When It Hurts To Be Married – Tax Debt

When it hurts to be married tax debtFor obvious reasons, I’ve changed the names and identifying circumstances. If you know a couple with these names, I promise they are not the people in this story.

Marybeth and Jack met when they were both in college and started living together after they’d been an item for a little over a year. Sharing one apartment cut down on their expenses. This allowed Marybeth to quit her part time job. She used the extra time to start a business installing and maintaining small vegetable gardens for people who wanted ultra-fresh veggies but were too busy to tend a garden. To Marybeth’s surprise, her business took off, and to keep up with customer demand, she had to hire another person. She got so busy and was making so much money, she sees no reason to continue working on a university degree. She did so well, she was  able to pay for the rest of Jack’s education, including law school. No student loans involved. Just cash payments. Life was good.

Fast forward 10 years … It’s now 2016. Jack and Marybeth have an 8-year-old daughter, Claire. Jack has a law degree and a steady job with  a salary of $89,000 and benefits,  but Marybeth’s business is in trouble. In 2012 she started doing commercial landscaping jobs. In 2015 she  got a couple of big contracts that required going into debt to purchase equipment and pay salaries. One of the contracts was with a residential developer I’ll call Procrustean Homes. Procrustean went under and ended up in a Chapter 7 bankruptcy. Marybeth had put a total of $183,000 into the project, expecting to get back $357,000. Instead, she got nothing except the $150,000 line of credit she still had to pay off.

One of the reasons Marybeth felt confident enough to bid the project with Procrustean is that she’d had her best year ever in 2015, making a net profit of $448,935. This was a substantial increase over her prior year income, and the quarterly estimated tax payments she’d made were not nearly enough to cover the tax due when her 2015 tax return was due in 2016. So Marybeth and Jack both signed a joint tax return with a liability to the US Government of $93,441. Which they couldn’t pay. Marybeth reported a net operating loss of $22,359 for 2016. If she had been filing as a single person, she could have carried the loss back to 2015, which would have helped with the debt. But here’s where filing status comes in.

Marybeth and Jack have been presenting themselves to the world as spouses for years, even though they never got a marriage license. They’ve also been filing tax returns as though they’re married. During the time when Marybeth was working and Jack was a student, and even after Jack started working as a lawyer, the couple paid lower taxes if they checked the Married Filing Jointly box on their tax return. They just kept doing the same thing, year after year. They even came to think of themselves as married.

Fast forward again to 2018. Marybeth has scaled back her business and is beginning to recover, but she still has not been able to make a dent in the 2015 tax liability. Jack is now making a salary of $105,000 per year plus benefits, but this has to be used to cover living expenses and taxes on Jack’s salary.  The couple still has to make their $3262 per month payment on their house and pay the $2800 leases on their cars. Claire is in private school. And so forth.

The IRS has already levied on Marybeth’s and Jack’s bank account, but they’ve moved to a new bank and think they can breathe easy for a little while. Then one day Jack gets his pay check, and it’s only a fraction of what it should be. The IRS has levied on his salary. Since he signed that joint tax return back in 2015, he is “jointly and severally liable” for Marybeth’s tax debts. Jointly and severally liable means the IRS can collect up to the whole amount due from either Jack or Marybeth. This doesn’t mean they can collect more than the amount owed. For example, they can’t collect 25% from Marybeth and $100 from Jack. But they sure can collect 100% from Jack, and they will if something is not done to stop the process.

Jack and Marybeth could have greatly reduced their problems by using Single filing status in 2015. Using Married Filing Jointly in the past certainly complicates the situation.

To Be Continued.

What You Lose By Checking Married Filing Separately

95644726 - young family budget cartoon illustrationWhat You Lose When You File Separately

There can be compelling reasons to use the Married Filing Separately tax filing status. This is especially true for non-community-property states, but sometimes it can be a good idea to file separately in community property states too, such as when a couple is in the process of getting a divorce.

Before checking the Married Filing Separately box on your tax return, though, you want to be aware of the tax breaks you stand to lose, which include:

  • The child and dependent care tax credit
  • The adoption credit
  • The Earned Income Credit
  • Tax-free exclusion of U.S. bond interest
  • Tax-free exclusion of Social Security benefits
  • The credit for the elderly and disabled
  • The deduction for college tuition expenses
  • The student loan interest deduction
  • The American Opportunity Credit and Lifetime Learning Credit for higher education expenses
  • The deduction of net capital losses
  • Traditional IRA deductions
  • Roth IRA contributions

When there’s a divorce in progress, I often recommend filing separately even if it means the couple as a whole pays higher taxes. The reason is that even if the divorce decree requires the wife to pay the taxes, this only gives the husband the right to sue her if she doesn’t follow through. The IRS doesn’t give a rat’s ass what the divorce decree says. If you sign a joint return, you have what’s called Joint and Several Liability for the taxes owed.

Joint and several liability means the IRS can collect up to 100% of the tax debt from either party. If the wife agreed to pay the taxes but doesn’t follow through, the IRS can legally collect 100% if the tax due  from the husband.

If you should find yourself in a predicament like the husband in the above example, all is not lost. You may be able to file for Innocent Spouse Relief.