may impact how the IRS chases taxpayers after death or divorce.

Under Section 6502, the IRS has 10 years to collect the tax due. The clock begins to run when tax is assessed, which is typically the later of Tax Day or the date that you file. The assessment date can change depending on any adjustments to your tax return, including the filing of an amended return, or pauses due to court action or appeals.

You remain liable for the tax during that time unless you can prove that you didn’t know, or had no reason to know, about the liability, or if you meet other criteria under Section 6015(b). This is typically referred to as innocent spouse relief—some variations, including separation of liability or equitable relief, may apply.

If you are granted innocent spouse relief, you are relieved of the responsibility for paying tax, interest, and penalties if your spouse—or former spouse—improperly reported items or failed to report items on your tax return. This relief only applies to individual income or self-employment taxes. Other kinds of tax liabilities, including Household Employment taxes, Individual Shared Responsibility payments, business taxes, and trust fund recovery penalty for employment taxes, are not eligible for innocent spouse relief.

The statute of limitations for claiming innocent spouse relief is typically two years after the date on which the IRS first attempted to collect the tax from you. That’s important: You can’t simply avoid paying the tax and later claim that you don’t wish to be held responsible for the tax.

So, how can you avoid these kinds of situations in the first place? There are a few steps that you can take to have some control over your tax matters.

  • Review your tax returns before you sign them. You are responsible for what is reported on the return. So take advantage of the opportunity to examine the returns and ask questions about anything that doesn’t make sense. Willful ignorance is not a defense: You must establish that when you signed the joint return, you did not know and had no reason to know that there was an understatement of tax.
  • Pay attention to retirement accounts. There may be immediate tax consequences to making withdrawals or borrowing against retirement accounts, unlike a regular bank account. Keep a watchful eye out for contribution limits for both spouses, and as you get older, pay particular attention to required minimum distributions.
  • File separately. It’s true that you’ll often achieve a more desirable tax result if you file jointly. But married filing separately does offer some advantages, including the fact that you will only be responsible for your own tax liability. And don’t get thrown by the name: You do not have to be separated or living apart to file separately. You can be happily—or not—married and use this status. And remember: If you are married as of Dec. 31, you are married for the whole year for federal tax purposes.
  • Check your tax account online. This is a wonderful—and free—resource for taxpayers. And the best part is that you don’t need your spouse’s permission to take a peek. Simply click over to IRS.gov and register to “View Your Account.” You can double-check that returns have been filed and processed, and confirm whether refund checks have been issued.

I am well aware that it’s not always easy to talk about money. In an ideal world, partners would regularly engage in conversations about financial health and consult with tax and financial professionals together. But even when you’re in a solid relationship, these discussions can be tricky and stressful.

And not all relationships—especially those that might be heading for a divorce—are healthy. Often, one spouse has no idea how much money is earned in the family, how much is being spent or the kind/extent of the liabilities. Sometimes, that’s the result of busy schedules and intentional decisions, but it can also be for more concerning reasons: financial abuse—behavior that seeks to control a person’s ability to acquire, use, or maintain economic resources, and threatens self-sufficiency and financial autonomy. Financial abuse occurs in 99% of domestic violence cases.

The bottom line: No matter whether you’re a newlywed or well into your golden years, financial and tax details matter. Take steps now to arm yourself with the information that you need to make good choices.

October is Domestic Violence Awareness Month. If you are in danger or believe that you are the victim of abuse, call 9-1-1 or the National Domestic Violence Hotline at 1-800-799-SAFE.

This is a weekly column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.

To contact the reporter on this story: Kelly Phillips Erb in Washington at kerb@bloombergindustry.com