Originally Published on forbes.com on January 22nd, 2012
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Innocent spouse cases frequently frustrate me. Often it is because the decision goes the wrong way at least by my lights. This particular case, Farzana Zaher, et vir. v. Commissioner, TC Memo 2012-11, went the right way, but my frustration about it is intense. Farzana Zaher is a dentist. Her husband, Mohamed Zaher, was an entrepeneur. Around the time of their marital dissolution in 2006, he owned a gas station, which he sold. He realized a gain of $587,760. After paying off loans, he deposited about $315,000 into their joint savings account. Mr. Zaher told Dr. Zaher that the proceeds would be available to pay the 2006 taxes, although noestimated tax payments were made with respect to the capital gain.
The Return
Petitioner and intervenor began living apart in November 2007. On November 20, 2007, intervenor sent an email to petitioner stating that he had left a copy of the couple’s 2006 joint tax return at her home for her to review and sign. From this email, petitioner learned for the first time that their 2006 tax return had not been filed by the due date and that there was a significant amount of tax due. Intervenor advised petitioner that they needed to sign and file the 2006 tax return and that he had set up an appointment for petitioner to discuss the tax return with their accountant.
In early December 2007, petitioner met with the accountant to review the 2006 tax return, which reported a tax due of $63,379. Petitioner then had her divorce attorney forward an unsigned copy of the 2006 joint return to intervenor’s attorney for intervenor’s signature, because petitioner was afraid intervenor would make unauthorized changes to the 2006 tax returnif she gave him a signed copy.
In a series of emails exchanged from November 2007 to January 2008, petitioner and intervenor discussed the 2006 tax return and how the tax due would be paid. Because petitioner no longer had access to the gas station proceeds, she urged intervenor to pay the tax. Intervenor responded that he did not have the money and suggested that they first file the return, then talk to the Internal Revenue Service (IRS) about a payment plan. Intervenor also said he was seeking another accountant to redo the 2006 return since he felt their accountant “went too much by the book”.
Right before the divorce filing in August 2007, Mr. Zaher had transferred most of the $315,000 to a separate account and from there to various relatives. According to him, the transfers were loan repayments. Dr. Zaher and her attorney maintained he was hiding assets. Given all that, with respect to the return we have to ask the question:
What Was She Thinking ?
Dr. Zaher is a dentist and a mother. It is likely that she was thinking about her patients and her kids. She had never been involved in filing tax returns beyond signing. The question is what were her lawyer and the accountant thinking. Filing a joint return is an ELECTION. It is not something that you have to do. It happens that it is an irrevocable election, which means that once you have done it, you can not undo it. A married couple can file separate returns and amend to a joint return, but not the other way around. A joint return will usually produce a lower tax than two married filing separate returns (Although often not less than two single returns). That would be the thinking behind filing a joint return. So what ? There is a price for the lower tax – joint and several liability. That means the IRS can collect the whole tax from either party. Given that the capital gain was nearly $600,000 and the balance due was just short of $65,000 on the joint return, it would seem likely that a separate return by Dr. Zaher would either be a refund or a small balance due. Mr. Zaher would likely have had a much larger balance due, but again – So what ? He was not able to pay the $65,000. Whatever he negotiated with the IRS would be based on his ability to pay, not the correct amount of his tax. As I have explained elsewhere, if you cannot pay the whole tax it does not matter how much it is.
It Still Worked Out – Kind Of
Dr. Zaher did qualify for innocent spouse status, although it was perilously close. The Court found that she had three factors in her favor and two against. The big one against her was that when she signed the return she should have known that Mr. Zaher would not be paying the tax. Even though she won , it took four years and presumably significant attorney’s fees.
Planning Point
Planning Point
I have found in my years of practice that there is a presumption by many divorce attorneys that the return for the final year of marriage will be joint. There is often a bit of haggling about responsibility for a balance due or how a refund might be divided. In the case of a balance due, though, the divorce agreement is not biding on the IRS. Likewise in the case of an audit, an agreement that one or the other is responsible is not binding on the IRS. I really think the planning presumption should be reversed. At the very least, the idea of filing separately should be on the table as an option.
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