What if your spouse ran a Ponzi scheme, reaping millions or billions, and you didn’t know it?
What if the scheme unraveled, and, along with everything else — your spouse’s shame, inmate number and myriad lawsuits — the Internal Revenue Service came after you for the unpaid tax on those dirty dollars?
If this nightmare happened to you, and you had filed a joint income-tax return, you would probably have little defense against the IRS’ claims.
But tax experts say that a wary spouse — a husband or wife who suspects a partner of not reporting income or of claiming fictitious deductions — can take a crucial protective step that will provide legal insulation.
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The trick, the experts say, is to file a separate return, which married couples are entitled to do.
In that situation, neither spouse is responsible for tax debts owed solely by the other, while if they file jointly, the IRS can seek to collect from either of them — even if they later divorced.
A separate return, though, cannot cut off liability for previous years’ returns that were filed jointly.
Filing separately will often result in a higher tax than the couple would pay on a joint return, although that is not always the case.
Julian Block, a tax lawyer in Larchmont, N.Y., noted that for married taxpayers each with taxable income of $34,000 or less — after all deductions — there would usually be no difference in the tax owed. And if there is a difference, it can sometimes be minimized.
The goal is to get the taxable incomes of the two spouses nearly as equal as possible, said Block, the author of “Julian Block’s Tax Tips for Marriage and Divorce.” That might mean giving the partner with the higher income — if they are on speaking terms — more deductions, like those for the property taxes on a jointly owned home, for instance.
One wrinkle is that both spouses filing separate returns must choose the same method — either taking the standard deduction or itemizing deductions.
But separate returns can provide quite a tax wallop because certain benefits and deductions are unavailable to or severely limited for spouses filing separately, said Sidney Kess, a tax lawyer at Kostelanetz & Fink in New York. Kess cited a $25,000 rental-loss deduction, tuition deductions, education credits and the dependent-care credit.
If the tax owed on two separate returns is more than it would be on a joint return, that higher tax might be considered “an insurance premium” for someone who suspects that something may be amiss, Block said.
“It’s nothing compared to the additional expenses she will incur if she files jointly and needs professional help to seek innocent-spouse status,” he said, referring to a narrow loophole in tax law. Anthony Burke, an IRS spokesman, said in the 2010 fiscal year, there were 50,149 applications for innocent-spouse relief; 7,683 were granted and 6,383 partially granted.
Short of filing a separate return, the wary spouse should ask questions, said Bob Scharin, a lawyer and a senior tax analyst at the publisher Thomson Reuters.
“Look at the returns,” he said. “If anything does not look reasonable,” that is the time to balk.