Divorce can be a challenging process, but for many, the financial aftermath can be just as difficult—especially when it comes to dealing with the IRS. Divorce settlements often involve splitting assets, debts, and obligations, which can lead to unexpected tax consequences. These issues sometimes escalate into IRS collection actions, leaving one or both spouses financially vulnerable. Understanding how divorce settlements can trigger IRS collection issues is key to avoiding problems and protecting your financial future.
Joint Tax Liabilities
When couples file joint tax returns, both spouses are jointly and severally liable for any tax debts owed, regardless of who earned the income or caused the liability. Divorce doesn’t erase this responsibility. If the IRS determines there’s unpaid tax from a previous joint return, they can pursue either spouse for the full amount—even if the divorce decree specifies that one party is responsible.
This often creates complications when one spouse fails to honor the divorce agreement, leaving the other on the hook. The divorce settlement terms don’t bind the IRS, so they’ll pursue collection from whoever they can, including garnishing wages or levying bank accounts.
Transfer of Assets and Taxable Events
Divorce settlements often divide marital assets, such as homes, retirement accounts, and businesses. While some transfers are tax-free under IRS rules, others can trigger taxable events. For example:
- Retirement Accounts: If a retirement account is split without following proper procedures, such as a Qualified Domestic Relations Order (QDRO), it could result in early withdrawal penalties and taxes.
- Property Transfers: The sale of jointly owned property may lead to capital gains taxes, especially if the home doesn’t qualify for the full primary residence exclusion.
If these taxes go unpaid, the IRS may initiate collection actions against one or both parties.
Alimony vs. Child Support
Alimony payments used to be tax-deductible for the payer and taxable for the recipient. However, for divorce agreements finalized after 2018, this is no longer the case. This shift has confused and, in some cases, errors in reporting alimony, leading to IRS audits or collection issues. While not taxable, child support can also complicate matters if payments are misclassified or missed.
How to Protect Yourself
- Seek Tax Advice During Divorce
Work with a tax professional during the divorce process to understand the tax implications of your settlement. Proper planning can prevent surprise liabilities. - Request Innocent Spouse Relief
If your ex-spouse’s actions caused the tax debt and you were unaware, you may qualify for Innocent Spouse Relief, which can remove your responsibility for certain liabilities. - Ensure Tax Liabilities Are Paid
If your divorce settlement includes provisions for paying back taxes, ensure they are resolved before finalizing the divorce. - Monitor IRS Correspondence
After a divorce, watch any IRS notices regarding prior tax years. Addressing issues early can prevent enforcement actions like liens or levies.
Conclusion
Divorce settlements can create complex financial and tax issues that lead to IRS collection actions. Understanding potential risks, planning ahead, and seeking professional advice can minimize the likelihood of being blindsided by tax liabilities and ensure a smoother financial transition post-divorce.
