The Federal Government allows married couples to file a joint tax return so long as they are married on December 31st of the tax year. Therefore, whether you are in the process of a divorce proceeding or not, as long as you are married on December 31st, you are allowed to file a joint tax return. Because the tax rates and deductions are more favorable for a married couple filing jointly than they are for a married couple filing separate returns, it is often advantageous from a tax perspective to file a joint tax return while in the midst of a divorce proceeding.
However, once a divorce proceeding has started and unless both the husband and wife are W2 employees (receiving a salary from a third party employer), there are many tax issues that can arise. Often, if one or both of the parties are self-employed or own their own business, the discovery process, which may include forensic accountants, can reveal a significant amount of underreported income, improper or inappropriate deductions taken from income, or unreported income. As a result, the signing of a joint tax return can make the signer of that return liable should any audit or tax deficiencies be uncovered at a later date.
If both spouses sign a joint tax return and it were later determined that significant income was not reported, or inappropriate deductions were taken resulting in unanticipated taxes owed to the government (plus penalties and interest which may be significant), the unknowing spouse would be liable for the tax on the same basis as the other spouse. That is, they are each jointly and severally liable for any tax, interest or penalties.
Although in theory, a defense to this tax liability may be that the unknowing spouse is “an innocent spouse” as defined by the tax code and case authority, in most circumstances the innocent spouse defense does not hold up in a court of law. The reason is that in most
circumstances the “innocent spouse” received the benefits of the unreported income either by having monies spent on the lifestyle, or for the payment of various bills, or deposited into investment accounts.
In most cases, in order to alleviate a known problem with underreporting taxes or in order to relieve a potential problem if it is unknown if the tax return is correct or not, the parties can agree to enter into an indemnity agreement. This indemnity agreement provides that each spouse is responsible only for the portion of the tax return that reports his or her individual income. That is, if one spouse correctly reports his or her income, and the other spouse does not, then if there is any tax liability, the party that incorrectly reported the income would be liable for the entire tax and any penalties and interest that occur as a result.
It is important to note that an indemnity agreement is only a contract between the husband and wife, and as between the parties and the government, it is not binding. Therefore, if the parties entering into an indemnity agreement do not have the financial assets to make this indemnity provision realistic, it is of little value. The indemnity agreement can also provide that should there be any attorney’s fees or costs incurred by either party in defending an IRS claim as a result of any underreporting of income, the party who created the problem will pay those expenses as well.
Notwithstanding the fact that in many cases an indemnity agreement can solve the parties’ concerns, a husband or a wife cannot be forced to file a joint income tax return if they choose not to do so. However, if the failure to file a joint return under reasonable circumstances results in an increase in tax, then that fact and evidence of that fact can be introduced in the divorce trial. The person responsible for the increased tax by refusing to sign a joint tax return under reasonable circumstances (i.e. either with an indemnity agreement or there is no evidence of any underreporting or non-reporting of taxes) can be made to pay the unnecessary tax expense incurred by the other party.
So although a party cannot be forced to sign a joint tax return, it may be wise to do so in many circumstances, so long as the party who is requested to sign the return is fully protected from any undiscovered or later discovered tax consequences.