Income Taxes and Self-Interest in a Marriage

Each spouse in a marriage with significant tax debts has his or her self-interest, which may need a different solution than the other spouse.

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Married couples can and often file bankruptcy together. Doing so when they both owe substantial income taxes may especially makes sense. But each spouse needs to understand his and her own rights and options before deciding whether to file bankruptcy or not, and if so whether to join in the other’s bankruptcy or file his or her own case.

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If a couple owes a lot of income taxes, often it is because of the actions of one of spouses—such as one spouse running a business into which that spouse puts his or her heart and soul but still eventually failed. The spouse who is “at fault” may well be feeling deep frustration and guilt, while the other spouse is experiencing feelings of anger, disappointment, and even betrayal. This extra source of conflict can not only make their situation more emotionally challenging but legally as well.

This blog suggests some principles to consider if you’re in a similar situation.

The Two Spouses Each Have Their Own Self Interest

To state what is probably obvious, just because two people are married does not mean that their financial situations are the same, or that their legal problems and the potential solutions are the same. While some spouses do have close to identical situations—if they are jointly liable on all the same debts and share ownership in all their assets—often that’s not the case. Each person can have his or her own separate debts and to some degree his or her own assets, making their financial situations very different. And beyond those tangible differences, each person can have different goals and different attitudes about how to deal with his or her individual problems and their ones in common.

Because income taxes are such an unusual debt, they can greatly complicate the self-interest of each spouse. Taxes are unusual in how they are incurred. For example, a tax debt can arise primarily out of the actions of one of the spouses, with the other spouse becoming completely liable by simply signing a joint tax return. That spouse might eventually be able to get out of that liability through the “innocent spouse” exception, another complication not available with any other kind of debt. Taxes are also quite unusual in how they are treated in bankruptcy.  There are relatively complicated rules about what taxes will and will not be discharged, and how each portion of each tax account can be handled under Chapter 13.

Each nuance of these rules can create different self-interests for each spouse.

The Two Spouses May Each Need Their Own Bankruptcy

The two spouses’ different self-interests may well lead to different solutions. Sometimes that may mean one person filing bankruptcy and the other not, or one person filing a Chapter 7 case and the other a Chapter 13 one.

The possible circumstances are endless, but let’s illustrate how this can work by using a twist on the scenario used in the last blog. Consider a couple jointly owing $25,000 in income taxes for 2008 because they filed a joint tax return. The debt arose because one spouse operated a business which generated income but the spouse did not pay any quarterly taxes. The following three years the other spouse refused to sign joint tax returns, and instead filed separate returns, had sufficient taxes withheld from wages, and so owes no taxes for those three years. However, the business-operating spouse owes $10,000 for 2009, $6,000 for 2010, and $4,000 for 2011—as the business generated less and less income, totaling an additional $20,000 in taxes for that spouse. Assume the 2008 tax is old enough and meets the other conditions to be discharged in bankruptcy, but the more recent years are not. In this situation the spouse who owes only the joint 2008 tax may well be best served by filing a Chapter 7 “straight bankruptcy” case to discharge that (and any other joint or separate non-tax debts). Whereas the other spouse, who is liable on all the other taxes as well, may well be best served by filing a Chapter 13 “adjustment of debts” to discharge his or her share of the liability on the 2008 tax, and be protected from the IRS while paying off the 2009 through 2011 taxes.

In this situation the spouse owing only the 2008 tax discharges his or her debts in a matter of a few months with a Chapter 7 case. Whereas the other spouse in the Chapter 13 case gets the many benefits of Chapter 13 law in dealing with all of his or her tax debts.

The Two Spouses Could Need Separate Attorneys

Without getting deeply into delicate attorneys’ ethical rules about conflict of interest, attorneys need to be careful about simultaneously representing any two people who have different interests. This is true regardless if these two people are married and have some common interests. In the end the two may end up filing a joint bankruptcy because it is in their individual and mutual best interest to do so. But before getting there each person must be made fully aware of his or her individual rights and legal options, whether this happens through two separate attorneys or through a single one. One or both spouses may decide to sacrifice some of their individual interests for their common good, but can only do so when their rights and options have been clearly laid out for each of them.  

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