Liability Relief on Joint Returns

Although most married couples benefit from filing a joint tax return, the spouses are held jointly liable for the entire tax, including penalties and interest. Since, in many cases, only one of the spouses either fills out the information for the return or provides the information to a tax preparer, the other spouse may not know about mistakes in the information or about an attempt to evade taxes by the reporting spouse. This is especially true if the couple become separated or divorced, or if a spouse is abandoned by the other. Nonetheless, under IRC § 6013(d)(3),the other spouse will be held jointly liable for the underpayment or underreporting of taxes unless she can take advantage of one or more of the 4 types of relief that are available to an innocent spouse: innocent spouse relief, separation of liability, equitable relief, and relief from liability because of community property law. Although the requirements for relief differ according to the type of relief sought, the electing spouse requests any type of relief by filing Form 8857, Request for Innocent Spouse Relief. In all cases where relief is sought, the IRS will notify the non-electing spouse so that he can present his own case.

If the request for relief is denied, then an appeal can be filed with the tax court, which must be within 90 days from when the IRS mails a determination refusing the request for relief. If the IRS does not mail a determination within 6 months, then the taxpayer can file a petition with the tax court requesting relief.

Innocent Spouse Relief

Innocent spouse relief is only available if there was an understatement of tax because the reporting spouse did not claim income, or he claimed deductions or tax credits that he was not entitled to or that were inflated.

There are several requirements that must be satisfied before being granted innocent spouse relief:

• the innocent spouse filed a joint return with the understatement of tax because of erroneous items reported by the other spouse;
• the innocent spouse had no reason to know and did not know or have reason to know, that there was an understatement of tax; and
• by considering all facts and circumstances, it would be unfair to hold the innocent spouse liable.

Crucial evidence that the IRS will consider is whether the electing spouse received any substantial benefits from the understatement of tax and whether the spouses were later divorced or separated or the innocent spouse was deserted by the other spouse.

However, if the innocent spouse had actual knowledge, or if she should have known, about the understatement of tax, then innocent spouse relief will be barred. If the innocent spouse knew about some mistaken items, but not others, then she may be granted partial relief from what she did not know.

Separation of Liability

If a couple becomes legally separated or divorced, or if they no longer live together, then a spouse may ask for a separation of liability for any understatement of tax by the other spouse. A separation of liability request must satisfy the following requirements:

• a joint return was filed;
• the joint filers are either no longer married or are legally separated, or the joint filers did not live in the same household for the 12 month period ending on the date of the filing of Form 8857.

A taxpayer who chooses relief under separation of liability has the burden of proving income and deductions.

Separate of liability does not prevent joint liability for unpaid tax if the proper amount of taxes was reported. Generally, under separate liability rules, income and deductions are allocated according to what they would be if the spouses had filed separately. However, if the innocent spouse benefited from any of the deductions, then she will have to pay that part of the liability by which she benefited.

For instance, if the husband had reported $10,000 of business income, his sole income, but also took a $20,000 deduction, then $10,000 of that deduction will eliminate the husband's business income and will also lower the wife's income by $10,000. Hence, the deduction benefited both spouses 50%. Therefore, if the IRS disallows the deduction, then the wife will have to pay 50% of the resulting tax.

Asset transfers between spouses may prevent a separation of liability consideration if the principal purpose of the transfer was to avoid taxes. Transfers made within one year before the first deficiency letter are presumed to have a tax avoidance purpose, unless the spouses are divorced or are under a decree of separate maintenance. The presumption can be rebutted by showing that the asset transfer was for another purpose, but if it is not rebutted, the value of the transferred asset increases the liability of the innocent spouse by the value of the asset.

Equitable Relief

If an innocent spouse cannot satisfy the requirements for innocent spouse relief or separation of liability, then she may still seek equitable relief, where considering all the facts and circumstances, it would be unfair to hold the innocent spouse liable for the understatement or underpayment of tax. For instance, if the correct tax was reported, but was not paid, then the innocent spouse must request equitable relief, since this is the only form of relief available for the underpayment of tax.

Previously, the request for equitable relief must have been made within 2 years of when the IRS started collecting a tax deficiency but the IRS has removed that restriction. In response to pressure from Congress and others, the IRS eliminated the two-year rule for requesting relief on July 25, 2011 (Notice 2011-70). Now the spouse can request relief at any time during which the tax can be collected.

Relief from Liability Arising from Community Property Law

The income earned by a married couple in a community property state — Alaska (if the couple requested community property status), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin — is considered to be earned equally by each spouse, so even if the spouses file separate returns, they each must report one half of the total marital income. However, if the spouses become separated or divorced, the innocent spouse may not know the income of the other. If an item of income was omitted on the separate return of a spouse who did not earn the income, then she may need to request relief from liability that arises because of community property laws.

To obtain relief, the couple must not have filed a joint return, an item of gross income was not included on the return of the spouse seeking relief that was earned or due to the other spouse, and the electing spouse had no knowledge nor had any reason to know of the omitted income.

Injured Spouse Claims for Refund

On a joint return, the IRS may withhold certain tax refunds if one of the spouses did not pay child or spousal support or certain federal debts, such as student loans. However, the spouse who is not responsible for the debts can ask for a refund of her part of the overpayment if:

• she is not required to pay the past due amount;
• she received the income reported on the joint return; and
• she reported the tax payments for which a refund is due, such as withheld federal income taxes or paid estimated taxes that were greater than her tax liability, on the joint return.

To claim an injured spouse refund, the term injured spouse must be written in the upper left-hand corner of Form 1040, U.S. Individual Income Tax Return and Form 8379, Injured Spouse Allocation must be attached. If the joint return was already filed, then the non-obligated spouse should simply file Form 8379 by itself to claim a refund.

Notes

• In 2010, there were 50,149 applications for innocent spouse relief – 7683 of them were granted and 6383 were partially granted.
  • Source: Why a Wary Spouse Should Consider a Separate Return - NYTimes.com