This article was featured on page 14 of The Family Law Review. Read it here.
Tax problems are more common than you may think. Currently, there are about 26 million taxpayers facing a federal or state tax issue. These taxpayers are not criminals; they are regular people with good intentions and a tax issue that is beyond their control. Maybe they are dealing with financial issues or a major change in their family. Perhaps they are going through a divorce and are unsure who is responsible for the family’s financial obligations. The relationship between tax law and family law can be complex, varied, and full of minutia. This article focuses on two primary issues: 1) What should you do if your client has an existing tax issue or liability, and 2) what should you do if your family law client has a tax issue that they are not yet aware of?
Clients With Existing Tax Issues or Liabilities
Let’s begin by establishing that if your client has a tax issue or liability, it is important for them to resolve it. Tax issues can spill over into many different areas of their family law case. It can impact their divorce proceedings and settlement, alimony, child support, and even their passports and ability to travel. Some individuals who owe taxes – whether through their own actions or because of their spouse or former spouse’s actions – may ask if they should pay those liabilities. The answer is yes if they have the available funds to do so. Owing a substantial amount of money is bad enough, but owing additional penalties and interests can make those financial hardships even worse.
So, what can they do? The goal is to help stop the government from penalizing your client while setting them up to resolve their debt. There are a couple of ways to achieve this. First, you want to make sure that your client is still filing their tax returns on time, even if they are not able to pay the tax liabilities in full. Tax penalties become more severe if the taxpayer does not file on time.
One common solution for family law clients with tax issues is for the taxpayer to submit a proposal for an installment agreement with the Internal Revenue Service (“IRS”). This is also known as an IRS payment plan; however, it should be noted that interest and penalties still apply. The IRS has four different types of installment agreements: guaranteed, partial payment, streamlined, and non-streamlined. The taxpayer could also submit an Offer in Compromise. This is an agreement between the taxpayer and the IRS that settles the taxpayer’s liabilities for less than the full amount owed. The IRS may accept an Offer in Compromise if there is any doubt as to the correct amount of the tax liability, if there is doubt the amount owed can be collected in full, or if there are exceptional circumstances that would create an economic hardship for the taxpayer. The IRS also offers taxpayers penalty abatements. For example, the First Time Penalty Abatement program is designed to provide relief for certain taxpayers. The program removes late-payment or late-filing penalties for individuals, businesses, and employers with clean compliance histories. Filing for bankruptcy is another means preventing the government from penalizing debt so that clients can work to resolve their tax issues. If a taxpayer files for bankruptcy, the court will issue an automatic stay, preventing the IRS from taking collection action. With bankruptcy, income tax liabilities can also become dischargeable. Another common solution for resolving a joint tax liability is for a taxpayer to file for Innocent Spouse Relief. This is a provision of U.S. tax law that allows a spouse/taxpayer to seek legal and financial relief from any penalties resulting from an error made by the other spouse on their joint tax return. Most commonly, that error is unreported income or inflated deductions. If the IRS grants Innocent Spouse Relief, the Georgia Department of Revenue will usually follow the IRS’ determination. Finally, a taxpayer could request to be placed into Currently Not Collectible status. If the client can demonstrate financial hardship or economic disadvantage, the IRS might grant Currently Not Collectible status, which temporarily pauses the IRS collection process until the taxpayer’s financial situation improves.
Clients With Tax Issues They Are Not Yet Aware Of
As a family law attorney who is evaluating your client’s case, you might realize that they have a tax issue that they are not aware of. Whether this problem happened because of the client’s actions or due to their spouse or ex-spouse’s actions, it is important to address the issue and resolve it. Again, avoiding the issue will only make it worse. With late filing penalties, the taxpayer is charged 5percent per month, with a maximum of 25percent charged. With late-payment penalties, the individual is charged 0.5percent a month, with a maximum of 25 percent charged.
Filing tax returns is a detailed and complicated process, and as such, it can be easy for an average taxpayer to make a minor mistake. But there is a difference between accidental errors and intentional ones. There are several intentional actions that the IRS considers tax crimes. An intentionally unfiled tax return can be a misdemeanor crime; a person can face criminal charges if their unfiled tax return was due within the last six years. Penalties include up to one year in jail and $25,000 in fines for each unfiled return. Tax fraud, also known as tax evasion, is the willful attempt to evade or defeat the assessment or payment of a federal tax. This includes failing to pay taxes, making fraudulent claims, preparing or filing a false return, or failing to report income. Tax fraud is a felony that carries up to three years in prison and $100,000 in fines. Not every taxpayer is prosecuted for tax crimes, but they can be audited and have additional civil penalties asserted against them if additional tax is owed. If the taxpayer’s understatement is more than 10percent of the tax required to be shown on the return
or more than $5,000, it is considered a “substantial understatement,” which carries a penalty of 20percent of the taxes due. The taxpayer may also be liable for a 20percent penalty if the IRS believes that the tax was understated due to the taxpayer’s negligence or disregard.
How can you help a client who just recently identified a tax issue?
If possible, they should correct the problem before the government discovers it. The client could consider the different Voluntary Disclosure Programs offered by the IRS and the Georgia Department of Revenue, which incentivize taxpayers to proactively disclose their unfiled or underreported tax liabilities. In exchange for disclosing the tax issue, qualified participants will usually receive immunity from criminal prosecution and a time limit on requirements to disclose and pay previous liabilities. For the IRS, if the taxpayer accurately files or amends their last six years of tax returns, they will only receive immunity from criminal prosecution. For Georgia, if the taxpayer files or amends their last three years returns, the state will waive all penalties along with the filing requirement for any prior-year tax return beyond the three-year lookback. This is usually an advantageous deal for the Taxpayer.
For clients involved in family law litigation, avoiding a tax lien should be a top priority. When a person neglects or fails to pay a tax debt, the government protects its interest in the taxpayer’s property (ex: real estate, personal property, other financial assets) by filing a Notice of Federal Tax Lien. This is a public document alerting creditors that the government has a legal right to their property. The lien attaches to all of the taxpayer’s current assets as well as future assets acquired during the duration of the lien – which can include business assets and accounts receivable. A tax lien can derail a family law case and disrupt the process of equitable division. Not only can the government file a tax lien against a taxpayer’s property, but if the situation worsens, the government can also take the person’s finances and possessions.
A potential way to avoid a tax lien is to file an appeal with the IRS explaining how the filing of a lien is not in the government’s best interest – meaning that the government would collect significantly less from the taxpayer if a lien were filed. If the taxpayer cannot pay their liabilities in full, but they owe less than $50,000, they can apply for a Streamlined Installment Agreement. Under this plan, the taxpayer agrees to a 72-month payment plan with automated direct debit payments or payroll deductions. In exchange, the IRS will not file a public notice of a federal tax lien.
If your client already has a tax lien against their property, there are a few ways to potentially resolve this issue. The first is to advise your client to pay the lien in full. If he or she is financially unable to do that, they might consider applying for a lien subordination which enables the taxpayer to refinance their debt with another creditor so they can pay the IRS more money on their tax liability. The client could also apply for a lien discharge to have the lien released from a specific property to enable them to sell that property.
Finally, another way a client can resolve their tax issue is to delay. The IRS has a ten year and thirty-day Statute of Limitation to collect a tax debt after it is assessed against the taxpayer. The delay strategy involves deferring payment of the tax liability as long as possible and then utilizing installment agreements or currently not collectible status until the statute runs out. Once the Statute of Limitations expires, the IRS must stop its collection efforts, and then typically will write off the debt.
Whether your family law client comes to your office with an existing tax issue or you discover a tax problem once litigation begins, it is vital that you help them address and hopefully resolve that issue. Doing so can make a significant difference in both the success of your case as well as your client’s future financial health.