It is easy to get discouraged by income tax bills, but it is a bad idea to get discouraged about a tax bill while there are still opportunities to contest the bill. If a client is willing and has a reasonable basis for challenging the validity of the bill we usually encourage him or her to be persistent in pursuing all options to try and gain relief from all or some portion of the bill. Even if a challenge to a tax obligation doesn’t fully resolve matters favorably, we have seen unusual twists during the administrative handling of a well thought through objection, and sometimes the twists work to the client’s benefit. Take this example.
Someone came to us after a bankruptcy which successfully discharged income taxes she owed on joint returns that she had filed with her husband, from whom she was divorced (she had already been divorced at the time of the bankruptcy). A notice of federal tax lien had already filed against our client and her former husband before her bankruptcy was commenced, so that while the underlying tax debt was discharged in the bankruptcy, the lien remained in place against property which was claimed as exempt in the bankruptcy. In this case, lien remain attached to the family residence which had been awarded to our client in the divorce. Shortly after our client’s bankruptcy was closed, IRS sent our client Letter 4067, Final Notice of Intent to Levy. IRS explained that because the notice of lien was filed before the bankruptcy it remained as a lien against property claimed as exempt in the bankruptcy. IRS put pressure on taxpayer to seek a loan against her home, making a veiled threat of seizure of the house.
We filed an innocent spouse (IS) claim on behalf of our client, even though our client’s former spouse had been on title to the house at the time the IRS lien was filed, so that even a favorable decision on the IS claim would free up only taxpayer’s one half interest in the house. The lien would remain as to her ex-spouse’s former one-half interest. But that at least would frustrate matters for the IRS because of the procedural hurdles they have to jump to sell a personal residence, especially when under the law they would have to set aside one-half of the proceeds on a sale of the house for our client if her innocent souse claim was successful.
Many months passed without word from IRS except communication that it was reviewing the claim. Then our client sent us an email showing that a certificate of release had been filed, releasing her interest in the property from the lien, but not her husband’s interest. This was very unusual as the IRS had not notified us of the granting of the IS claim, but it had just released the only hold it had over our client on the old taxes (which, remember, had been discharged in the bankruptcy). I assumed this was an unusual way of granting the IS claim.
A month later, however, I was contact by the IRS person reviewing the IS claim who told me that the claim was being denied. I told IRS how unusual I found it that they were denying the IS claim, when they had just released the lien. The reason for the release the IRS person gave me was absurd, because lower level administrative staff usually defend administrative actions even when they are clearly mistakes: and the lien release before any decision on the IS claim was probably a mistake. We will never know why the mistake happened, and the lien still clouds title (if a title company doesn’t itself make a mistake and insure the property if it faisl to see that the IRS lien still encumbers a 1/2 interest).
IRS can still try to jump the hurdles to seize the house as to ex-husband’s one half interest (setting aside for our client her own one half interest in the proceeds), but would need court approval to do so, and that is extremely unlikely. While the innocent spouse claim itself didn’t work, the result turned out to be the same. The IRS can no longer press our client for payment because the taxes were discharged in the bankruptcy, and the lien was released and cannot realistically be refiled. The point is, the lien release is unlikely to have happened even by mistake unless the innocent spouse claim had not been put into the works. The moral? – Sometimes putting a claim forward leads to a favorable result for the darndest of reasons.
One other moral – a divorce one, not a tax one. If it is at all possible take care of paying off taxes during the divorce. The reason is that agreements as to who has to pay taxes in a divorce decree are not binding on IRS, which can pursue either or both spouses who filed a joint return without respect to the terms of a decree. Similarly, as the story here just shows, a tax lien survives the divorce unless the taxes are paid off as part of the divorce. This means that while the spouse awarded property may think that he/she has gotten it free and clear, it remains subject to liens of record regardless of agreements between the spouses as to who will pay the taxes. The fact is that our client should have bargained for full payment of the tax during the divorce to secure release of the lien.