Tax details are not small details in a divorce; they can make a substantial difference in the award of property you receive or the amount of child support you pay. And yet, I find that tax implications are often brushed aside in the context of divorce settlement negotiations or completely ignored at trial.
Do not assume that tax issues are matters that can be “worked out later” between you and your spouse. Treat them instead as significant issues that should be addressed comprehensively and directly during negotiations and at trial. The Internal Revenue Service (“IRS”) puts together an updated publication every year to educate taxpayers about divorce related tax issues such as the taxability of alimony/maintenance and the qualifications for head of household status. Although helpful, Internal Revenue Service Publication 504, “Divorced or Separated Individuals” does not provide all of the tax information you may need to know while you are planning your divorce strategy. As such, it is important for you and your attorney to analyze the tax ramifications of all of your divorce related decisions point by point.
The first tax question you may face in your divorce proceeding may be whether you and your spouse should file jointly or separately. The answer depends in large part upon your individual circumstances but there are some general considerations to first take into account. With some exceptions your marriage status as of December 31 of the tax year will determine your eligibility to file jointly. Even if your divorce is pending, you may still file jointly so long as you are not divorced on the last day of the tax year. In most cases it is to both parties’ financial benefit to file jointly and make arrangements to split any outstanding liability or share in any refund.
Your accountant can confirm the most cost effective route for you and your spouse by calculating a joint tax return and individual tax returns and then comparing the financial outcomes. In the event you, your attorney and your accountant agree that it is beneficial for you to file a joint return with your spouse, there are some issues that need to be clarified from the outset in writing. These clarifications can be memorialized informally through correspondence between your attorneys or formally through a stipulated temporary order submitted to the Court. In my opinion, it is advisable to resolve at least the following issues in advance:
- Decide upon an individual accountant or accounting firm by name.
- Make sure that you have made provisions for payment of any costs associated with the preparation of your taxes.
- Ensure that documents necessary to finalize your taxes are either exchanged or provided directly to the accountant by a date certain.
- Make arrangements for the division of your refund or liability and make certain that the division of the refund and the division of liability are consistent. For example, I often receive proposals in which a spouse earning minimal income tries to divide a refund equally but divide liability pursuant to the parties’ pro rata shares of income.
- If you anticipate a refund, determine whether the refund should be issued in traditional check form or by direct deposit.
It is important that as many issues as possible be addressed in advance of filing. You may find that you and your spouse are simply unable to reach a consensus about your returns while discussing some of these finer points. It is better to know the lay of the land early so that you can file separately and on time if necessary. Even if there seems to be an immediate financial benefit to you to file jointly, keep in mind that there are occasions where joint filing may have long term disadvantages that should be taken into consideration. First, consider that no matter what the terms of an agreement or ruling from the court regarding tax liability, the IRS is a third party creditor not bound by your agreement or the ruling from the court. Pursuant to IRS guidelines, taxpayers filing jointly are jointly and individually liable for the tax and any additions to tax, interest, or penalties that arise as a result of the joint return.
In practice what this means is that regardless of whether or not you have agreed your spouse will be 100% responsible for tax liability arising from a joint return, the IRS can still levy on your wages and your property to satisfy 100% of the liability and leave it to you to enforce your agreement or order against your spouse. You do have the option to require your spouse to indemnify you, or pay you back, any amounts paid by you to satisfy your spouse’s court-ordered portion of the tax debt. In most cases you would also be able to request reimbursement of your attorneys fees and other costs associated with procuring the indemnification. However, practically speaking, this can be a time consuming, costly process. There are no guarantees that you will be able to collect on any judgment for indemnification you obtain from the Court.
If you suspect that you will be incurring a significant liability on your tax return, you will have to weigh the anticipated future complications of filing jointly with the immediate financial benefit with your attorney. Second, please also keep in mind that it is not a good idea to sign off on a joint tax return while you are contemplating a divorce or a divorce is pending if your ultimate position at trial will be that your spouse makes more money than he/she discloses on his/her tax return. Not only is it a rather disingenuous argument to make on the stand after filing joint returns but it could also send you to jail. Do not ratify your spouse’s income disclosures to the IRS if you do not believe they are accurate. Although in some cases one spouse may obtain relief from the other’s tax liability by applying for Innocent Spouse Relief, Relief by Separation of Liability or Equitable Relief, it has been my experience that these forms of relief are often misunderstood by taxpayers and are not freely granted by the IRS.
In sum, make the decision to file cautiously and with the aid of trusted professionals. While this article attempts to touch upon a common tax issue that arises in divorce proceedings, it is by no means exhaustive. Please keep in mind that advice from your divorce attorney can not replace the advice given to you by your tax accountant. While your divorce attorney should help you remain mindful of the tax ramifications of all of your divorce related transactions, you should always seek the individual advice of an accounting professional.
Jill Rauk Daugherty is the Managing Attorney for the Overland Park, Kansas office of Cordell & Cordell, PC.