Writing the Tax Debt Into the Divorce: What Your Settlement Should Say About the IRS

Your divorce settlement will not bind the IRS. I say that up front because people keep hoping it will. But a well-drafted settlement can still do a lot of work for you in a later innocent spouse case, and a badly drafted one can quietly hurt you. If you are in the middle of a divorce and there are joint tax years in the picture, this is the time to get it right.

I am a tax attorney, not your family law attorney, and the state law parts of your settlement are your family lawyer's territory. What follows is the federal tax side: what the IRS will look at later, and how the agreement can help.

Start with an inventory

You cannot allocate a debt you do not know about. Before anyone drafts tax language, find out:

• Every year you filed jointly.
• What the IRS shows as owed for each of those years, including penalties and interest.
• Whether any year is under audit or has an open notice.
• Whether any refunds are pending or were offset.
• Whether either of you has unfiled returns for any year of the marriage.

Your IRS account transcripts will answer most of these questions. Get them for both spouses if you can.

Known liabilities: be specific

If there is a balance due on a joint year, the settlement should say exactly who pays it. Name the year. Name the tax. Say whether the allocation covers interest and penalties.

Here is why the precision matters. Revenue Procedure 2013-34, section 4.03(2)(d), makes legal obligation a factor in equitable relief. A legal obligation means one arising from a divorce decree or other legally binding agreement. If your former spouse has the sole legal obligation to pay the outstanding income tax, the factor weighs in favor of relief. If the decree is silent, the factor is neutral. If the decree puts the sole obligation on you, the factor weighs against relief.

A vague clause that "each party is responsible for their own debts" does not clearly assign a joint tax debt. A specific clause does.

The knowledge trap

There is a catch in the same factor. Revenue Procedure 2013-34 says the factor is neutral, not favorable, if you knew or had reason to know, when entering into the decree or agreement, that your former spouse would not pay the income tax liability.

So if your former spouse has a long history of not paying the IRS, an agreement that assigns the debt to that person may not help you as much as you hope. That does not mean you should not negotiate the allocation. It means you should think about how payment will actually happen: paying the IRS out of the property division at closing, for example, rather than relying on a promise.

Unknown liabilities: plan for audits

The IRS generally has three years from the date a return was filed to assess additional tax. The Form 8857 instructions describe the period of limitations on assessment as generally 3 years from the date you filed the return. Longer periods can apply in some cases. That means joint years from the last part of your marriage can still be audited after the divorce is final.

A settlement can address that risk by allocating responsibility for any future deficiency on joint returns, often based on whose income, business or deductions generated the adjustment. That approach lines up with how separation of liability under section 6015(c) allocates items: to the spouse who earned the income or owned the business or investment, under Treasury Regulation 1.6015-3(d)(2).

It also helps to include cooperation terms: an obligation to share IRS correspondence about joint years and to provide records needed to respond to an audit.

Property transfers and the disqualified asset rule

Separation of liability has a provision aimed at spouses who shift assets to avoid tax. Under section 6015(c)(4), the requesting spouse's share of a deficiency increases by the value of disqualified assets transferred from the other spouse, and transfers made after a date one year before the first letter of proposed deficiency are presumed to be for tax avoidance.

But the statute exempts transfers made under a decree of divorce or separate maintenance or a written instrument incident to such a decree from that presumption. Treasury Regulation 1.6015-3(c)(3)(iii) and its examples show the effect: property received under the decree is not presumed to be a disqualified asset. Make sure significant property transfers between you are made pursuant to the decree or a written instrument incident to it.

Refunds and estimated payments

Pending refunds on joint returns should be allocated in the agreement. So should joint estimated tax payments for the current year. Publication 504 says that if you made joint estimated tax payments but file separate returns, either of you can claim all of the payments, or you can divide them in any way you both agree on. If you cannot agree, the publication provides a formula based on the tax shown on each separate return. Writing the split into the settlement avoids that fight.

The current year's filing status

Your marital status for the year is generally determined at year-end. Publication 504 says you are married for the whole year if you are separated but have not obtained a final decree of divorce or separate maintenance by the last day of the tax year. If the divorce will not be final by December 31, you will need to decide how to file for that year.

Filing jointly one last time can lower the total tax, but it creates one more year of joint and several liability under section 6013(d)(3). Filing separately keeps your liability to your own return. And section 6013(b) allows changing from separate returns to a joint return later, within three years of the due date, but Treasury Regulation 1.6013-1(a)(1) does not allow switching from joint to separate after the due date. The guides to filing separately after separation and switching filing status cover those choices.

If you agree in the settlement to file jointly for the final year, consider addressing who pays any balance due and how the return will be reviewed before signing.

A short checklist for your family law attorney

Bring this list to the meeting where the settlement is drafted:

1. Transcripts for every joint year, showing balances and any open audits.
2. A specific allocation of each known joint tax balance, including interest and penalties.
3. A rule for any future deficiency on a joint year, tied to whose items generated it.
4. A plan for actually paying known balances, ideally from identified funds.
5. Allocation of pending refunds and joint estimated tax payments.
6. The filing status decision for the current year, and who reviews and pays if it is joint.
7. Cooperation terms for IRS correspondence and records.
8. Property transfers made under the decree or a written instrument incident to it.

What not to do

• Do not sign an offer in compromise or closing agreement on a joint year without evaluating innocent spouse relief first. Treasury Regulation 1.6015-1(c) bars relief for years covered by those agreements. See the guide to bars to relief.
• Do not assume the decree solves the IRS problem. It does not. See why a divorce decree does not bind the IRS.
• Do not ignore the two-year clock. If the IRS has already sent you a levy notice or offset your refund, your window for innocent spouse relief and separation of liability may be running during the divorce.

The bottom line

The settlement cannot make the IRS forget a joint return. What it can do is document ownership, assign the debt clearly, route property transfers through the decree, and plan for payment. Those are the facts a later innocent spouse claim is built on.