Episode Description
You thought your divorce settlement gave you a fresh start - until an old tax bill pulled you right back into your ex’s financial problems. Tax liens, unpaid taxes, and overlooked filing choices can complicate even the most carefully negotiated divorce. In this podcast episode CPA and IRS tax resolution specialist Patrick Wanzer explains how to spot divorce tax mistakes before they derail your financial future.
Patrick shares real client stories that show how much is at stake.
For example, one woman turned what looked like a tax debt of several thousand dollars into an $18,000 refund by taking advantage of a filing status most people never think about during divorce.
Another client found that the divorce decree his lawyer approved of was impossible to follow because of a tax lien that no one had checked for.
This conversation with Patrick touches on tax debts, payment plans, and why a settlement that looks like a perfect 50-50 split on paper may be very different in reality.
The conversation also explores what happens when a tax debt outlasts your marriage, what innocent spouse relief may offer, and how a tax lien can interfere with selling your home. Understanding these issues before you sign can help you ask better questions and negotiate a divorce settlement with a clearer picture of your financial future.
If you’re headed toward divorce, or you work with people who are, this is a practical look at the questions worth asking before you sign anything.
Show Notes
About Patrick
Patrick H. Wanzer, CPA, CTRC, CDS, is a Certified Public Accountant with over a decade of experience and ten years dedicated to IRS Tax Resolution. His practice focuses on empowering individuals and businesses to resolve complex tax issues, stand up to the IRS, and regain financial stability through tailored solutions like Offers-in-Compromise and Installment Agreements. Patrick is also a Certified Tax Representation Consultant, Certified Divorce Specialist, National Trainer with Tax Rep LLC, and author of five books, including Break Free From the IRS: Taxes & Divorce and Break Free From the IRS – Gray Divorce Tax Strategies for Dividing Life’s Second Half. Outside of work, Patrick enjoys reading, watching football, and spending time with his wife, Kimberly, and their dog, Lucy.
Connect with Patrick
You can connect with Patrick on LinkedIn at Patrick Wanzer. To learn more about how to work with Patrick, visit his website at Breakthrough Tax Resolution. You can also sign up to receive a free digital copy of his latest book, Break Free From the IRS – Gray Divorce Tax Strategies for Dividing Life's Second Half, here.
Key Takeaways From This Episode with Patrick Wanzer
- Check for a tax lien before you settle. A title search will reveal any filed federal tax lien on a home, and a lien can make it impossible to follow a settlement agreement that requires selling or refinancing. Getting the IRS to discharge a lien can add a month or more to a closing, so start early. And if both spouses owe, the lien stays on the house until the tax is resolved for both of them.
- You may be able to file as head of household even if you're still married. If you're separated under a decree, haven't lived with your spouse for the last six months of the year, and have a dependent, head of household may be available. One of Patrick's clients turned what would have been a couple thousand dollars owed into an $18,000 refund simply by using the right filing status.
- For the IRS, custody means overnights. It doesn't matter what the divorce decree calls joint or physical custody: whoever has the greater number of overnights with the child gets head of household status. If the overnights are exactly equal, the parent with the higher adjusted gross income gets it. Patrick suggests marking a full-year calendar of overnights into the settlement agreement, and keeping your own record as life happens.
- Signing over the child tax credit doesn't sign away head of household. A parent can release the child tax credit to the other parent (using Form 8332) and still keep head of household status, with its better tax rates, higher standard deduction, and potential earned income tax credit. And if you're worried about a tug-of-war, filing first matters: the IRS will reject a second return that claims the same child.
- Pay the tax debt off before the divorce if you can. An installment agreement sits on both spouses' accounts, so if one ex falls out of compliance, the whole agreement can default, and penalties and interest keep adding up while you pay. If paying up front isn't possible, consider the approach one client took: she agreed to take on the payment plan because she didn't trust her spouse to pay, and negotiated extra assets in return to even things out.
- Not every dollar in a settlement is worth the same. A $250,000 Roth IRA and a $250,000 traditional IRA look equal on paper, but the traditional account carries a tax bill down the road. Bringing in a tax professional early helps you account for that, and spot other issues, like penalties and extension deadlines, before they become costly surprises.
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Transcript
The Divorce Tax Mistakes Most People Miss
SPEAKERS
Karen Covy, Patrick Wanzer
TRANSCRIPT
Karen: Hello, and welcome to Off the Fence, a podcast where we deconstruct difficult decision making so we can discover what keeps us stuck, and more importantly, how we can get unstuck and start making even tough decisions with confidence. I'm your host, Karen Covy, a former divorce lawyer, mediator, and arbitrator, turned coach, author, and entrepreneur. And now without further ado, let's get on with the show.
With me today, I have the pleasure of speaking with Patrick Wanzer. And with over a decade of experience as a certified public accountant and 10 years dedicated to IRS tax resolution, Patrick has built a reputation for helping clients navigate and resolve complex tax issues. Patrick's practice focuses on empowering individuals and businesses to stand up to the IRS and regain their financial security. Whether through an offer in compromise, installment agreement, currently not collectible status, or other custom-tailored solutions, Patrick has successfully guided countless clients toward financial freedom.
In addition to being a CPA, Patrick is also a certified tax representation consultant, a certified divorce specialist, and a national trainer with Tax Rep LLC. Patrick is also the author of five books, including his latest book, Break Free from the IRS: Gray Divorce Tax Strategies for Dividing Life's Second Half, which, shameless promotion for Patrick, is linked in the show notes. So if that is an interesting title to you, please click on the show notes and get it. Patrick, welcome to the show.
Patrick: Well, thank you, Karen. I really appreciate it.
Karen: I have so looked forward to this conversation, which is an odd thing to say about taxes, right? Sure. Because they're all dry and boring. But I'd like to start with your backstory. What got you into this? Because I know as a lawyer myself, the tax class was not my favorite. So what made you want to be a tax attorney?
Patrick: Sure. So one of the things when I first went out on my own to have my own firm, it was going to be the typical CPA firm. It was going to be doing the tax returns and then the tax season and do accounting and bookkeeping and that sort of thing. And frankly, while that was a good business, I just didn't really enjoy it much. And after my first tax season, I hit a dry spell. I didn't have much work. So I had to find something else to do to fill the void.
And I stumbled upon this idea of tax resolution, had no idea what it was, no idea how to do it, never heard of it before. Took a class on it, learned about it, and realized I can actually help people resolve their issues. It's not just preparing a return. Now I'm taking people who have issues with the IRS who feel this huge behemoth coming after them and represent them to help resolve those issues.
And the very first case I had was an innocent spouse case. The IRS is coming after my client for $18,000 for a tax debt that her husband should have paid. The divorce decree said he should have paid it. He had filed for bankruptcy a couple years later, was absolved of the tax, and so she now had to, quote, pay it. And so we filed innocent spouse, got granted, and got her out of that eighteen thousand dollar tax debt. And that was the case that sparked me, springboarding me into doing this, because I actually helped somebody who was in desperate need of getting out. She didn't have the eighteen thousand dollars to pay the IRS. And even if she did, she shouldn't have had to. And so we were able to get that resolved for her and get her on her way.
Karen: I love that, but that brings me to, I have so many questions for you. But that just sparked a question. I didn't think it was possible to go bankrupt on the IRS.
Patrick: Well, yes, it can. You can declare bankruptcy and have tax debts absolved, but they have to be at least three years old. So if tax debts are more than three years old, they can be resolved through bankruptcy. But if they're only at one, two, or three years old, then you can't get resolution through bankruptcy. You have to use another route. Now, the other thing is if you do bankruptcy, you can't do an offer and compromise. You can't do other routes, you got to wait till bankruptcy follows its track. So we struggle with that. Do you recommend bankruptcy, or do we try another pattern first before we go down that route?
Karen: Wow. So interesting. So before we dive into, I want to talk about some specific situations, tax situations as they relate to divorce. But before we get to that, I've got one more question that I'm not sure my colleagues are gonna like me asking. But a lot of divorce lawyers think that they can do it all. Why would someone need a tax specialist like yourself, in addition to a divorce lawyer?
Patrick: Well, so here's the thing. When it comes to resolving tax issues, especially in a divorce, there's so many different angles that you have to approach. The family law attorneys are so great at looking at all the different angles when it comes to a divorce overall. I mean, that's their experience, that's what they do. But when it comes to tax, fam law attorneys I've dealt with are always like, we hate tax, we don't want to touch tax, we can't stand tax, and they want to work with somebody who can take that off their hands. And we can help give them the strategy of which way to go that would best help their client. Filing status. If there's back taxes, who's gonna pay?
I've helped clients or attorneys write the settlement language. I basically give them the layman's terms, I want it to say this, and then they use the legalese to write it up for the settlement agreement to help protect their client and that sort of thing. And we use strategies looking at the tax implication down the road, and we see three or four blocks down the road that it may be an attorney who doesn't deal with this on a regular basis will know.
Now, one thing I also tell my clients is I'm not an attorney, so I do not provide legal advice. And so I've had clients ask me legal questions and I tell them, you need to speak with your counsel. I cannot provide legal advice, but I provide tax advice. And one last point is I do expert witness testimony. I've testified in many divorces to provide the court with information pertaining to that divorce to give them that expert witness information so they can have the best outcome.
Karen: Okay, so in what kind of situation or what kind of case would require your expert witness testimony, right? When does somebody need someone like you?
Patrick: Sure, that's a great question. I just had this about a month ago. We have a client who got divorced, and a divorce decree said he had to either refinance his house within a certain amount of time, or if he couldn't, then he had to sell the house. Well, there's a huge tax lien, and so we had to do a lien subordination was our first idea. We actually ended up doing a lien discharge to discharge the house from the tax lien. Well, there's a specific process you deal with, the IRS.
Well, I had to testify because his ex-spouse wasn't sure what the process was and didn't know if wanted to go through that and didn't think that it was real, and so I was brought in to testify to the court of exactly what it is, what we do, what the process is, how to deal with it, and then let them know that we can get this done and get this house sold. We just have to take these steps.
Karen: So, just for people who are listening who might not be as familiar with taxes, let me see if I got this and understood you. There's a divorce case, and he had to either refinance or sell within X amount of time. The time was running, and he couldn't sell because there was an IRS tax lien on the property, and it was impossible for him to do what the agreement said he had to do.
Patrick: Exactly. Yes, yes, that's specifically on point. The settlement agreement could not have been followed without this lien discharge. Tell the IRS we'll sell the house, take the money, pay the proceeds to the IRS. They'll let the house be sold because they'll take whatever they can get out of it, but the IRS has to agree to discharge the house from the lien or else it'll never sell. And so that's the process we had to go through.
Karen: Interesting. So, how does somebody know if there's a tax lien on their house?
Patrick: Well, when you go to sell the house, a title company will do a title search, and that's when all the liens will show up. Now, these are filed liens. Notice of federal tax liens were filed and recorded. Because the IRS will have what's called a silent lien. Technically, when a tax is assessed, a lien arises, but it's not filed anywhere. So nobody really even knows about it. But technically, there's still a lien. But when they file an actual notice of federal tax lien, they've actually filed it. The title search will pick that up. And at that point, you want to bring in somebody who has experience dealing with approaching the IRS and filing all the correct paperwork to do that.
Now, I have a couple of contacts locally with the IRS that I'm able to work with to help get these things moved a little bit faster. But we still have to go through that process and provide all the correct documentation. And it takes a while to do it. It's not something that happens within a few days. So it could delay the closing by a month, but if you get it done early enough, you can still stay on track.
Karen: Yeah, this is a government agency, and as far as I've ever known, none of them go particularly fast. Right. This reminds me actually of a story a colleague of mine had. She's a divorce lawyer, settled a case for her client, similar circumstances to what you described, but nobody knew there was a tax lien. And so it ended up being that the marital settlement agreement couldn't be followed because there was a tax lien nobody knew about. And she went crazy. And from that day forward, she said, I will not. If my client's keeping the house, we're doing a title search before that happens, because otherwise there could be a big surprise at the end.
Patrick: Absolutely. And once the tax is settled, the lien has to go away. So even if you file an offer and compromise and settle it for less than tax owed, the IRS has to release the lien because they've accepted and resolved the issue. So there again, there are lots of caveats. Now here's the thing: if you have two spouses, both have old tax, one could do an offer, the other one still owes the tax. The lien stays attached to the house until the tax is paid. And so one person may think they're out in the clear, but they may not be, because the lien doesn't go away until the tax is resolved for both parties.
Karen: So what I'm hearing, you tell me if I'm wrong, but I'm hearing this is a good reason why both spouses have to cooperate with each other in a settlement, whether they like each other or not. You can't stick it to the other spouse necessarily and get out scot-free while the lien stays on the house without affecting you.
Patrick: Exactly. And that's the best way to resolve it. And what would have really worked well in this case is, and I came in much further down the line, so it was past the time to do this, but they both could have filed either a joint offer, gotten out of the tax, or filed separate offers, both gotten out of the tax. And then once that happens, there is no lien, then the house just sells and everything's fine. But because they hadn't done that and they weren't very cooperative, we had to go down this route.
Karen: Wow. So that's interesting. I want to back up a little bit because you mentioned something about filing status. Can you explain for us what that means and how, I mean, obviously, once you're divorced, you can't file as married anymore. But how does tax status work, especially after you're divorced?
Patrick: This is such an important area that a lot of divorce attorneys may not necessarily know. So filing status is basically how you file on your return. If you're single, you file single. If you're married, you file married filing jointly, married filing separately. You can file head of household if you have dependents and that sort of thing. But there are rules on whatever status to file.
Now, what's interesting is people think that if you're married, you have to file married filing jointly and married filing separately. But there's a rule for divorced couples that if you're separated under a maintenance or a separation decree and you have not lived with your spouse for the last six months of the year, and you have a dependent, you can file head of household even if you're still married. And I had a client where we did that. She came to me, she's like, I need to file married filing separately for the six years of back taxes we had to file. I said, No, we're gonna file you head of household because she hadn't lived with her spouse for the last six months of the year.
And so by doing that, we took what would have been a couple of thousand dollars owed to the IRS and turned it into about an $18,000 refund. Why? Because married filing separately would have denied her the right to the earned income tax credit, head of household did not. So she got a big tax credit because we filed her head of household. She's still married, but because the rules were she was living with a spouse the last six months, had a dependent, she had more than half of the year, she could file head of household, and that filing status allowed her to get a big refund instead of owing taxes.
Karen: Wow. That right there is reason to hire you. Because to me, that's something that I as an attorney wouldn't have necessarily known. I didn't know you could file head of household under certain circumstances. But then what does that do to her spouse? Does that change anything for him?
Patrick: Well, so he would either, he should file head of household, or well, he could file head of household if there's two dependents and each of them had a child for more than half the year, that sort of thing. Otherwise, he would file single. Full disclosure, he wasn't my client, so what he did wasn't really my responsibility or anything like that.
The one caveat to understand, and this is something that divorce attorneys need to understand: custody in a divorce agreement is different than what the IRS considers custody. To the IRS, custody is who has the greater number of overnights. That's it. So if you have the greater number of overnights, then you can file head of household. If you do not, you cannot file head of household. You haven't had the child for more than six months, because you have to have more than, it's what, 182 plus one or whatever that is. So what you as an attorney would consider custody, we have joint custody, physical custody, legal custody, whatever. Great. But the IRS looks solely at the number of overnights to determine custody for tax purposes.
Karen: Well, what if the spouses agree that in this year one spouse is gonna claim head of household and take the child as a deduction? In the next year, the other person is going to do that. But it's not a 50-50 split. I mean, one spouse definitely has more time. Can the other spouse ever file head of household?
Patrick: Well, so the rule is you have to have the greater number of overnights. Now, here's the thing: you do not include on your tax return the number of overnights when you file. It's not like the IRS is going to come and audit and ask you to prove you had the child for this number of nights and child for that number of nights. When it arises is if spouse A files head of household but wasn't supposed to, and spouse B files their return and it gets rejected because the child had already been claimed. That's when the issue may come up.
The other thing is if you have two children, each parent can have the greater number of overnights with one child, and then they both can file head of household, because they have a dependent that they've had more than half the year, and then the other parent has dependent B for over half the year, so then they can file head of household.
Now, one thing I tell clients to do and tell attorneys to do is in the divorce settlement agreement, pull out a full-year calendar and mark overnights, who's gonna have who on what night. That would be your proof of number of overnights that you had. And one last point is if you have the child this weekend and your child spends the night at a friend's house, it's still your overnight. The IRS doesn't look at that and go, Oh my gosh, you didn't have them. Because they spent the night at a friend's house doesn't negate that. But if you voluntarily give up your overnight to the other spouse, then you do lose that overnight.
Karen: Wow. So what I'm hearing is that it matters what the paperwork says, but it matters more what actually happened.
Patrick: Yes, absolutely. And so having that divorce decree where you and I know it gets tedious, and I'm sure that attorneys have had instances where they've had to divide spoons and knives and forks and cups and plates and things like that. So it's getting a 12-month calendar and indicating who has the child for what nights, to calculate the number of overnights might be a good avenue to go down if that's warranted.
Karen: Interesting. Now, what does filing status, which post-divorce is either going to be individual, you're filing individually, or you're filing head of household, because married is off the table, right? So this is post-divorce, and you're gonna file one of those two statuses. What does that have to do with claiming the child as an exemption? A lot of people talk about that. I get to claim the child. No, I get to claim it. How does that play into all of this?
Patrick: Absolutely, and that's a huge thing. So claiming the child for the child dependent credit is separate than the filing status. Filing status is based solely on the number of overnights. Do you have the greater number of overnights for that child? And then you sign that 8332 to allow the other parent to claim the child for the child tax credit. It's only for the child tax credit. It does not allow them to file head of household, it does not allow them to do the dependent care credit if they haven't paid for the dependent care. It doesn't give them all the other things, it only allows them to file for the child tax credit. The filing status stays with the parent who had the greater number of overnights.
Karen: Wow. So it's possible that, let's say you and I are married, okay, with all respect to our respective spouses. You and I are married, and then we get divorced, and the kids are with me. I'm gonna go stereotypical. The kids are with me more than 50% of the time, but it's your year. And I said you can claim the tax credit, the child tax credit this year. So you claim the kids as an exemption, but I can still file head of household and you can't.
Patrick: Exactly. Absolutely right. You still get the head of household filing status and everything that goes with it. I would just get the child tax credit for that particular year. And with the head of household filing status, you get better tax rates, you get a higher standard deduction, you get a claim to earned income tax credit if you still are eligible for it. There's a variety of things you can claim that you can't claim when you file married filing separately.
Karen: You know what I love about this is that it just depends on how many overnights there are, and it's not a separate negotiation. Right. It's how many nights were the kids with you, period, full stop. And if you don't meet the criteria, too bad so sad, right?
Patrick: Absolutely. Now, again, the IRS doesn't audit this, you don't include it with your return. So I could have the child for a greater number of overnights, but you really wanted to file head of household, and I let you do it, and no one says a word to anybody. It's one of those things. But if you filed head of household, or if you were the one eligible to and I filed it and I wasn't supposed to, then you can challenge that. And we can prove that you can challenge the IRS, you can go back to court, that sort of thing, saying, hey, he filed head of household, he wasn't eligible to do so. What's the remedy for that?
Karen: That's fascinating for me because in all the decades that I've been a divorce attorney, everybody always negotiates who gets to claim the children, but I haven't really seen that many people negotiate how many nights there are for head of household, or specifically put a provision in the marital settlement agreement that says this person can file head of household.
Patrick: Exactly. And that's one of the rare instances. Every family law attorney I've spoken to where I talked about this was surprised, wasn't aware, especially the whole thing, you can still file head of household if you're still married, you haven't followed the last six months, that sort of thing. They just weren't aware about the IRS's rule on custody, which is the number of overnights. It doesn't matter what the decree says, it's the number of overnights.
Now, here's one quick caveat: leap year, 366 days in that year, right? What if you have an equal number of overnights? Well, the parent with the higher adjusted gross income gets to claim the child head of household. That's the tiebreaking rule.
Karen: Wow. So it seems to me, because no matter what the paperwork says, life happens, right? And the kid's in a different place for what, so it seems to me that it would make sense, it would behoove both parents, or at least one of them, who thinks they're gonna claim head of household, to keep a calendar and keep track.
Patrick: Absolutely. And here's the thing: let's say one parent takes a child on vacation and the flight was delayed because of a snowstorm for two days. So now they have two extra overnights. You can bring that into effect. You can then say, well, I'm gonna exchange two overnights later on to keep the calendar balanced, that sort of thing. It's the total number overall. But you're right, life happens, life intercedes, and there are ways to get around that because when it's completely out of your control, what are you supposed to do? I mean, I can't make the plane fly.
Karen: Right, right. But it also sounds like if the ex-spouses agree and are playing fairly with each other, like they work this out, the IRS doesn't care if the flight was delayed and you really had one less overnight that year. Exactly, the IRS isn't gonna care.
Patrick: Nope. And they're never gonna know. And frankly, it really comes down to exes who have a very unamicable divorce and separation, and they don't co-parent very well, that's when this is more of an issue.
Karen: All right. So let's stay on this for a second because okay, taxes, I don't know how early you can file, probably after February 1st, after everybody gets their W-2s and what have you. But is there any benefit if you think you're gonna be in a tug of war with your spouse about head of household and you can't agree between yourselves, is there any benefit in being the first to file?
Patrick: Absolutely, because once you file, you're gonna put on the return your child as the dependent, and the social security number. You file the return, it's accepted by the IRS. If the other spouse files the return with the dependent, the return will be rejected, saying that the social security number attributed to the child, this is a paraphrase, has already been used. And so you can't claim the child again.
Karen: So now let's change the subject a little bit and talk about the innocent spouse rule, because that's something that I think a lot of people have heard about, but aren't really sure what it is or how it works. So can you enlighten us?
Patrick: Absolutely. So the innocent spouse rule is basically this. First of all, they have to file a joint return. Because if you don't file a joint return, you have a separate return, you didn't file with your spouse, there's nothing to worry about. So you have to file a joint return. Then basically, one spouse says that they, in essence, didn't know and should not have known about the tax issues that arose from the other spouse.
Now, there are three types of innocent spouse. Actual innocent spouse, where you file that one when you say there's an understatement of tax. I didn't include all the income or something like that. So my spouse hid income, didn't include it. I'm not responsible. I didn't know and shouldn't have known. There's also what's called separation of liability, where basically you separate the liabilities between the two. But then there's a catch-all called equitable relief, which is innocent spouse saying, Yeah, the tax is correct, we just didn't pay it. And so that's where you file it that way. I usually file mine under that.
And there's a whole gamut of items that have to be ticked off in order to file for innocent spouse. Didn't know, shouldn't have known. Was there any abuse? To whom is the tax attributable? Does a divorce settlement agreement say to whom the tax is attributable? Were they married or are they separated at the time? It's a variety of these tests that have to be met when you file innocent spouse.
Karen: So what if somebody goes into a divorce, a couple's going into a divorce, and they owe taxes and they know they owe taxes either because they haven't filed returns for a certain number of years, or they have filed returns, but nobody paid the tax. What do you do with that?
Patrick: So this is where it comes down to you definitely want to work with somebody with a CTRC, a CPA like me, because we will go through all the different options that are available. So if you haven't filed the taxes, first of all, we have to file back taxes. Do you want to file them as married filing separately? Or in the case of my one client, head of household, even though they were still married. If they do have taxes, if they had filed their taxes, have tax owed, how does that get resolved? Do you do an installment agreement? Do you do an offer and compromise?
Now I had a client come in and their divorce decree literally said that once the divorce is final, they will file a joint offer and compromise and it'll be accepted by the IRS within six months. Once you're divorced, you can't do a joint offer and compromise. The IRS won't allow it. And the IRS will never go work that fast. So the decree could not have been followed, because once divorced, they can't do a joint offer. So you've got to want to work with somebody. Do we file the offer before they get divorced? Do we wait till afterwards and they each file their own offers if they qualify?
If you do an installment agreement, do a payment plan, who takes a payment plan? I had a client, they wanted to get in the payment plan. She does not trust her spouse to make the payments. So she took the tax and then argued for more assets to balance it out in the marital pot. Because she said, I know I'll make the payments. I don't trust my spouse to make the payments. And so if he doesn't, they're going to come after me anyway. So she took the installment agreement, took the tax, but then also took more assets to balance it out in the marital pot.
Karen: That makes so much sense. Especially because there's not a lot of trust in a divorce between the spouses. And sometimes you know that a spouse has a lot to lose, so they're gonna make the tax payments for whatever reason. But when you don't, that's an interesting approach to take.
Patrick: Sure. And that's the thing, because when you do an installment agreement, the IRS isn't gonna want both parties making payments. Basically, they're gonna set it up with one person. They don't want spouse A to make half the payment, spouse B to make half the payment. Basically, they just want one payment from somebody, makes it easier for the IRS. So you work with saying, okay, I'll take the $12,000 tax debt, okay, but you owe half of that, $6,000. So I want $6,000 more from the savings account to cover your half. Now I'm whole and I'll just make the payments. Maybe I take your $6,000, pay it directly to the IRS, make the payments on the rest, that sort of thing. It keeps the IRS like, okay, you're in a payment plan, you're good. Keeps the spouse whole who took the tax, and then the other spouse doesn't have to worry about it.
Karen: So is this something, if you've got an outstanding tax debt, in my world as a lawyer, I would say the easiest, cleanest thing to do is to pay off the debt first, liquidate what you can from the assets, pay off the tax debt, and then get divorced. What do you think?
Patrick: Well, that's absolutely what you should do. Either A, do that, or B, negotiate assets in the settlement agreement that will pay off the tax. Okay. So in my example with the client I had to go to court with and do the lien discharge, that was the whole point of selling the house, was to pay off a portion of that tax debt, those tax liens. And so they had to negotiate that, and of course, it got drawn out, that sort of thing. But that was the whole purpose of that. They didn't have the cash to pay it then. But if they sold the house, they'd have money to help pay off some of that tax lien.
But absolutely, getting the tax paid, getting the IRS off your back is the best way to go. Because any type of resolution requires tax compliance, meaning you file on time going forward, you make all your estimated payments going forward, and you have your withholding going forward. And so, if the two people on the return, even though one person's making the payments, if the other person doesn't stay compliant, it could default the entire installment agreement and you have to go through the whole process again. And so paying it off, exactly. I've had that happen. So we had to go through the process again. So paying it all off up front, if you can, is always the best way to go.
Karen: Yeah. That, I didn't realize that. So if I'm understanding you, again, we're married for purposes of this conversation, and then we're divorced, and I'm making the installment payments, but you're not paying your quarterly taxes, or you're no longer following the rules moving forward. The IRS can default my agreement.
Patrick: Well, they will default the installment agreement, because the IRS will have a separate module for you and for your spouse. And if one isn't in compliance, it'll default the installment agreement, which is on both accounts, both modules. Now, we can work with the IRS, get it reinstated, that sort of thing, but it costs money, it costs time, there's more penalties, there's more interest. There's a lot of things that go into it. Where if you just paid the tax up front, it's over with. And that's the other real quick point. There's no more penalties and interest if you pay the tax up front. You just pay it off, you're done. Even in an installment agreement, penalties and interest continue to accrue.
Karen: I didn't know that. That doesn't sound fair, right?
Patrick: And the IRS doesn't assess penalties and interest like a credit card each month. They'll just randomly one month say, Okay, boom, we've assessed penalties. I had a client who was in a payment plan, $20,000 a month, and they assessed penalties and interests randomly. And for that month, the penalties and interest was $22,000. So his payment almost covered all the penalties and interests, but after that payment, his balance actually went up a little bit. So that's the thing with the IRS, they're very odd at how they do it. They don't just regularly assess interest and penalties, they will randomly do it whenever they feel like doing it.
Karen: And that's okay.
Patrick: Yep, absolutely.
Karen: They can, oh my goodness. Wow. Talk to me about penalties and interest. I know that they expand geometrically, but I don't know exactly how that works with the IRS. A credit card has a high interest rate, you want to pay off that debt. But I always have counseled people pay the IRS first because that's worse. But can you explain how it's worse?
Patrick: Well, so paying off the IRS first is the best for a variety of reasons. First of all, the IRS can actually go down, if they go to down collections, they can eventually levy your bank accounts, garnish your wages, and take your money, that sort of thing. And that's down the road, but the credit card company doesn't actually go into your bank account and take your money. The IRS can do that. Number one.
Number two, paying off the IRS is, the penalties are based on the tax that's owed. That's why if you file your tax return late, but you're getting a refund, there are no penalties, because it's calculated on the tax that's owed. And then that interest rate, off the top of my head, I don't remember what the exact interest rate is. But the penalties, it's like 5% per month up to a certain number of months is the amount. And then each year they'll assess those penalties and they'll continue to accrue that interest, and then they'll assess it. And it's always gonna be more than what you're gonna pay with the credit card company.
Karen: Wow. Well, all right, that brings up another question. Let's say you're one of those people that never files taxes in April, you're gonna wait until October. What I'm hearing you say is that if you don't owe taxes, if you know you're not gonna owe taxes that year, that's fine. But what if you owe and you got the extension, you're filing in October and you owe. Are there penalties on that?
Patrick: Absolutely. You can file for an extension to file, you cannot get an extension to pay. And so if you file the extension, and let's say you file in July and then you pay the tax in July, you avoid the failure to file penalty because you had an extension, but you don't avoid the failure to pay penalty because you didn't pay on time. And so that's why you have to do an extension payment by April 15th. You kind of calculate what you think you're gonna owe, you make that payment to the IRS on the 15th, then you can wait till October to file your return.
And here's one of the reasons why people do that: perhaps they're not gonna get a K1 or some tax document from an outside source until June. Well, then you know what, they can't do that. Or what if they want to contribute to their IRA for the prior year? They can do that up to the date the return is filed. So if you extend it till October 15th, you can continue to contribute for the prior year. And so it's a way for people to kind of max out their contributions as well.
Karen: Interesting. Because I've had a lot of clients who are partners in law firms, partners in accounting firms, partners in whatever, they don't get their K1s in time to file by April 15th. So what you're saying is they still need to do a calculation of what their tax is likely to be and make an extension payment.
Patrick: Absolutely. Unless they've known that they've made enough estimated payments throughout the year, then they don't have to worry about it. There is a penalty for not making your estimated payments on time or paying enough estimated payments. That penalty can be avoided if you hit the safe harbor amount. There's a calculation for that. There's all kinds of different little aspects of saving money here and there when it comes to penalties that we deal with.
And then you can also get penalties abated under first time abatement, which you could, the failure to file, failure to pay. If you have a clean three-year track record, they'll just, it's a goof penalty, a goof relief. Hey, you goofed. All right, we'll release it. Or you can have reasonable cause. You have a reasonable cause for filing late or paying late that can help abate the penalties.
Karen: Wow. What I'm taking from this conversation, and I hope the people who are listening to it are taking, is it's complicated. And this is a really great reason for people to hire someone like you to take a look at what's going on if they have any potential tax issues in their divorce.
Patrick: Absolutely, because you just don't, if, and I'm trained, I've been doing this a long time. I see around the corner all the time. If it comes to a family law, I don't see the family law issues around the corner. The family law attorney sure as heck does. Well, so but I see the tax issues around the corner. Here's one instance. What if you divide two IRAs and each client gets $250,000? Great. Client A gets a Roth, tax already paid. Client B gets a traditional. There's an embedded tax amount. So that's not really a 50-50 there. And so we will work with attorneys to tax effect what the tax would be on the traditional so they can add that to the negotiation, saying, hey, it's $250,000, but there's gonna be an X number of amount of gain later on, or income tax later on, and you include that in the negotiation. We tax effect that all the time.
Karen: Wow. So many reasons people need someone like you. So if someone knows they need someone like you, I mean, first of all, because taxes are federal, can you work with people all over the country?
Patrick: Absolutely. We work with, for the IRS, yes, but we also work with all state departments of revenue. And I have clients all over the country dealing with the state departments of revenue. That's why I love Florida, because they don't have a state income tax. I love Tennessee, they don't have a state income tax. I love Texas, because we don't have to deal with that. And I say that jokingly, but we work with all departments of revenue around the country as well.
Karen: That's wonderful. Patrick, thank you so much for coming on and sharing all of your wisdom. If people are interested in working with you, if they've got a problem and they know you're the guy to solve it, because you are, where can they find you? Where's the best place?
Patrick: Well, they can go to our website, www.breakthroughtaxresolution.com. They can email me directly at [email protected]. They can call us, 317-413-7120. And we can help them out that way as well. But the website's the best place to go. You can find information about us, about where I'm speaking, about my books. You can sign up for a free consultation through our website. So it's the best place to go to get information.
And we work with both the direct client, we also work with the attorneys. So attorneys can bring us in to help work with them and help resolve the case and not necessarily specifically with their client. Now we can and we do often work with their clients, but if they want just some information or just want to ask some questions, we work with them as well.
Karen: That's awesome, Patrick. Thank you so much. And for everyone listening, everything that Patrick just mentioned is all going to be linked in the show notes. His website, his phone number will be there. All links to all of the various books that he has written. So, Patrick, thank you so much for sharing all of your wisdom on this podcast. I appreciate it.
Patrick: Thank you, Karen. I appreciate you having me on.
Karen: And for those of you who are watching and who are listening, if you appreciate today's conversation, if you liked what you heard and you want to hear more conversations just like it, do me a big favor. Give this episode a thumbs up, like the podcast, subscribe to the podcast, subscribe to the YouTube channel. And I look forward to talking with you all again next time.
