If you are an innocent spouse and marry a tax cheat, it can result in divorce or worse…..jail. What can you do? How do you protect yourself from a financially irresponsible spouse? Let me share a real life story: Roberta and Tim have been married for over 25 years. Tim is self-employed and Roberta stays at home.
They travel all over the world, live in a multi-million dollar home…and declare less than $50,000 in income on their business tax return each year. Tim’s business is a sole proprietorship, so that’s all the income they declare. While I’m no forensic accountant, it’s painfully clear that Tim isn’t declaring all of his income. And that’s not how to take advantage of legitimate tax deductions.
The IRS caught up with Tim recently. They audited his returns for the past five years and handed him a huge tax penalty. Tim was lucky – he could have gone to jail. What Roberta doesn’t know is that she’s lucky too. She was on the hook just as much as Tim since she signed the tax return.
Note – One of the most important ways to protect yourself is to maintain tax records yourself – and make sure you hold on to those records even longer than the IRS suggests.
Why is this important to you?
If you file a joint tax return, you do benefit by paying lower taxes, and that’s great. But sometimes one spouse goes too far in trying to reduce the tax liability. When they break the law, you’ve got a problem.
Why?
If you file a joint return and the information is false or wrong, the IRS can go after either of you because you both signed the return. It’s just like co-signing a loan.
Big Brother can put you both (or individually) in legal hot water. And subsequent divorce won’t help you. Even if your divorce decree says that one party has to pay the tax, the IRS doesn’t care. They can still come after you both.
So even if you are an innocent spouse, it’s really important for you to carefully review the tax return before you sign it. After all, you are liable for what you sign.
The typical situation:
Usually, one spouse knows more about the couple’s finances and files the tax return. Often, the other spouse simply signs the return without really understanding what’s in it.
So what can an innocent spouse do to protect themselves from becoming a target for the IRS?
1. Be aware.
Think about your lifestyle. What does it cost you to live? Where is the money coming from? Check your credit. (You can now get a free credit score without a credit card service charge.) Is it being reported? If you sign a fraudulent return, you are going to be held responsible. Roberta was living the life of Mrs. Don Corleone. How can she claim to have the income of Mrs. Homer Simpson? Don’t play that game…the IRS may not be so forgiving with you as they were with Tim and Roberta.
2. Ask questions.
If you see something on the return you don’t understand, ask. If something stinks, don’t let it pass. There is nothing so complicated that it can’t be made clear. Don’t stop asking questions until you understand what’s going on. If you have to, get your own CPA and get her opinion on the matters you question. Remember, this is your future we’re talking about.
3. Get to Kinko’s.
Get copies of your last three years’ tax returns. Don’t count on your spouse to keep copies for you. Also, keep statements of investment and savings accounts for your own records.
4. Protect yourself.
If you think your spouse is trying to pull a fast one, you’re going to have to protect yourself. Seek legal and tax advice from the pros. If your spouse is underreporting income or committing other tax fraud, start filing separate returns and set up separate banking and credit card accounts too.
Do you keep your own copies of your tax return? Do you understand everything in the return? Has this ever been a problem for you or someone you know? Would it freak your spouse out if you went through the return and asked questions?
edward korzinski says
i want to report my wife which is an E.A. accountant for hiding income from the IRS. she is giving part of her income away so does have to disclose it at the end of the year. so how do i go about this matter? thank you very much for your time an information you provide me with.
Neal Frankle, CFP ® says
I would start with my own CPA and/or attorney. What options have you already pursued. If she is breaking the law you have to approach the IRS but I would do so only with proper legal council.
Kacey says
In a divorce case where the spouse is self employed but you have to sign a joint tax return and have no way of knowing if they are hiding income is a letter from the spouse saying you are not responsible for false claims enough to protect you in case of an audit. Also if your ex is being audited and four 3 years you have not jointly filed, and hey find he has lied on his taxes will they then audit you as well for previous joint filing?
Neal Frankle says
I am not an expert in this field but I would say:
a. the letter from your spouse will not protect you.
b. you would probably be audited if your ex is audited but you could still claim to be an innocent spouse.
Wishing you the best.
Neal
lee says
My husband was issued a W-2 for the first 3 months of 2011, but worked construction without paying taxes for the remainder of the year. Unable to persuade him to file taxes on himself, I sought relationship counseling. I have accepted the fact that I cannot control his actions. I pay all of our living costs through my bank account. I am the sole owner of our house and my business. We do not comingle assets and even though I struggle, I do not ask him for money to help support our family. I have removed his name from my accounts and will be filing separate. What other steps should I take to insulate my assets from his tax evasion? Should I ask him to use a separate accountant to file his W-2?
Neal Frankle says
Other than the steps outlined above, I’d talk to a tax attorney and/or your tax advisor.
Betty says
I married a tax cheat! What do I do?
My husband is self employed and has not paid taxes since 2001. I was not aware of this when we married. He appeared to be a very together, successful business owner. I think I found out about a year and a half into the marriage. We have almost been married 3 years, married ironically on April 15, 2007. Since the day I found out I have asked him to take care of it, do the right thing, etc. I have lost countless nights of sleep worrying about this.
He has had the taxes prepared for all those years. That is a good first step. HOWEVER he owes thousands and I do not see anyway for him to pay them off any time soon and I can’t even trust he will, base on his history. He wants me to file jointly for the years we have been married because it would save him about $20,000 (not included penalties and interest). That is how those returns were prepared.
I am going to REFUSE to file a joint return! I am also seriously considering a divorce or a legal separation ASAP. I do not want to leave him because I love him and value the companionship. I just want to distance myself financially and legally and hope that he does take care of this the way he is promising. In the mean time I just don’t think I can take any chances.
We are certainly not living a glamorous lifestyle as the couple above did. We do not own a home, take fancy vacations or own expensive cars. I have separated my finances from him and struggle a bit to make ends meet for my 3 children and myself with my $40,000 a year income.
I want to be able to protect myself and my children’s future. What do I do in this situation? Divorce? Legal separation? Separate finances? NOT filing a joint return? Anything else?
I really want to be smart about this and do the right thing!
Neal@Wealth Pilgrim says
Len….excellent point. Well worth the focus. Thanks.
Len Penzo says
Although it was kind of implied in the other steps, Neal, I think this step needs to be explicitly called out:
If you aren’t satisfied the return is accurate: DON’T SIGN THE RETURN! It is your responsibility to ensure the return your spouse submits to the IRS is accurate.
Neal@Wealth Pilgrim says
I think your comment absolutely fits the context and I agree that the marriage issue is core. I’m glad you brought it up Erik.
Erik says
I was taking issue with the only advice being “seek legal and tax advice”. To me, that’s only the symptom, not the root of the problem. Yes, these would be important steps, but the core issue here is a marriage that needs serious help…something most lawyers and CPAs can’t do much with. But as this is a post on wealth matters, perhaps that doesn’t fit the context.
Neal@Wealth Pilgrim says
Erik,
Thanks again. I completely agree that separating the accounts isn’t anywhere near sufficient. That’s why I suggested the spouse seek professional guidance immediately.
Erik says
How about some serious marriage counseling? Both parties are at fault here: Tim is a liar playing an illegal game that seriously jeopardizes his and his family’s. Roberta is at best naïve, and at worst is an accomplice.
It strikes me as odd to suggest “protecting yourself” by getting separate accounts and credit cards. Then what? Let the cheating spouse continue cheating? That’s like suggesting a wife letting her husband continue fooling around with a mistress but insist that she wear a female condom to protect herself from STDs. C’mon.
When you get married (even with a JP in the courthouse) there should be a team formed, that is, two parties working together in a trusting relationship. Splitting finances or donating money to charity just covers up the symptom, it doesn’t address the problem. I hate paying too much in taxes just like most Americans; however, there are legal remedies. Take deductions where they are allowed, invest in tax exempt municipal bonds, stash money in ROTH IRA to reduce retirement income tax. And for goodness sake, sit down with your spouse each month and go over the budget. That keeps both parties honest, informed and working together, the hallmark of all successful marriages.
LeanLifeCoach says
In this situation you could also explore the possibility of getting relived of the responsibility via the Innocent Spouse Relief process.. http://www.irs.gov/pub/irs-pdf/p971.pdf
Neal@Wealth Pilgrim says
Absolutely correct. There are actually a few things you could do. I was considering doing an entire post on the options….
Financial Samurai says
Best method is exactly to tell the spouse to stop cheating on his taxes, b/c it will affect them both. Then again, the gov’t taxes us way too much anyway, so maybe Tim is OK.
Just tell Tim to use the money saved in his cheating and donate it to charity. Win win!
Neal@Wealth Pilgrim says
Novel approach Sam…..nice