If the IRS determines that as between spouses only one is liable for a tax debt, should that finding be binding on a divorce court determination as to whether the marital tax debt should be allocated to only one spouse?
Married couples who choose to file a joint tax return are jointly and severally liable for the tax and any additions to tax, interest, or penalties that arise from the joint return, even if they later divorce. Joint and several liability means that each taxpayer is legally responsible for the entire liability. Thus, both spouses on a married filing jointly return are generally held responsible for all the tax due even if one spouse earned all the income or claimed improper deductions or credits. This is also true even if a divorce decree states that a former spouse will be responsible for any amounts due on previously filed joint returns.
In some cases, however, a spouse can get relief from being jointly and severally liable. Such “Innocent Spouse Relief” relieves a spouse from additional tax owed if based upon the other spouse’s failure to report income, improper reporting of income, or the claiming of improper deductions or credits.
In order to qualify for Innocent Spouse Relief:
- The understatement of tax (deficiency) must be solely attributable to the other spouse’s erroneous item (omitted income, or incorrectly reported deductions, credits, or property basis);
- The innocent spouse must establish that at the time the joint return was signed the spouse didn’t know, and had no reason to know, that there was an understatement of tax; and
- taking into account all the facts and circumstances, it would be unfair to hold the innocent spouse liable for the understatement of tax.
Justice Catherine M. DiDomenico, in her August 29, 2017 Richmond County (Staten Island) Supreme Court opinion in S.M. v. M.R. (the subject of last week’s blog post on the effect of an attorney retainer agreement cap), appeared to hold that a Tax Court innocent spouse finding should, conclusively, result in the equitable distribution of the entire tax debt to the other spouse.
During the divorce trial before Justice DiDomenico, the wife established that in or around 2014 she received documentation from the IRS indicating that she and her husband jointly and severally owed a federal tax debt, with penalties, representing underpayments in tax years 2008 and 2009.
The wife filed for and was granted innocent spouse relief under Internal Revenue Code §6015(c). At the subsequent divorce trial, the wife sought a ruling from Justice DiDomenico that the tax debt be deemed 100% attributable to the husband for purposes of equitable distribution.
The husband had testified that in 2008 or 2009 he was contacted by the IRS due to a tax debt. The husband claimed that this tax debt occurred because he had hired a new accountant who made an error on his tax return. As of the time of the husband’s direct testimony, the IRS audit was still ongoing. The husband testified that he owed approximately $62,000 for tax year 2008 and $49,000 for tax year 2009.
Justice DiDominco noted that as with assets, the debts incurred during a marriage are subject to the principles of equitable distribution. Tax liabilities, generally, fall under the category of debts that should be distributed.
However, the Court noted that when a prior court has determined that a party is entitled to “innocent spouse” protection, the Matrimonial Court has discretion to determine that the protection afforded by the prior Court should be extended to the principles of equitable distribution. See Cooper v. Cooper, 84 AD3d 854, 923 N.Y.S.2d 596 (2d Dept. 2011).
Here, by order of the United States Tax Court, the wife had been adjudicated to be an innocent spouse under I.R.C. §6015(c). She was found not to be liable for tax debts and penalties for tax years 2008 and 2009.
The wife had testified at the divorce trial that the tax debt that was somehow related to 12 money transfers to Egypt that were made at that time by the husband to himself and his brother totaling over $500,000.
Justice DiDomenico found that the husband had credibly testified that in 2006 he had taken out a home equity line of credit. In 2008, he utilized the line of credit to withdraw $305,000 for the purpose of transferring the same to Egypt for a business venture. The husband further credibly testified that this business venture was a private medical clinic from which the wife (licensed as a medical doctor only in Egypt) could run a practice. The clinic would also employ other doctors as an additional source of income to the parties. The husband claimed that the wife was aware of the plan, and that she agreed with it, as she no longer wished to reside in the United States due to her difficulty in becoming licensed to practice medicine here. The husband detailed at least one occasion when the wife visited the clinic’s proposed location and she indicated that it was a good size. The Court did not credit the wife’s claim that she knew nothing about the husband’s plan to open a clinic.
After reviewing the IRS documentation, the wife had speculated that the husband must have transferred between $800,000 and $1,000,000 to Egypt. However, at the divorce trial, the wife did not specify how she came to this calculation, nor did she provide any documentation regarding the same. The only information provided by the wife regarding the IRS debt was the order from the United States Tax Court absolving her from liability. There was no indication in that document as to why the parties had a tax deficiency.
Moreover, Justice DiDomenico rejected the wife’s general claim that the husband’s money transfers amounted to “marital waste.” Even if the Court were to go back in time and second-guess the parties’ financial decisions, the Court did not credit the wife’s account that she knew nothing about the husband’s plan to open a clinic. While she may not have known the financial details, or may not have anticipated that the venture would fail, the Court credited the husband’s account that the wife was aware of the business venture, and that it would have allowed her to practice medicine in Egypt.
Nevertheless, Justice DiDomenico assigned sole responsibility for the 2008 and 2009 tax debts to the husband.
Accordingly, after consideration of the factors above, including the fact that wife was granted innocent spouse protection by the Federal Tax Court, 100% of any tax liability from calendar years 2008 and 2009 were distributed 100% to the husband.
Other than the discussion concerning the home equity withdrawal, the wire transfers, and the Egyptian clinic, there is no discussion of the husband’s income in 2008 and 2009. There is no suggestion that the tax deficiency involved any moral impropriety. There is no suggestion that only the husband had benefitted from the failure to timely pay proper taxes for 2008 and 2009. The IRS debt would appear to be no different than any other marital debt of the parties.
Comment: What specific factors, other than the Innocent Spouse determination, itself, caused Justice DiDomenico to assign the husband sole responsibility for the tax debt is not clear. However, use of the Tax Court order beyond the its necessary findings is concerning. The Tax Court order determined only that:
- the increase in tax was only attributable to the income or deductions of the husband;
- the wife had no reason to know that there was an understatement of tax; and
- taking into account all the facts and circumstances, it would be unfair to hold the wife liable to the IRS for the understatement of tax.
None of those findings demonstrated that the debt was not marital in nature, or that the wife did not indirectly benefit because marital income or assets were not then spent to pay the additional tax then due.
Justice DiDomenico did note the opinion of the Appellate Division, Second Department, in Cooper v. Cooper, 84 A.D.3d 854, 857, 923 N.Y.S.2d 596, 599 (2nd Dept. 2011), that upheld assigning a wife 50% responsibility for a federal income tax debt (but not interest and penalties), but no liability for the corresponding New York State tax liability because the wife “was officially adjudicated an innocent spouse” in a state court decision.
However, absolute reliance upon an innocent spouse determination should not conclude the equitable distribution issue, either on the basis of collateral estoppel principles or traditional E.D. factors.
As stated in Capasso v. Capasso, 129 A.D.2d 267, 293, 517 N.Y.S.2d 952, 968-69 (1st Dept. 1987):
Viewing marriage as an economic partnership, we are in agreement with the proposition that spouses should share losses as well as profits, liabilities as well as assets incurred in the pursuit of marital wealth. Upon settling the accounts of the spouses, it should make no difference that wealth was acquired through unlawful means where, as here, the innocent spouse benefits therefrom.
For a variety of sentiments, see, Bauman v. Bauman, 132 A.D.3d 791, 794, 19 N.Y.S.3d 58, 62 (2nd Dept. 2015); Lago v. Adrion, 93 A.D.3d 697, 700, 940 N.Y.S.2d 287, 290-91 (2nd Dept. 2012); Moyal v. Moyal, 85 A.D.3d 614, 615, 927 N.Y.S.2d 19, 22 (1st Dept. 2011); Frey v. Frey, 68 A.D.3d 1052, 1053, 892 N.Y.S.2d 159, 160-61 (2nd Dept. 2009); Costello v. Costello, 304 A.D.2d 517, 519, 757 N.Y.S.2d 588, 590 (2nd Dept. 2003); Fiedler v. Fiedler, 230 A.D.2d 822, 823, 646 N.Y.S.2d 839, 841 (2nd Dept. 1996)