Generally if couples reside in a community property state, there is a presumption that all assets acquired during the marriage are community property assets. However community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) have created laws that allow couples to enter into prenuptial or postnuptial agreements to overcome the presumption of community property. Each state has their own legal requirements to determine the validity of any prenuptial or postnuptial agreement between spouses.
The prenuptial and postnuptial agreements can protect taxpayers to some extent, but if separate property funds are used to gift property during marriage, are commingled, or if federal law differs from state law, separate assets can be converted into community property assets. Taxpayers should seek the advice of a professional to make sure that they are informed about the tax ramifications of any transfer of assets.
Taxpayers that are married and do not want to share in the responsibility of their spouse’s tax debt have the option of filing married filing separate tax returns. However, in community property states (specifically California), each taxpayer must report one-half of the community income. If one person earns wages of $100k and the other earns wages of $50k, each person must report $75k in wages on their married separate tax return. If a tax return is later audited by the IRS or the state, only one person is liable for any additional tax assessment, not both.
If a tax lien is filed against a liable spouse, it attaches to all of the liable spouse’s separate property. If the tax lien is filed in a community property state, like California, the tax lien attaches to the liable spouse’s one-half interest of community property assets. If the tax authority wants to foreclose on the real property, they can, but they will have to compensate the non-liable spouse’s interest in the real property.
In community property states, the IRS can levy a non-liable spouse’s income to pay for the spouse’s outstanding debt. However, even though one spouse is liable for the tax, the IRS and other taxing authorities may still collect the tax due from the non-liable spouse. In community property states the income earned during the marriage is considered community property. Therefore, the IRS may levy a non-liable spouse’s wages to pay for the taxpayer’s debt. Many times the IRS will do this to get the attention of the taxpayer. This enforced collection action is a strong motivator for the taxpayer to seek resolution of his or her tax matters.
Generally, if the IRS issues a wage garnishment against a taxpayer, the garnishment is continuous (deduction every pay period). The IRS can levy everything except the required exemption amount based on the filing status, how often the taxpayer is paid, and the number of exemption claimed on the Form W-4. However, if the IRS chooses to levy a non-liable spouse, the levy is a one-time levy. The IRS will have to issue a new levy every time the IRS wants to levy the non-liable spouse’s wages.
If a taxpayer is married to a person who has a pre-marital tax debt and the taxpayer files a married joint tax return that is due a refund, the IRS will automatically apply the total refund to the spouse’s outstanding tax debt. In this case, the non-liable spouse can file a Form 8379 Injured Spouse Allocation which will allocate the income, deductions, and exemptions between the liable and non-liable spouse to determine the non-liable portion of the tax refund. Based on the information provided, the non-liable spouse will receive their portion of the refund from the IRS. However, keep in mind that special rules apply to taxpayers who reside in community property states.
If a taxpayer files a married joint return, both taxpayers are jointly and severely liable for the tax liability. To overcome the presumption that both taxpayers are responsible for the tax debt, the person who should not be held liable for the understatement of tax may file a Form 8857, Request for Innocent Spouse Relief. Note that if there is not an understatement of tax, the taxpayer does not qualify for Innocent Spouse relief. Underpayment does not qualify as an understatement of tax. This means that one spouse did not know at the time he/she signed the return, that the information on the return was not reported correctly or accurately (i.e. all of the income was not reported and/or some or all of the deductions or business expenses were overstated).
It is the IRS’s position, that if both parties sign a joint tax return, both parties should be held responsible for the information that was reported on the tax returns. Therefore, it is difficult to prove that one party did not know when he/she signed the return that they did not know taxes were due, or that income may have been understated and/or expenses overstated. A taxpayer, may dispute the IRS’s position, if he or she can prove that the return was signed under duress. However, the taxpayer will have to provide documentation such as medical records, police reports, third party testimony, etc. as proof of domestic violence.
The IRS will also inquire on the taxpayer’s involvement in the household finances. Who paid the household bills? Did the couple have a joint bank account? Did the couple have separate bank accounts?
If there is a tax liability prior to death that has not been paid, the IRS can and will collect from the assets that the liable spouse had prior to death. Death of a spouse terminates the community, so there are no new community assets. However, the assets of the former community and separate assets can be collected upon to pay the tax debt of the deceased liable spouse.