When a married couple files a joint tax return, each spouse is jointly and severally liable for the tax showing due on that tax return, and any subsequent audit adjustments the IRS may make. This means each spouse is responsible for the entire tax bill independently of the other. This doesn’t mean the IRS is doubling the tax, it just means the IRS can collect all of a jointly owed tax from just one of the spouses, which can create an unfair financial strain on the spouse from whom the IRS seeks to collect. The IRS can grant Innocent Spouse Relief (not to be confused with injured spouse relief) to alleviate this unfair financial strain.
There are basically four types of relief: 1. innocent spouse relief; 2. separation of liability relief; 3. equitable relief; and 4. relief from application of community property laws. The IRS has a very good publication on the requirement requirements for these categories of relief. The current version of the Publication 971 can be found here.
Asking for innocent spouse relief is kind of like asking the IRS to approve an offer in compromise. It is difficult to persuade the IRS to accept the request. The IRS seem predisposed to denying these types of requests. Part of the reason for this problem may be that too many taxpayers try to represent themselves and submit requests that simply do not have merit. What the IRS thinks is fair is often very different than what a taxpayer thinks is fair. The IRS sees a lot of requests that don’t meet the criteria for approval and that, in part, creates a predisposition in the IRS to reject applications. This means that getting approval on difficult or complex fact scenarios may require an appeal or even litigation in the U.S. Tax Court.
Innocent Spouse Relief (traditional)
The traditional form of innocent spouse relief allows the requesting spouse to be relieved of a joint tax liability resulting from the understatement of tax. A taxpayer must meet all of the following conditions to qualify for innocent spouse relief:
1. Filed a joint return with either a current or former spouse;
2. There is an understated tax on the return that is due to erroneous items of the requesting taxpayer’s spouse or former spouse;
3. The taxpayer can show that when he/she signed the joint return they did not know, and had no reason to know, that the understated tax existed; and
4. Taking into account all the facts and circumstances, it would be unfair to hold the taxpayer liable for the understated tax.
Separation of Liability
Separation of Liability allows a joint tax debt resulting from the understatement of tax to be apportioned between the requesting spouse and the non-requesting spouse. Separation of Liability relief is only available for unpaid liabilities. To qualify for Separation of Liability relief the following elements must be satisfied:
1. Filed a joint return; and either; and
2. Must not have been a member of the same household with the spouse for a twelve-month period ending on the date of the filing of the request for relief; or
3. Be no longer married to, or legally separated from, the spouse with whom the joint returns was filed.
Even if the above elements are satisfied, relief may be denied when:
1. A transfer of assets occurred between spouses as part of a fraudulent scheme; or
2. The joint return was signed by the taxpayer requesting relief with actual knowledge of any erroneous items giving rise to the deficiency that were allocable to your spouse, or former spouse.
Equitable Relief
Equitable relief allows the IRS to grant relief joint tax debt when collecting the debt from the requesting spouse would be inequitable, or unfair. Equitable relief is available for both an understatement of tax or an underpayment of tax, whereas the other two forms of relief discussed above are only available for an understatement of tax.
Taxpayers may qualify for equitable relief if he/she meets all of the following conditions:
1. The taxpayer is not eligible for traditional innocent spouse relief, relief by separation of liability, or relief from liability arising from community property law;
2. The taxpayer and his/her spouse, or former spouse, did not transfer assets to one another as a part of a fraudulent scheme;
3. The taxpayer’s spouse, or former spouse, did not transfer property to you for the main purpose of avoiding tax or the payment of tax;
4. The taxpayer did not file, or fail to file, a return with the intent to commit fraud;
5. The taxpayer did not pay the tax;
6. The taxpayer establishes that, taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement or underpayment of tax; and
7. The income tax liability from which a taxpayer seeks relief must be attributable to an item of the spouse, or former spouse, with whom you filed the joint return, unless one of four exceptions applies:
a. The item is attributable or partially attributable to the requesting taxpayer solely due to the operation of community property law;
b. If the item is titled in the requesting taxpayer’s name, the item is presumed to be attributable to that taxpayer. However, this is a rebuttable presumption;
c. The taxpayer did not know, and had no reason to know that funds intended for the payment of tax were misappropriated by the spouse, or former spouse, for his or her benefit; or
d. The taxpayer establishes that he/she was the victim of abuse before signing the return, and that, as a result of the prior abuse, did not challenge the treatment of any items on the return for fear of retaliation.
As you can see, there are many elements that must be satisfied before the IRS can grant equitable relief. Successfully navigating through each element can be a real challenge for taxpayers.
Relief From Application of Community Property Law
States with community property laws may expose a spouse who is not liable for their spouse’s separate tax debts to collection of those debts. The IRS recognizes that in some circumstances it is truly unfair to collect from a non-liable spouse even though community property laws allow them to do so. A taxpayer may seek relief from the application of community property laws when:
1. The taxpayer did not file a joint tax return for the tax year with a balance owing;
2. The taxpayer did not include the item of community income in their gross income;
3. The item of community income not included in gross income is one of the following:
a. Compensation of the other spouse received as an employee, sole proprietor, or partner;
b. Income the from the other spouse’s separate property;
c. Any income that belongs to the other spouse under community property laws;
4. The taxpayer establishes they did not know of and had no reason to know of the community income; and
5. It will be unfair under all the facts and circumstances, to include the item of community income in income of the requesting taxpayer.
Now, the effect of a successful request for any form Innocent Spouse relief is to saddle the non-requesting spouse (NRS) with the sole responsibility for paying all or a greater portion of the liability for which relief has been granted. The question may come to mind whether or not the NRS can dispute the request. The answer: absolutely. The law requires notice be provided to the NRS of an application for relief and the NRS has the right to participate in all proceedings.
Injured Spouse Relief
Do not confuse any form of Innocent Spouse relief with Injured Spouse Relief as they are very different forms of tax relief. If one spouse has certain types of separate debt(s), the IRS may capture an entire joint tax refund for application toward the separate debt(s). A joint tax refund generally results from a married couple filing a joint tax return showing an overpayment of tax. Injured Spouse relief allows the spouse that is not responsible for the separate debt of the other spouse to recoup their portion of the joint tax refund applied to the other spouse’s separate debt.
An application for Injured Spouse relief can be submitted when a refund was, or is expected to be, applied to a spouse’s separate debt. If applying after a refund has been captured, there are time limitations. A taxpayer may lose the right to a refund under Injured Spouse relief if they wait too long so do not procrastinate.