Income Taxes and Self-Interest in a Marriage

Law Office of Robert L. Firth March 28, 2016

If you and your spouse have significant tax debts, each of you have your own self-interest, which may require different solutions.

Joined in Marriage Does Not Necessarily Mean Joined in Bankruptcy

Married couples can and often file bankruptcy together. Doing so if you both owe substantial income taxes may especially make sense.

But you each need to understand your own individual rights and options before deciding whether you should file bankruptcy at all. And if a bankruptcy is needed, you need to decide whether to do so by yourself, with your spouse, or by your spouse alone. It may seem obvious that if you’re married and both owe taxes and have a bankruptcy solution that you should file it together. But that’s not always the best. Either way, all the options should be carefully explored.

For example, sometimes when there is a lot of income tax debt, that may mostly be because of the actions of one of you—such as either you or your spouse operating a business which eventually failed. The spouse with the failed business and resulting debt may well be feeling deep frustration and guilt, while the other spouse is angry, disappointed, and may even feel betrayed. This can make the situation both more emotionally and legally challenging.

This blog post suggests some principles to consider in these difficult situations.

Each Spouse Has an Independent Self Interest

To state the obvious, just because you and your spouse are married does not mean your financial situations are the same. Your legal liabilities are usually not identical and may even be quite different. That’s especially true if one of you had better credit or more need to use it because of operating a business, so that most of the debt is owed by only one of you. Or maybe one of you came into the marriage burdened with much more debt.

With different debt liabilities—and sometimes with some different assets as well—you each have different legal problems and so each of your best solutions could easily be different. Beyond these tangible differences, each of your can have different goals and different attitudes about how to deal with your individual problems as well as your joint ones.

The Uniqueness of Income Taxes

Because income taxes are such an unusual kind of debt, they can greatly complicate the self-interest of each spouse. Taxes are unusual in how they are incurred. For example, a tax debt can arise primarily out of the actions of one spouse, but then the other spouse often becomes liable by simply signing a joint tax return. That spouse might eventually be able to get out of that liability through an “innocent spouse” determination, an opportunity not available with other kinds of debts.

Income taxes are also quite unusual in how they are treated in bankruptcy. There are quite complicated rules about what taxes will and will not be discharged (written off), and how each portion of each tax account can be handled under either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts.”

Each nuance of these rules can create different self-interests for each spouse, including whether and/or your spouse would be best served by bankruptcy, under which Chapter, and whether you should both join in the same case.

Two Spouses May Each Need Their Own Bankruptcy

You and your spouses’ different self-interests may lead to different solutions. Sometimes that may mean one person filing bankruptcy and the other not, or one person filing a Chapter 7 case and the other a Chapter 13 one.

The possible circumstances are endless, but let’s illustrate this with an example. Consider a couple jointly owing $25,000 in income taxes for 2011 because they filed a joint tax return. The debt arose because one spouse operated a business which generated income but the spouse did not pay any quarterly taxes. The following three years the other spouse refused to sign joint tax returns, and instead filed separate returns, had sufficient taxes withheld from wages, and so owes no taxes for those three years. However, the business-operating spouse individually owes $10,000 for 2012, $6,000 for 2013, and $4,000 for 2014—as the business generated less and less income, totaling an additional $20,000 in taxes for that spouse. Assume the 2011 tax is old enough and meets the other conditions to be discharged in bankruptcy. But the more recent years of tax debt cannot be discharged yet.

In this situation the spouse who owes only the joint 2011 tax may well be best served by filing a Chapter 7 “straight bankruptcy” case to discharge that (and any other joint or separate non-tax debts). Whereas the other spouse, who is liable on all the other taxes as well, may be better served by filing a Chapter 13 “adjustment of debts” to discharge his or her liability on the $25,000 2011 tax, and be protected from the IRS while paying off the $20,000 in liability on the 2012 through 2010 taxes.

In this situation the spouse owing only the 2011 tax discharges his or her debts in a matter of a few months with a Chapter 7 case. At the same time the other spouse gets the many benefits of a 3-to-5-year Chapter 13 case in dealing with all different years of his or her tax debts.

Two Spouses May Need Separate Attorneys

Without getting deeply into delicate attorney ethics rules about conflict of interest, attorneys need to be very cautious in not simultaneously representing two people who have materially different interests. This is true even when the two people are married and have many common interests.

In the end you and your spouse may end up filing a joint bankruptcy because it is in your individual and mutual best interest to do so. But before getting there each of you must be made fully aware of your individual rights and legal options, whether this happens through two separate attorneys or through a single one. You and/or your spouse may decide to sacrifice some of your individual interests for the common good. But you should only do so when your rights and options have been clearly laid out for each of you.