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Joint Tax Liability & Divorce – A Warning
November 10, 2012
Today’s blog post serves as a warning for couples with joint tax liability contemplating or in the midst of a divorce. Joint tax liabilities are often assigned to one of the spouses as part of the division of assets and liabilities. Once the divorce decree is signed, sealed and delivered, the spouse relieved of the tax liability often believes this is the end of the story. WARNING – Relief of joint tax liability in a divorce decree does not in and of itself actually relieve the spouse of his/her liability with the IRS. A divorce decree at its most fundamental level is a contract governed by state law. It does not supersede federal tax law. The IRS could not care less about what you say in a divorce decree. If divorcing spouses want to effectively separate tax liability, they need to deal with the IRS directly. When dealing with joint tax liability in a divorce, one should think about it as a multi-step process. First, how will the liability be doled out amongst the spouses? Second, what are the specific steps that each spouse will take to pay off or pay down the liability? Third, is the completion of step two an obligation to finalizing the divorce? Most of the divorce decrees I have reviewed include step one but leave out steps two and three. Unfortunately, this not only leaves both spouses with unfinished business post-divorce but also requires the ex-spouse relieved of liability in the divorce reliant on the other ex-spouse to actually pay off the tax liability. Originally, I found myself asking how ex-spouses who could not trust each other enough to stay married could possibly trust the other to pay off an often five or six figure tax liability? This question, however, begged a further question – how could the attorneys representing the relieved ex-spouse allow their client to be put in such a position? The potential ramifications can be devastating. Consequences include, but are not limited to job loss, terrible credit and an inability to resolve their issues with the IRS later on. Now, I am not a family law attorney so I do not know all the potential ways for accomplishing steps two and three. However, if an asset is used to satisfy a tax obligation (e.g., pulling equity out of a home, borrowing against a 401(k), etc.), I offer one suggestion – liquidate the asset, place it in ESCROW and pay it off before the divorce is finalized. Until next time, Alex