Most married taxpayers should file a joint return as it is rare to cut your taxes by filing separately. Another overlooked reason for married taxpayers to file a separate return is to protect from spousal liability. This week a perfect example arose in the office on when to file a separate return.
A client informed me a family member of theirs had embezzled money from his employer. I had to tell the client that the legal issues are only the beginning of his problems. Once convicted or a plea agreement is reached, the IRS reviews the public documents and sends the taxpayer a bill for the unreported income. Yes, embezzled money is reportable and taxable income. Then the state will follow-up with their tax bill.
If the tax return with unreported income is a joint return, both spouses are fully liable. If the spouse that committed the crime ends up in jail, the other spouse will owe the entire tax bill. Since the criminal charges were already filed when the tax return was signed by both spouses, neither innocent nor injured spouse protection applies.
I feel bad for this family. They filed their tax return a few weeks prior to my knowledge of the situation. The wife will owe a lot of taxes her husband is guilty of creating.
If you suspect your spouse is gambling, or partaking in questionable business activities, or embezzling, file a separate tax return. You can always amend a “married filing separately” tax return to a joint return, but you cannot amend a joint return to a separate one.
Since these tax issues usually end up in the tens of thousands of dollars, think long and hard before you sign any tax return. It is very difficult to convince the IRS or courts you had no knowledge of the illegal act. When in doubt, pay the extra tax, and file your own “separate” return.