There are some people who should just not be filing joint returns. That is the lesson in a recent Tax Court Memorandum decision – TCM 2017-144. As is my new practice I will refer to the couple involved as Robin and Terry. Going to Tax Court makes their identities public, but I figure they would just as soon I did not spread their fame further. Robin is a physician specializing in family medicine and Terry is a lawyer practicing in both probate law and bankruptcy.
It seems that Terry might have a certain affinity for one part of his client base. According to the decision he has a “long history of failing to pay his debts when due”. Robin became aware of this when, as is the common practice nowadays, they purchased a home before marrying in 2004. She did not know the specifics of Terry’s financial past, but she was aware that he had a low credit score and outstanding student loans. As a result, Robin and Terry have separate credit cards and the mortgage on the house is exclusively in Robin’s name.
Filing Jointly
When it came to filing tax returns from 2004 to 2012, the way it worked was that Terry (i.e. the lawyer) gathered all the documents together and gave them to an accountant who prepared the return. When the return came back Terry asked Robin to sign it, which she did. Robin was an employee with withholding and Terry was self-employed. She thought that Terry was sending in the balance due. He was not.
In 2011 Robin learned about some of the balances due when her husband asked her to make a payment of $53,502 for 2007 and 2008. She thought that was it.
She learned the details of the remaining liabilities in May 2014. She consulted with an accountant and has been filing separately beginning with the 2013 return. She and Terry are still married with four children.
The Decision
Robin was in Tax Court, pro se, on an innocent spouse claim for $55,859 for 2009 and 2012. She had no luck. She was not entitled to “streamlined relief” because she and Terry were still married. That led to a “fact-specific inquiry” on whether it “is inequitable to hold an individual liable for all or part of any unpaid tax or deficiency arising from a joint return”. There is a seven-factor test.
“The factors “are the requesting spouse’s (1) marital status; (2) economic hardship if relief is not granted; (3) knowledge or reason to know that the tax liability would not be paid; (4) legal obligation to pay the outstanding income tax liability; (5) receipt of a significant benefit from the unpaid income tax liability; (6) compliance with income tax laws; and (7) mental and physical health”
Although Judge Buch found that most of the factors were neutral or slightly favored relief, the overwhelming factor was the third “knowledge or reason to know that the tax liability would not be paid”
“Dr. _____ had reason to know that her husband was not paying the amount of tax owed each year and had actual knowledge of outstanding tax liabilities. The fact that she did not know the details of those outstanding liabilities is unfortunate, but for the purpose of this inquiry, it is immaterial. Dr. ____ had reason to know the full extent of the liabilities; the fact that she lacked actual knowledge does not release her from the tax liabilities.” (Name was included in the original)
What Was The Husband Thinking?
The part of this story that I think is of most interest is not Robin’s misfortune, but trying to figure out what Terry was thinking. Terry is a bankruptcy attorney. He should have known better. By having Robin file jointly with him, he was putting more of the family’s income in the hands of the IRS. Reilly’s Tenth Law of Tax Planning – Once the tax is more than you can pay it might not matter how much more.
We don’t know whether Terry’s accountant knew whether or not he was paying the balance due on the return. If he or she did, then there was a failure to recognize that Robin was also a client, whose interest was not in alignment with Terry’s. This is a pretty common failure of tax preparers who focus on minimizing the tax without considering collection issues. Even though it is usually not the right answer, filing separately should always be an option.
It is important to note that Robin and Terry did not live in a community property state, which would introduce another set of complications. Don’t get me started.