At every stage of a divorce case, particularly when writing a marital settlement agreement, there is an opportunity to deal effectively with tax consequences and avoid tax traps. In my book, Frumkes & Vertz on Divorce Taxation, we provide sample tax clauses that can be included in a marital settlement agreement. These clauses will help to anticipate and control tax ramifications to avoid unintended consequences in routine and complex divorce cases.
- Deciding whether to file jointly
When married people are separated, they have an option to file their income tax returns separately or jointly. Joint filing offers the lowest tax rates, and allows them to pool their deductions, but may expose a spouse to audit risk and penalties if the other spouse takes deductions that are disallowed or fails to report income. In a marital settlement agreement, divorcing spouses may decide whether to file their final returns as married couple jointly or not.
- Allocating the risk of joint and several tax liability
When divorcing spouses file joint tax returns, each of them is legally liable for the entire tax liability, regardless of who earned the taxable income. So, in a marital settlement agreement, they might want an indemnification clause that will allocate the risk. The indemnification clause does not tie the hands of the IRS, but it opens the door for a divorce court to fashion remedies if an innocent spouse is held liable by the IRS.