Divorce and Taxes | Filing MFJ or MFS – California Tax Lawyers
When Spouses are going through a divorce, one of the main issues they will have to contend with is whether they should file their taxes as married filing jointly for married filing separately during divorce proceedings.
Since the spouse are technically not single (specific state rules may apply), unless the spouses meet certain qualifications, they must still file their tax return as married.
If they had been filing taxes as married filing jointly, then they need to take a good hard look at their finances to determine whether it is worth it to filing married filing separately or whether they should continue to file MFJ.
Divorce and MFJ
In most cases, by time spouses are ready to divorce the last thing they want to do is file taxes jointly with their soon-to-be ex-spouse. The problem is under the Internal Revenue Code, it will almost always be monetarily beneficial for the spouses to file married filing jointly (MFJ) The way the tax code is set up, there are more tax breaks and tax deductions for married couples when they file MFJ. In fact, the code essentially penalizes a married couple for filing separately.
With that said, if one of the spouses believes that the other spouse may have been acting fraudulently such as having previously filed false return or maintaining undisclosed or unreported income – it may be a good chance for the “innocent” spouse to file separately
Tax Fraud, Married Filing Separately and Innocent Spouse
If one of the spouses only learns of the “guilty” spouse’s fraud at the time of divorce and/or learns of other facts that the non-guilty spouse can use against the guilty spouse, this may be the best time for the non-guilty spouse to file married filing separate and filing a request for innocent spouse.
Taxes are complex and even more so during a divorce. If you are unsure how to proceed you and/or your divorce attorney should consider speaking with an experienced California tax lawyer.
At Golding & Golding, we are experienced in representing spouses both domestically and abroad. The following is a summary of California divorce tax law:
Divorce Tax Law Summary
Tax Law is an integral part of divorce. “Divorce Taxation” or “Divorce Tax Planning” can provide benefits when facilitating a marital settlement agreement.
The failure to implement divorce tax planning techniques and strategies when hashing out a divorce settlement agreement can severely impact the net value of a divorce settlement. It can be a great benefit to a divorcing spouse to retain experienced Divorce Tax Law Representation to best achieve a cost-effective marital settlement agreement (MSA).
How do Tax Attorneys help with Divorce?
Prior to entering into a marital settlement agreement it is important to carefully review, evaluate, and resolve marital tax issues. While code section 1041 provides certain types of relief from taxation for otherwise “taxable events,” a proper tax analysis requires a more complex evaluation.
Tax Issues & Divorce Settlements
Once a divorce proceeding begins and it’s time to start valuing assets – that is when the divorce tax planning should begin. A very intricate web of IRS and California tax issues can arise. With proper tax analysis prior to distribution, an experienced tax attorney can utilize divorce tax planning techniques to assist in evaluating property and assets and working to leverage alimony and other payments in accordance with the allocation of current and future distributions.
Divorce Tax Planning – “The Family Business”
- If the parties are members of a partnership, LLC, or S corporation, what happens to the business? Depending on whether the business is a sole or joint proprietorship, S corporation, Partnership, LLC or other business type, there are specific winding down issues that must be handled through proper divorce tax planning– and it is important to delineate those tasks, as well as ensure that one party is not using tax planning (or lack thereof) to get the upper-hand, resulting in a financial windfall while the other party would be none-the-wiser.
- Moreover, if there is a family business involved, and the business is either going to continue, or wind- down, then it is crucial to determine who gets the credits, deductions, and carry-forwards. This aspects of divorce tax planning includes how the assets are going to be divided, and how will tax credits, rebates, or refunds be resolved (For example, if the business owned by the parties received favorable tax treatment, but due to the divorce the parties are winding down the business early, those tax “benefits” may turns into tax “liabilities.”) All of these issues will impact the value of the estate.
Divorce Tax Planning – “The Family Residence”
- What if one of the parties is going to remain in the family home, but the other party is making the mortgage payments and/or deductions? Specifically, who gets the deductions for mortgage interest, property tax, etc. If the parties want to sell the home, should they postpone the divorce so they can receive all the benefits of a married filing jointly tax status, and limit Long Term Capital Gain — or not.
Divorce Tax Planning – “Post-Divorce IRS Tax Issues”
- What if one spouse has unreported income? Sometimes one – or both – of the parties have unreported foreign income, assets, or accounts which could result in an audit situation. The parties must determine how they want to proceed – in light of the fact that since the parties presumably filed their taxes together for the years they were married, it will require both the parties to consent to certain investigations, disclosures, etc. In this scenario, divorce tax planning can literally save the couple tens if not hundreds of thousands of dollars – or even millions – depending on the amount of foreign assets involved.
- How will Retirement, Stock and Investment Accounts be Distributed? When it comes to the distribution of stocks, securities, retirement accounts, and other investment schemes, the tax result of current or future distributions and/or withholdings can become quite impactful over time. Furthermore, if these monies, assets, or properties are being held in a trust, it is important to ensure these documents are properly updated and the tax planning revised in accordance with divorce tax planning strategies.
Innocent Spouse Defense
Innocent spouse is a term used when the IRS is seeking to enforce tax debt against both spouses, but one of the spouses is innocent.
For example, it could be the situation were prior to the spouses being married one of the spouses of large tax that or other Irish issue that he or she did not disclose to the other spouse.
Alternatively, it could also be that while the parties are married when the spouses committed an act in which the other spouse is being penalized for by the IRS. Generally, the parties determine that they will file married filing separate immediately to avoid the tax liability of the guilty spouse (but this is not always feasible). Under IRS tax if one spouse committed an act, BUT the parties filed together as married filing jointly, then the IRS sees those tax returns as “one tax return” and can therefore can go after both spouses even though only one spouse is guilty of tax crime.
If the IRS accepts the non-guilty spouse’s innocent spouse application, and the IRS will only go after the guilty spouse for the tax liability. If you find yourself in a position where the IRS is coming after you for a tax debt that he did not personally think her may be worth pursuing an innocent spouse application to try to get relief from this tax liability.
International Tax and Divorce
Divorce Tax Planning – International Tax Law
The breakdown of a marriage has a far reaching impact on the spouses’ financial affairs – not the least being the tax ramifications of a divorce. The stakes are even higher when the spouses have foreign property and offshore assets (especially if the spouses have not properly reported and disclosed the foreign accounts and income).
Under new International Tax Law Rules and Regulations, including FATCA (Foreign Account Tax Compliance Act) FBAR Regulations (Report of Foreign Bank and Financial Accounts), 8938 (Statement of Specified Foreign Financial Assets) 3520 (Annual Return To Report Transactions With. Foreign Trusts and Receipt of Certain Foreign Gifts) and 5471 (Information Return of U.S. Persons With Respect. To Certain Foreign Corporations), there are various reporting requirements that must be followed. The failure to follow these reporting requirements can result in penalties that will swallow the entire foreign account balances.
If you, your family, your business, your foreign trust, and/or PFIC (Passive Foreign Investment Company) have more than $10,000 (in annual aggregate total at any time) overseas in foreign accounts and either have ownership or signatory authority over the account, it is important that you have an understanding of what you must do to maintain FBAR (Report of Foreign Bank and Financial Accounts) compliance. There are very strict FBAR filing guidelines and requirements in accordance with general IRS tax law, Department of Treasury (DOT) filing initiatives, and FATCA (Foreign Account Tax Compliance Act).
Filing FBARs and ensuring compliance with IRS International Tax Laws, Rules, and Regulations is extremely important for anyone, or any business that maintains:
- Foreign Bank Accounts
- Foreign Savings Accounts
- Foreign Investment Accounts
- Foreign Securities Accounts
- Foreign Mutual Funds
- Foreign Trusts
- Foreign Retirement Plans
- Foreign Business and/or Corporate Accounts
- Insurance Policies (including some Life Insurance)
- Foreign Accounts held in a CFC (Controlled Foreign Corporation); or
- Foreign Accounts held in a PFIC (Passive Foreign Investment Company)
What are the Penalties for Failing to File an FBAR?
Recently, the Internal Revenue Service issued a memorandum which details how the IRS “believes” the agents should penalize individuals in accordance with their authority. Essentially, there are two sets of penalty structures and they are based on whether the taxpayer was willful or non-willful.
Willful is determined by a “totality of the circumstances” analysis. Somebody is considered to have acted willfully if they intentionally evaded the payment of taxes or disclosure of foreign accounts. In other words, they willfully or knowingly “knew” about the requirement to disclose and report overseas assets, accounts, and income but chose not to. In these situations, the Internal Revenue Service has the authority to penalize the taxpayer upwards of 50% of the value of the assets per audit year for failing to file the FBAR (in addition to a slew of several other non-FBAR penalties), but no more than 100% value of the account over an audit period.
Generally, audits last three years and the Internal Revenue Service has made it known that they will not penalize the individual beyond the value of the accounts for the audit periods at issue. Thus, if you had $1 million in your foreign bank account and you knowingly did not report this information to the IRS and they audit you for three years, they can take all of your $1 million.
When a person is non-willful, it generally means they were unaware of the requirement to file an FBAR. In this situation, the IRS takes some mercy – but nowhere near as much mercy as you can imagine certain people deserve (example: individuals who relocated from overseas and have foreign accounts that they simply did not use or earn much income on, or individuals who inherit money from overseas relatives.)
In these situations, the IRS has four (4) main options in terms of penalizing the taxpayer:
- The IRS agent can simply issue a warning letter instead of a monetary penalty to the taxpayer. This will rarely happen (although Golding and Golding has achieved this result on multiple occasions for individuals who have been audited and did not file FBAR statements and/or otherwise do not qualify for one of the IRS offshore voluntary disclosure programs, but were non-willful).
- The IRS agent could penalize the taxpayer a total of $10,000 for all of the years that the taxpayer did not file FBAR statements. For example, if the taxpayer is audited for three years and did not file FBARs for those three years, the IRS may penalize the taxpayer $10,000 for the total amount of the audit.
- The IRS agent could penalize the taxpayer $10,000 for each year that the FBAR was not filed. So using the example above, if the taxpayer is audited three years and did not file an FBAR for three years, then the IRS could penalize the taxpayer $30,000 – and usually not beyond the value of the account.
- The IRS agent could penalize the taxpayer $10,000 per account per year. In other words, if the taxpayer had four different bank accounts and was audited for three years – the IRS could penalize taxpayer $120,000.
One very important thing to remember is that the penalty scheme listed above is for non-willful taxpayers. In other words, even though the IRS knows the taxpayer did not intentionally attempt to evade tax, the IRS has the power to still issue tens, if not hundreds, of thousands of dollars in penalties in a non-willful situation.
Whether a person is willful or non-willful is a complex evaluation which requires a comprehensive factual analysis by an experienced FBAR lawyer to ensure the taxpayer is informed before making any representation to the IRS.
OVDP (Offshore Voluntary Disclosure Program)
The failure to timely and properly report foreign income and overseas assets and accounts can result instaggeringly high penalties, which the Internal Revenue Service enforces against all taxpayers. If you find yourself in this impossible situation, what are your options?
The most common option for individuals and businesses that have unreported and undisclosed offshore and foreign accounts is to enter the OVDP (Offshore Voluntary Disclosure Program). OVDP is the International Tax Law Program for U.S. Taxpayers (including Legal Permanent Residents and Expats) seeking IRS tax law compliance. The main reason why people enter the OVDP program is because by doing so they can almost always avoid criminal prosecution of their international tax crimes.
Do Both Spouses Need to Apply to Enter OVDP?
No. In order to enter either one of these programs and depending on which program the individual, business, or trust applies for, the IRS requires the parties amend either three years or eight years of prior tax returns. Oftentimes, when the person seeking to apply to either of these IRS programs is an individual who is married and either heading for divorce and/or legal separation – if not divorced and/legally separated already (or in a registered domestic partnership) it is difficult, if not impossible to convince the other spouse or partner to enter the program.
- That is because one of the spouses is scared and/or one a prior spouse wants usually wants little if anything to do with the other spouse – never-mind agreeing to enter into either the OVDP or Streamlined Program together, amend a prior tax returns, and possibly pay a penalty and/or outstanding tax.
What if We Filed Our Tax Return Jointly?
Even though both parties must sign and amended tax return, there are exceptions when one of the parties is seeking to enter into either the IRS Offshore Voluntary Disclosure Program (OVDP) or IRS Streamlined Offshore Disclosure Program. If you are the individual who is seeking to enter the program but cannot obtain the consent and/or cooperation of your ex-spouse, you can go ahead and submit to the program anyway.
- If you submit to the program without having your ex-spouse’s or uncooperative current spouse’s signature on the amended tax return, all you have to do is include the language “refuses to sign” in the signature block reserved for the other spouse.
- Depending on which IRS agent receives the amended tax return will determine whether the IRS will go ahead and contact the other spouse.
The IRS Wants Compliance From ALL U.S. Taxpayers
Stated another way, the IRS will not necessarily contact the other spouse in order to obtain the signature on the amended tax return. And even if they do contact the other spouse and he or she refuses to sign the amended tax return, your application will still be submitted and you should be protected if the IRS then decides to audit the other ex-spouse at a later time involving anything to do with the foreign and offshore accounts and income you identified in your application (as long as you made a full disclosure).
Golding & Golding provides Divorce Tax Planning for:
- Business Valuation Issues
- Company Wind-Downs
- Capital Gain issues
- Real Estate Tax
- Business Tax
- Property Tax
- Gift and Estate Tax
- International Asset Taxes
- Foreign Asset Taxes
- Tax Litigation
- Innocent Spouse
- Injured Spouse
- Deductions and Carry-forwards
- Tax Planning and Structuring
- Retirement Account Taxes
- Investment Taxes