We routinely discuss IRS enforcement trends, but rarely in conjunction with family law matters. News outlets routinely report the divorce rate to be around 50% in the U.S., with infidelity often cited as the leading cause. A less reported reason is when one spouse is convicted of a felony. While infidelity often refers to an affair, it can also refer to a spouse failing to honor his or her professional obligations and embezzling from an employer. Depending on the amount, the cheating spouse can be prosecuted in federal or state court, which can result in an order directing the defendant to repay the stolen sum to the victim. Most lawyers will tell you defendants often lack the ability to pay restitution, which results in the tax code treating the embezzled funds as taxable income. Problems arise with the IRS when the illegal income is not reported on jointly filed tax returns. If the IRS detects unreported income, even if illegally earned, the IRS will attempt to collect the back taxes, interest, and fines (what I will call tax penalties in this article) from the defendant and his or her spouse, even when the innocent spouse was unaware of the illegal conduct and the unreported income.
In 2011, a state court charged a wife, who was a trained accountant, for embezzling approximately $500,000 from her employer. The embezzled funds were not included as income on the 2010 and 2011 tax returns the wife jointly filed with her husband. Before her arrest, the husband trusted his wife to handle the family’s finances based on her training as an accountant. Ultimately, the wife was sentenced to five years in prison, among other penalties. The wife filed for divorce in 2014, and divorce proceedings concluded in 2015. Despite a pending bankruptcy proceeding in federal court, in 2014, the IRS informed the husband that he owed approximately $150,000 in tax penalties. The IRS assessed the tax penalties against the husband despite no evidence that the husband lavishly spent stolen money, knew his wife stole the money, or knew the tax return deficiencies. The tax code treats joint filers as individually responsible for the tax and, if applicable, tax penalties. The wife, no doubt hoping for leniency, told the government that the husband knew of her crimes. In 2018, after a thorough presentation, the Tax Court found the innocent spouse defense applied and relieved the husband from paying the tax penalties.
When faced with an IRS assessment of tax penalties (which can include a 75% fraud penalty), the tax payer has several options to challenge the assessment. First, the tax payer must generally exhaust all administrative remedies with the IRS. If unable to obtain relief from the tax penalties, the tax payer can file a lawsuit in the U.S. Tax Court, U.S. Court of Federal Claims, or the relevant U.S. district court. The Tax Court and Court of Federal Claims are located in Washington, D.C., and the relevant district court is located near the tax payer. Unless proceeding in Tax Court, the law requires the taxpayer to pay the back taxes, penalties, and fees before seeking relief in the Court of Federal Claims or district court. While a trial by jury is not provided for in Tax Court or in the Court of Federal Claims, some claims may require a trial by jury if proceeding in district court. Generally, the tax payer has the burden of proof in these proceedings.
In addition to deciding where to file for the tax payer, skilled lawyers will consider appropriate defenses to the tax assessment and what evidence is necessary to prove the tax payer is entitled to relief. In addition, when criminal issues arise in a tax case, it is imperative to retain counsel experienced in tax and criminal investigations to navigate the perils you face when the IRS assesses back taxes, penalties, and fees against you. You should also retain a lawyer who can demonstrate he or she has significant trial experience. If the IRS has contacted you, or if you are an attorney or accountant with a client facing an IRS assessment of back taxes, penalties, and fees, contact the Law Offices of Horwitz & Citro, P.A. immediately. Call (407) 901-5852 to request a free initial consultation with an experienced lawyer.