Divorce and I.R.S. Trouble for the Innocent Spouse

by Larry Goldsmith, CPA, J.D., M.A.F.F.

As a Financial Forensic CPA traveling down the road of hidden assets and hidden income, I often observe bad behavior meant to intentionally punish a former spouse.  More than once, I have seen fear in the eyes of an innocent spouse who simply signed her name to a joint tax return and is now being relentlessly pursued by the Internal Revenue Service collection division.

We all know how this happens; in preparation for a separation or divorce, some spouses seeking a better settlement will decrease their business profits by diverting income or by claiming improper business expenses. The trouble for the innocent spouse who has agreed to file a joint income tax return before or during the separation is that when the Internal Revenue Service or the State of Illinois discovers the unreported income, the taxing agencies will hold both the innocent and guilty spouse ‘jointly and severably’ liable for the under reported income taxes, tax penalties, and accrued interest. ‘Joint and severably’ liable simply means that the Internal Revenue Service will take the money from either spouse, without concern as to fairness.

Unfortunately, it is often the case that the guilty party who is hiding assets will allow the innocent spouse to be burdened by paying 100% of the tax debt. Last year a woman was referred to me. Her husband of three years was cheating on his income taxes and his business was audited by the IRS. The young woman was told by an IRS collections officer that since she filed a joint tax return she owed $220,000. The IRS garnished her wages, placed a lien on her pre-marital real estate and levied her bank accounts. Her husband told her it was a mistake and “not to worry”.

How can you be protected?

Both the Internal Revenue Service and the State of Illinois recognize that there are innocent spouses who:

  1. Filed a joint income tax return not knowing the guilty spouse failed to report on the income tax returns, gross income, deducted improper deductions, or took improper tax credits.
  2. The innocent spouse, like a reasonable person in a similar circumstance, would have not known of the under reporting. The government will consider the innocent spouse’s education, business experience, the nature of the under reporting and the individual’s financial condition.

The government recognizes that innocent spouses must be protected and has established procedures where an innocent spouse can be freed from financial pitfalls orchestrated by the guilty spouse’s tax trap. In evaluating an innocent spouse claim the government will consider the benefit the innocent spouse received and whether the spouses are separated or divorced. As the Forensic CPA who examines the spouse’s business for possible hidden income or assets, I will recommend at times to the innocent spouse that filing a separate tax return rather than a joint tax return may be financially safer.

An agreement drafted by the attorneys where the guilty spouse agrees to pay all tax liabilities should the Internal Revenue Service determine that there is income tax liability is not considered binding by the IRS and affords the innocent spouse little protection.

My experience is that if an innocent spouse presents a well documented case the government will consider the granting of innocent spouse protection. In the case I used as an example, it took several months but eventually I was able to get the woman’s money returned and her property freed of the liens. Had she listened to her now ex-husband, she would have been penniless, chasing after her ex-husband with no financial resources to pay an attorney.

The lesson is: if you are in a shaky marriage and you believe that your husband or soon to be ex-husband is improperly reporting his taxable income from his business, DO NOT SIGN a joint tax return.

CJBS, LLC is a Chicago based firm that assists its clients with a wide range of accounting and financial issues, protecting and expanding the value of mid-size companies. E-mail me at larry@cjbs.com if you have any questions about this posting or if I may be of assistance in any way.

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