In the 20 years I’ve been helping people navigate the complex world of taxes, I’ve encountered numerous cases involving tax debt and payment plans, but one particular case stands out for its unique set of circumstances. In this blog article, I’ll walk you through the case study of John (not his real name), a recently divorced individual with a substantial tax debt. By the end of this article, you’ll have a better understanding of your options if you find yourself in a similar situation, and I encourage you to call me at The Tax Defenders at (312) 345-5440 for a free consultation on your tax debt situation.
Unraveling John’s Tax Knot
Before we dive into the details, let’s paint a picture of John’s tax situation. He owns a contracting business with his father and receives a salary of $100,000 as a W2 employee, plus another $100,000 from his Form K1. Recently, John went through a divorce, and as he started rebuilding his life, he realized he needed to address his past tax liabilities.
John filed his taxes jointly with his ex-spouse, but he now wishes to be the one who pays the IRS back. He has already filed his 2021 taxes and paid the IRS $20,000. However, John believes he owes approximately $100,000 for the years 2017 through 2019 and is looking for a payment plan or to pay the balance in full.
In this article, I will guide you through the tax maze that John faced, unraveling each twist and turn to help you understand your options if you find yourself in a similar situation.
Assessing the tax liability: Filing Taxes After a Divorce
Like John, many people are unsure of the exact amount they owe the IRS. The first step in resolving your tax debt is to accurately assess your tax liability. This means ensuring that all income, deductions, and credits were correctly reported on your tax returns. If there are any discrepancies, you may need to file amended returns to correct them.
In John’s case, he needed to review his joint tax returns from 2017 through 2019 to ensure everything was reported accurately. For some, this might be a daunting task, but it’s essential for understanding the true scope of your tax debt.
Joint liability for joint returns (Not Married Filing Separately)
When couples file joint tax returns, they enjoy the benefits of a lower tax rate and the ability to claim various credits and deductions. However, joint filing also comes with a double-edged sword – both individuals are jointly and severally liable for any taxes, interest, and penalties due. In layman’s terms, the IRS can collect the full amount owed from either spouse, regardless of who earned the income or incurred the tax liability.
In John’s case, this meant that the IRS could go after either him or his ex-spouse for the full amount of the tax debt. But John wanted to be the sole party responsible for paying back the taxes owed. The question then arose: How could he achieve this without causing further hardship for his ex-spouse?
Innocent Spouse Relief and Separation of Liability: The lifeline you didn’t know you needed
One option that John’s ex-spouse could consider was applying for Innocent Spouse Relief. This little-known provision can be a lifesaver for individuals who find themselves saddled with tax debt incurred by their ex-spouse. To qualify for Innocent Spouse Relief, John’s ex-spouse needed to prove that she did not know, and had no reason to know about the understatement of tax, and that it would be unfair to hold her responsible for the debt. This provision is like a hidden trap door in the tax maze, providing a much-needed escape route for those who find themselves unwittingly burdened by their partner’s tax liabilities.
If granted, Innocent Spouse Relief would allow John to assume full responsibility for the tax debt without involving his ex-spouse. This option not only aligned with John’s wishes but also provided his ex-spouse with a way out of the tax labyrinth they had found themselves in together.
IRS rules for payment options: The map to your tax debt resolution
With John’s ex-spouse potentially relieved from the tax debt through Innocent Spouse Relief, John needed to explore his options for resolving his tax liability. The IRS offers several payment options, each with its own unique set of advantages and drawbacks. Let’s delve into these options to provide you with a map for navigating your own tax debt resolution journey.
Installment Agreement: The slow and steady path
An installment agreement allows taxpayers to pay their tax debt in monthly installments over a specified period. This option is like a winding path that gradually leads you out of the tax maze, allowing you to tackle your debt in manageable increments.
John could apply for an installment agreement with the IRS, and they would consider his financial situation, the amount he owed, and his ability to pay when determining the terms of the agreement. This option provides the flexibility to pay off the debt over time, which can be a more feasible solution for many taxpayers.
Offer in Compromise: The shortcut to tax debt resolution
An Offer in Compromise is a tax settlement option that allows you to resolve your tax debt for less than the full amount owed. Think of it as a hidden passage in the tax maze that can lead you directly to the exit, bypassing a significant portion of the twists and turns.
To qualify for an Offer in Compromise, John would need to demonstrate that he was unable to pay the full amount of his tax debt. The IRS would then consider his ability to pay, income, expenses, and assets in determining whether to accept his offer. While this option might seem like a godsend, it’s essential to note that not everyone qualifies, and it requires substantial documentation and negotiation with the IRS.
Pay in Full: The straight path to tax resolution
If John had the means to pay his tax debt in full, this option would resolve his liability and minimize any additional interest and penalties. It’s like taking the most direct route out of the tax maze, allowing you to leave the labyrinth behind as quickly as possible.
While this option is the most straightforward, it may not be feasible for everyone, as it requires a substantial upfront payment.
Finding your way out of the tax maze
As you can see, navigating the complex world of tax debt and payment plans after a divorce can be a daunting and confusing journey. In John’s case, we unraveled his tax knot by accurately assessing his tax liability, exploring Innocent Spouse Relief, and weighing various payment options to find the best course of action for his unique situation.
If you find yourself lost in the tax maze, remember that there are multiple paths to resolution, and you don’t have to face the journey alone. I have over 20 years of experience guiding individuals through the twists and turns of tax law, and I’m here to help you find your way out.
If you’re ready to tackle your tax debt situation, I encourage you to call me at The Tax Defenders at (312) 345-5440 for a free consultation. Together, we’ll find the right path to help you regain control of your financial future and leave the tax maze behind.
Does the IRS really have a fresh start program?
Yes, the IRS has a program called the Fresh Start Initiative, which was launched in 2011 and expanded in 2012. The Fresh Start Initiative is designed to help taxpayers who are struggling with tax debt by providing more flexible terms for payment plans, Offers in Compromise, and penalty relief. The goal of the program is to make it easier for individuals and small businesses to resolve their tax liabilities and get a “fresh start” with their tax obligations.
The Fresh Start Initiative includes:
- Installment Agreements: The program increased the threshold for streamlined installment agreements, allowing more taxpayers to qualify. Taxpayers with tax debt up to $50,000 can now enter into an installment agreement without providing detailed financial information. The repayment period was also extended to 72 months.
- Offers in Compromise: The IRS has become more flexible in evaluating taxpayers’ ability to pay when considering Offers in Compromise. They now take into account factors such as the taxpayer’s income, expenses, and future earning potential.
- Penalty Relief: The Fresh Start Initiative provides penalty relief for certain unemployed taxpayers who owe a failure-to-pay penalty. Eligible taxpayers may have their penalties waived for up to six months.
- Tax Liens: The IRS increased the threshold for filing tax liens and implemented new procedures to make it easier for taxpayers to have liens withdrawn once their tax debt is resolved.
While the Fresh Start Initiative has helped many taxpayers resolve their tax liabilities, it’s essential to consult with a tax professional to determine if you qualify for the program and which options are best suited for your situation.
Are you liable for your spouse’s IRS debt?
When you file a joint tax return with your spouse, both individuals are generally considered jointly and severally liable for any taxes, interest, and penalties due on that return. This means that the IRS can collect the full amount owed from either spouse, regardless of who earned the income or incurred the tax liability. In other words, if you file a joint return, you could be held liable for your spouse’s IRS debt.
However, there are certain circumstances where you might not be liable for your spouse’s IRS debt. If you can prove that you qualify for Innocent Spouse Relief, Separation of Liability Relief, or Equitable Relief, the IRS may relieve you from the responsibility of your spouse’s tax debt. Each type of relief has specific eligibility requirements:
- Innocent Spouse Relief: To qualify for this relief, you must prove that you did not know, and had no reason to know, about the understatement of tax on the joint return, and that it would be unfair to hold you responsible for the debt.
- Separation of Liability Relief: This relief allocates the tax liability between you and your spouse (or former spouse) separately, based on the portion each of you is responsible for. To qualify, you must be legally separated, divorced, or not living together for at least 12 months prior to making the request.
- Equitable Relief: If you do not qualify for Innocent Spouse Relief or Separation of Liability Relief, you may still be eligible for Equitable Relief. This relief is considered on a case-by-case basis and is granted when it would be unfair to hold you responsible for the tax debt, considering all the facts and circumstances.
If you believe you should not be held liable for your spouse’s IRS debt, it’s important to consult with a tax professional to discuss your situation and determine which relief options you may qualify for.
What happens to tax debt when you get divorced?
When you get divorced, the responsibility for any existing tax debt generally depends on the nature of the tax filing during the marriage and any agreements made as part of the divorce settlement. Here are some key points to consider:
- Joint tax returns: If you and your spouse filed joint tax returns during your marriage, both of you are considered jointly and severally liable for any taxes, interest, and penalties due. This means that the IRS can pursue either spouse for the full amount owed, regardless of who earned the income or incurred the tax liability.
- Divorce decree or separation agreement: Your divorce decree or separation agreement may specify how you and your ex-spouse should divide the responsibility for any tax debt. However, it is essential to understand that these agreements are not binding on the IRS. The IRS can still pursue either spouse for the full amount of the tax debt if you filed joint returns.
- Innocent Spouse Relief, Separation of Liability Relief, or Equitable Relief: In certain situations, you may qualify for one of these types of relief, which could release you from responsibility for your spouse’s tax debt. Each type of relief has specific eligibility requirements, and you would need to file a request with the IRS using Form 8857 to seek relief.
- Individual tax returns: If you and your spouse filed separate tax returns during your marriage, each of you is generally only responsible for your own tax liabilities.
You should consult with a tax professional or attorney to understand your specific situation and how your tax debt may be affected by your divorce. They can help you explore relief options, negotiate with the IRS, and ensure that you take the necessary steps to resolve any tax debt arising from your marriage.
Who pays tax underpayment after divorce?
After a divorce, the responsibility for tax underpayment depends on various factors, including the nature of the tax filing during the marriage and any agreements made as part of the divorce settlement.
When a couple files joint tax returns during their marriage, both individuals are considered jointly and severally liable for any taxes, interest, and penalties due. This means that the IRS can pursue either spouse for the full amount owed, regardless of who earned the income or incurred the tax liability. In the case of tax underpayment, the IRS can seek payment from either or both spouses.
A divorce decree or separation agreement may specify how the ex-spouses should divide the responsibility for any tax debt, including tax underpayment. The spouses can negotiate and agree on the division of tax liabilities, and the court can include this arrangement in the divorce decree. However, it’s important to note that these agreements are not binding on the IRS. The IRS can still pursue either spouse for the full amount of the tax debt if they filed joint returns, even if the divorce decree assigns the tax liability to one spouse.
In certain situations, an individual may qualify for Innocent Spouse Relief, Separation of Liability Relief, or Equitable Relief, which could release them from responsibility for their spouse’s tax underpayment. Each type of relief has specific eligibility requirements, and the ex-spouse seeking relief would need to file a request with the IRS using Form 8857.
If the couple filed separate tax returns during their marriage, each spouse is generally only responsible for their own tax liabilities. In this case, the spouse who underpaid taxes would be responsible for settling the tax debt with the IRS.
How to file taxes if divorced mid year?
If you get divorced mid-year, your filing status for that tax year will depend on your marital status as of December 31st. The IRS considers you to be unmarried for the entire year if you are legally divorced or separated under a final decree of divorce or separate maintenance by the last day of the tax year. Here’s how to file your taxes if you’re divorced mid-year:
- Determine your filing status: If you’re legally divorced by December 31st, you cannot file a joint tax return with your ex-spouse. You will need to choose between two filing statuses: “Single” or “Head of Household.” To qualify for the “Head of Household” status, you must meet the following requirements: (a) Be unmarried or considered unmarried on the last day of the year; (b) Have paid more than half the cost of maintaining your home for the year; (c) Have a qualifying person (such as a dependent child) who lived with you in your home for more than half the year, except for temporary absences.
- Report your income and deductions: When filing your tax return, you will need to report your income and deductions for the entire year. If you and your ex-spouse received joint income during the part of the year when you were married, you should divide the income and deductions between both of you according to each person’s share.
- Claiming dependents: If you have children, you and your ex-spouse will need to determine who claims the children as dependents on your tax returns. Generally, the custodial parent (the parent with whom the child lives for the greater part of the year) claims the child as a dependent. However, the noncustodial parent can claim the child if both parents agree and the noncustodial parent attaches Form 8332, “Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent,” signed by the custodial parent, to their tax return.
- Alimony and child support: Alimony payments made under divorce or separation agreements finalized after December 31, 2018, are not deductible by the payer and are not considered taxable income for the recipient. For agreements finalized before January 1, 2019, alimony is generally deductible for the payer and taxable for the recipient. Child support payments are not deductible by the payer and are not considered taxable income for the recipient.
- Division of assets and tax implications: If you and your ex-spouse divided assets during the divorce, you might have tax implications related to capital gains or losses.
Filing taxes after a mid-year divorce can be complex. It’s a good idea to consult with a tax professional or attorney to ensure you’re filing correctly and taking advantage of any tax benefits you’re eligible for.