Divorce Causes Tax Audits

Cameron Keng for Forbes writes: Divorce is an experience everyone dreads and hopes to forget.  The worst way to be reminded of something you want to forget is a “tax audit.”  The IRS turns the divorce into a recurring nightmare.  Divorce is a common part of our lives and it’s something that we all need to know more about.  This article came about from a client that recently fell into the unfortunate circumstance, where the IRS came calling to discuss that “divorce.”

Before you assume that this will “never happen to you,” we should probably look at your “chances.”  This situation is unfortunately commonplace.

Breaking Marriage Down By The Numbers:

• More than 50% of all marriages end in divorce. (Based on CDC, 6.8 marriages per 1,000 people in the US are married.  3.6 marriages per 1,000 people divorce. )
• 41% of First Marriages End in Divorce (30 Years-Old)
• 60% of Second Marriages End in Divorce
• 73% of Third Marriages End in Divorce
• The average marriages lasts 8 years.
• There is a divorce every 13 seconds in the United States.

English: Marriage and divorce rates in the US, 1990-2007. Source: Statistical Abstract, 2009. (Photo credit: Wikipedia)

This means that the first time people learn about divorce is when they turn 30 years-old.  This is the first time you’ll hear the words:

• Moneyed Spouse
• Non-Moneyed Spouse
• Equitable Distribution
• Sequester
• Forensic Accountants
• Hidden Assets

The timing of the age is relevant because it’s the period of our lives, where we’ve begun to amass a significant amount of assets or net worth.  Taking a huge “hit” could affect your long-term future by setting your retirement back years.

How Does The IRS Know About Your Divorce?

The IRS has the single greatest databank of personal information ever collected on American citizens.  Its information is so sensitive that it’s legally required to be held in a secure server that is never permitted to be connected to the internet.  Notice of your marriage is required to be disclosed by selecting either (1) Married Filing Joint or (2) Married Filing Separately.  Divorce is required to be disclosed by filing as either (1) Single or (2) Head of Household.

How Does the IRS Know That They Should Audit You From The Divorce?

Divorces can be contentious and painful, where emotions overwhelm reason and cause dire consequences to all those involved.  Hidden assets, undisclosed income and other facts will always become exposed in a divorce proceeding because of the required “forensic audit.”  These facts are collected and reported by forensic accountants to property determine the value of all the income and assets for “equitable distribution.”  But, the Judge is required to review all the facts and circumstances in order to determine the final judgment or distribution.  The problem is that the Judge is also required to report or refer any reasonable inconsistencies to the IRS under their ethical requirements.  Thus, the Judge is legally required to report these facts to the IRS for a tax audit.

The Recurring Nightmare (Statute of Limitations)

After a divorce occurs, the IRS has 3 years to audit your finances during the marriage.  This period can be even longer depending on the scale of the “discrepancy” or the existence of “fraud.”  A discrepancy over 25% will extend the review period or “statute of limitations” to 6 years.  Fraud will cause extend the review period indefinitely, thus the IRS can always audit you for fraud.

Innocent Spouse Relief

When the IRS audits you because of an ex-spouse, an option that might be available to you is the “innocent spouse relief.”  Often, the IRS notice you’re getting is a total shock and has nothing to do with you.  In cases where you’re completely innocent, you may ask the IRS to allocate or assign the fault to the “right” spouse at fault.  The three types are relief possible are (1) innocent spouse relief, (2) separate of liability relief or (3) equitable relief.

• Innocent Spouse Relief provides you relief from additional tax you owe if your spouse or former spouse failed to report income, reported income improperly or claimed improper deductions or credits.
• Separation of Liability Relief provides for the allocation of additional tax owed between you and your former spouse or your current spouse from whom you are separated because an item was not reported properly on a joint return. The tax allocated to you is the amount for which you are responsible.
• Equitable Relief may apply when you do not qualify for innocent spouse relief or separation of liability relief for something not reported properly on a joint return and generally attributable to your spouse. You may also qualify for equitable relief if the correct amount of tax was reported on your joint return but the tax was not paid with the return.

Qualifying for these types of relief are taken into consideration on a case-by-case basis, but the general rules are available to help you navigate through the heady waters.  The IRS gives a great summary and straight-forward explanation in their publications.  Hopefully, you’ll never find yourself in the awkward position of need to apply these rules and regulations.

Conclusion

An ounce of prevention can save a pound of flesh.  While I sincerely hope that none of the readers find themselves in this predicament, it is safe to say that knowing the above can only help.