How Are Tax Liabilities Handled in a Divorce Settlement?

For the unfamiliar, Avvo.com is an online law firm database where users can compare attorneys, research common issues, or ask real lawyers legal questions. One such user, who recently wrote from Los Angeles, CA, wanted answers to a question about the tax effects of divorce-related debt. Specifically, this individual wanted to know whether her husband retained the ability to reduce the payments he owed her, citing unanticipated tax liabilities, after their divorce was finalized. It’s an excellent question – and the answers affect thousands of taxpayers in California and beyond. If you need assistance resolving divorce tax issues, such as a tax liability related to separation, annulment, or divorce proceedings in California, contact the Tax Law Office of David W. Klasing for help.

Can I Become Liable for Taxes Because of My Divorce?

On May 29, 2018, an anonymous user writing from Los Angeles posted the following tax question to Avvo.com:

“[We] came to an agreement and [our] divorce was finalized. [My] husband owes money, but wants to reduce the amount owed. Can he do that? Our divorce was finalized after we came to an agreement to the terms. We own a house, but [my] husband owes me money. Our initial agreement was to sell the house, [and my] husband will give me what’s owed [while] the rest goes to him. Now, he says he says he made a mistake, and didn’t consider the taxes that he has to pay, so [he] wants to reduce the amount owed to me. He is threatening to take me back to court.”

If you’ve found yourself in a similar position – on either side of this type of dispute – pay close attention, because the following information impacts you directly.

Divorce can trigger numerous tax issues, guidelines for which are established through a combination of IRS rules and dissolution agreements. Both parties to a divorce can assume tax liabilities, depending on factors such as:

  • How you and your spouse’s marital debt was allocated to each of you
  • The terms of your marriage dissolution agreement
  • Whether either spouse is paying/receiving spousal support, child support, or alimony
  • Whether the sale of your home resulted in the realization of capital gains

If you owe taxes as a result of your divorce, you should make it a priority to develop a game plan for resolving the unpaid liability as swiftly as possible. Why? Because, in answer to this user’s question, neither you nor your spouse may change the terms of your divorce settlement, nor the terms of court support orders, unless:

  • One of you successfully petitions the family court for a modification of your existing alimony and/or child support order
  • You and your spouse both agree to the updated terms

When resolving divorce-related tax liabilities, the first step is determining your tax status for the pertinent year – in other words, whether the liability arose from a tax return that was filed jointly or separately. Depending on whether you selected “married filing jointly” or “married filing separately,” you’ll (1) be placed in a different tax bracket, and (2) qualify for deductions of different sizes.

It’s also important to determine whether your state follows community property or equitable distribution laws, which impacts division of debts and assets. California belongs to the small handful of states that observe community property laws, which introduces another layer of complexity into tax planning (and payment). For instance, California gives unique tax treatment to separate and community assets. For more information on taxes and community property laws, readers may be interested in our articles addressing the following topics:

Because of these and other factors, the sale of your home has major tax ramifications. In this particular situation, the Avvo user’s spouse did not account for these ramifications, which – as evidenced by his attempts to reduce payments owed – resulted in burdensome financial consequences. These consequences could have been anticipated and mitigated through careful tax planning.

It’s also important to consider the impact not only of the Tax Code, or of California’s property laws, but furthermore, the dissolution settlement agreement itself. In most divorce cases, such agreements will contain detailed provisions regarding the treatment of tax debt and its allocation between parties. However, the Internal Revenue Service (IRS) is under no obligation to honor these provisions – a fact which often startles divorcees.

This becomes especially critical in cases where the tax liability is associated with a jointly filed tax return. In such scenarios, the IRS can (and likely will) pursue the taxpayer aggressively, engaging in a host of tax debt collection actions, regardless of the divorce agreement’s contents. Be advised that, when attempting to collect a delinquent tax debt, the IRS may utilize tax liens, levies, and garnishments to secure the unpaid amount – plus interest.

For these reasons, it is crucial to familiarize yourself with the steps you can take to protect yourself financially should the IRS initiate collection efforts against you. For instance, it may be appropriate to explore innocent spouse relief, depending on the circumstances. For more information, see our articles on:

California Innocent Spouse Relief Attorneys Handling Divorce Tax Issues

Consulting with a tax relief attorney or innocent spouse relief lawyer should be your first step when creating a plan of action to address unpaid tax liabilities resulting from divorce. An attorney can help you understand the potential risks and dangers involved, represent you in IRS negotiations, and keep the process moving efficiently. It is in your best interests to examine your legal options with the guidance of a dually licensed attorney-CPA. For a reduced-rate consultation concerning divorce-related tax issues in Northern or Southern California, contact the Tax Law Office of David W. Klasing online or call us today at (800) 681-1295.

Also, we’ve expanded our offices! In addition to our offices in Irvine and Los Angeles, the Tax Law Offices of David W. Klasing now have offices San BernardinoSanta Barbara, Panorama City, OxnardSan Diego, Bakersfield, San Jose, San FranciscoOakland  and Sacramento.

Helpful Q and A Library:

https://klasing-associates.com/topics/divorce-tax/