If the IRS is pursuing collection action against you for an income tax liability for which you believe you are not responsible because the liability was derived from a spouse (or former spouse), you may be correct and have legal grounds to dispute the liability. The IRS has a specific provision called innocent spouse relief that may apply provided certain criteria are satisfied. If so, it may relieve you of the assessed tax liability.
Normally, when a married couple files a joint return with a tax liability, the law makes both of them responsible for the entire tax liability. This is referred to as a joint and severable liability. This law cannot be overcome even if you get divorced and even if the divorce decree specifically states that you are not to be held responsible for the taxes. While the divorce decree might require one of the spouses to pay the tax liability, the IRS is generally not bound by the decree, and may pursue collections from the court decreed non-liable spouse. If the IRS succeeds in collecting from the court decreed non-liable spouse, then his or her only recourse is to pursue the court decreed liable spouse for reimbursement.
Three Exemptions of Innocent Spouse Relief
There are, however, three exemptions that can be utilized by the “innocent” spouse in order to be relieved of the joint and several liability. These exemptions are innocent spouse relief, separation of liability relief, and equitable relief. The IRS does allow for tax relief from a liability arising out of community property law (for taxpayers residing in a community property state), but the specifics of this provision will not be addressed in this article. It is important to note that with only a few exceptions, in order for the IRS to consider a claim of relief, it must be submitted no later than two years after the date in which the IRS first attempts to collect the tax.
In order to qualify for innocent spouse relief four conditions must be satisfied:
1. You filed a joint return.
2. There is an understated tax on the return that is due to erroneous items of your spouse (or former spouse).
3. You can show that when you signed the joint return you did not know, and had no reason to know, that the understated tax existed (or the extent to which it existed).
4. Taking into account the facts and circumstances, it would be unfair to hold you liable for the understated tax.
Although this seems simple enough, in order to ensure that you satisfy the conditions, a closer look must be taken. An understated tax is when the IRS determines that the total tax should be more than the amount that was reported on the return. Erroneous items are when income is underreported or the amount of deductions, credits, or basis reported on the return is incorrect. You must be able to demonstrate that you did not actually know of the understated tax and that a reasonable person in a similar circumstance would not have known either.
In order to offer some assistance, the IRS does provide a list of specific facts and circumstances that are used to make a determination on whether you had reason to know of the understated tax. Similarly, the IRS provides some examples of factors that they consider to determine if it would be unfair to hold you liable for the understated tax. These factors primarily revolve around whether you received a significant benefit (directly or indirectly) from the understated tax, whether your spouse abandoned you, and whether you are currently divorced or separated from your spouse. A significant benefit is defined as any benefit in excess of normal support. The IRS does not specifically state that you had to have knowledge of the benefit. Nonetheless, it is reasonable to assume that you are not required to have knowledge of the benefit but only to have received the benefit.
Even if you do not satisfy the criteria of lack of knowledge, you may still be entitled to partial relief provided that you knew or had reason to know about only a portion of the erroneous item. Another beneficial aspect of this law is that the IRS will also take into consideration all facts and circumstances of your case to determine if it is unfair to hold you responsible. While several of the criteria are subjective, the IRS does provide a few examples of factors that they will consider. An experienced representative can assist you in applying these factors to your specific factual situation in order to make as strong of a case of relief as possible.
If you do not satisfy all of the criteria of innocent spouse relief, do not give up all hope as the IRS created another similar provision called separation of liability relief. Under this type of relief the understated tax is allocated between you and your spouse (or former spouse). The requirements for this type of relief are:
1. You filed a joint return.
2. You are no longer married to, or are legally separated from, the spouse with whom you filed the joint return for which you are requesting relief.
3. You were not a member of the same household as the spouse with whom you filed the joint return at any time during the 12 month period ending on the date you file the request for relief.
In order to be considered as being in a separate household you must be living apart and be estranged from your spouse. Being temporarily absent is not sufficient to meet the threshold. You are also responsible with the burden of proof in showing that all of the requirements, except actual knowledge, have been met. However, even if you have actual knowledge, you are not disqualified from relief provided that you were the victim of spousal abuse or domestic violence before signing the return and that, because of the abuse, you did not challenge the treatment of any items on the return because you were afraid your spouse (or former spouse) would retaliate against you. Moreover, if you can establish that you signed the joint return under duress, then the IRS will deem the return to not be a joint return. In this case, you will not be held liable for any tax or deficiency on that return. However, you may be required to file a separate return for that year.
To discourage dishonesty and criminal activity, there are limitations to separation of liability relief even if all of the requirements have been satisfied. The IRS will not grant separation of liability relief if the IRS can prove that the assets were transferred from the spouses (or former spouses) in a fraudulent scheme, that you had actual knowledge of any erroneous items giving rise to the deficiency (unless it has been established that you are the victim of spousal abuse or domestic violence as mentioned above), or assets were transferred between spouses (or former spouses) in an attempt to avoid taxes. A transfer will be presumed to be an attempt to avoid taxes if it is done within 1 year before the IRS sends the first letter of the proposed deficiency unless it was part of a divorce decree or similar agreement. As an additional deterrent, if the IRS determines the transfer was done to avoid taxes, then the tax liability will be increased by the fair market value of the property transferred, on the date of the transfer, but the increase cannot be more than the entire amount of the liability.
If you do not qualify for innocent spouse relief or separation of liability relief, you may still qualify for equitable relief—the only remaining, “catch-all” relief available. Equitable relief is slightly broader in that you can be held not responsible for both an understated tax as well as an unpaid tax. The requirements for equitable relief are:
1. You are not eligible for the other types of relief.
2. You have an understated or underpaid tax.
3. You did not pay the tax.
4. You establish that, taking into account all of the facts and circumstances, it would be unfair to hold you liable for the understated or underpaid tax.
5. You and your spouse (or former spouse) did not transfer assets as part of a fraudulent scheme or for the main purpose of avoiding taxes or the payment of taxes.
6. You did not file or fail to file your return with the intent to commit fraud.
7. The income tax liability for which you seek relief must be attributable to an item of the spouse (or former spouse) with whom you filed the joint return. The IRS does list four specific exceptions to this provision.
A couple of factors that weigh in favor of granting equitable relief is whether your spouse (or former spouse) abused you, and whether you were in poor mental or physical health on the date you signed the joint return or at the time you requested relief.
Another noteworthy aspect of the three types of relief is that if you are granted relief by the IRS, tax refunds are permitted under innocent spouse relief, not permitted under separation of liability relief, and permitted under limited circumstances under equitable relief. However, the IRS will only refund payments if it can be proven that the payment was made with your own money.
Due to the fact that the IRS will hold you with joint and severable liability for the tax liability unless you are able to effectively prepare a claim for relief, timely file the claim for relief, and finally negotiate the approval of the claim of relief, it is advisable to obtain qualified representation with a skilled professional, such as a tax attorney, who has knowledge and experience in knowing all of the criteria and factors that are necessary for the IRS to consider and ultimately grant tax relief. This is the case because the last thing that you want is for the IRS to assess a tax liability that you are not responsible for and then commence collection and possibly enforcement action against you.