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If spouses file a joint tax return, each spouse is responsible for the information on the return, and the mistakes or omissions made by the other spouse. You need to be aware of these responsibilities and the possible consequences related to filing your taxes as your divorce proceeds. However, the innocent spouse rules may be available and may permit one spouse to be relieved from the usual joint and several liability for taxes, interest and penalties that result from the return. The Internal Revenue Code (IRC) § 6015 provides three possible avenues of relief:
- A general “innocent spouse” provision offering relief to all joint filers
- A proportionate relief provision allowing divorced or certain legally separated spouses to limit their joint and several liability
- Equitable relief
In addition to these relief provisions, IRC § 66 provides relief from tax liability resulting from community property income in some cases.
General Provision for Relief Available to All Joint Filers
All joint filers are entitled to seek relief from joint and several liability if:
- A joint return is filed
- There is an understatement of the tax owed that can be traced to one spouse’s errors or omissions on the return
- The other taxpayer-spouse filing the return establishes that he or she did not know, and had no reason to know, that there was such an understatement of tax
- Considering all facts and circumstances, it is inequitable or unfair to hold the innocent spouse liable, and
- The spouse elects the benefits of the innocent spouse provisions within two years after the date that the IRS began collection activities against the innocent spouse
If these conditions are met, the innocent spouse may be relieved of liability for tax, interest, penalties and other additions to the tax for that year to the extent that liability can be attributed to the understatement.
The most common issue that arises under these rules is whether the innocent spouse has constructive or actual knowledge of the understatement of the tax owed or the erroneous item causing it
In a case involving the omission of income, the focus is on whether the spouse who is seeking innocent spouse relief knew or had reason to know of an understatement of tax if he or she knew of the transaction that gave rise to the understatement. So, for example, relief can be denied when the relief-seeking spouses knew about the income but did not know it was taxable.
In cases involving deductions, the more the relief-seeking spouse knows about a transaction, the more likely it is that he or she will know or have reason to know that the deduction arising from that transaction may not be valid, and so innocent spouse relief will be denied.
A duty to inquire may arise when the relief-seeking spouse has notice – a reason to believe or suspect – that a particular deduction could result in a substantial understatement. The failure to inquire may result in the constructive knowledge of the understatement. That is, it will be presumed that the relief-seeking spouse knew about the understatement. Factors to be considered in determining whether the spouse had reason to know of the understatement or had a duty to inquire include:
- The spouse’s level of education
- The spouse’s involvement in the family’s business and financial affairs
- Spending habits that appear lavish or unusual when compared to the family’s past levels of income, standard of living and spending patterns and
- The non-innocent spouse’s evasiveness and deceit concerning the couple’s finances
Another matter that arises in the application of the general innocent spouse relief provision is the equity, or fairness, of holding the relief-seeking spouse liable. The critical factors here are:
- Whether there has been a significant benefit to the spouse claiming relief. Normal support is not considered a “significant benefit” for these purposes, and
- Whether the failure to report the correct tax liability on the joint return results from concealment, dishonesty, or any other wrongdoing on the part of the other spouse.
Proportionate Relief Provision
“Proportionate relief” under the innocent spouse rules allows divorced and certain separated taxpayers to limit their tax liability. It operates by means of an election: the relief-seeking spouse elects to use the provision, and his or her liability is limited to the amount that is properly allocable or traceable to him or her. The electing spouse bears the burden of proving how much of any deficiency is traceable to him or her.
To be eligible to elect this relief, these requirements must be met:
- A joint return must be filed
- At the time the election to seek the relief is filed, either (1) the spouse seeking relief must no longer be married to, or must be legally separated from, the other joint filing spouse, or (2) the spouse seeking relief was not a member of the same household as the other spouse at any time during the 12-month period ending on the date the election is filed, and
- The innocent spouse elects this relief within two years after the date that the IRS began collection activities against him or her
There are some noteworthy instances when the election for proportional relief will be denied:
- When spouses have engaged in certain fraudulent transfers of property between themselves
- When a tax deficiency resulted and the spouse seeking relief had actual knowledge when signing the return of the item that gave rise to the deficiency. However, this particular restriction does not apply if the spouse seeking relief signed the return under duress, such as a threat.
Equitable Relief Provision
Equitable relief may be available for innocent spouses if relief is not available under the other innocent spouse provisions of IRC § 6015. Generally stated, if, taking into account all facts and circumstances, it is inequitable, or unfair, to hold an individual liable for unpaid tax or deficiency, the IRS may relieve an individual of all or a portion of that liability.
Eligibility for equitable relief requires that:
- The requesting spouse must have filed a joint return for the taxable year for which he or she seeks relief
- Relief is not available to the requesting spouse under the general innocent spouse or the proportionate relief provisions
- The requesting spouse must apply for relief no later than two years after the date of the IRS’s first collection activity with respect to the requesting spouse
- No assets were transferred between the spouses as part of a fraudulent scheme by the spouses
- The non-requesting spouse did not transfer disqualified assets to the requesting spouse
- The requesting spouse did not file (or fail to file) the return with fraudulent intent, and
- The income tax liability from which the requesting spouse seeks relief is attributable or traceable to an item of the non-requesting spouse, unless; (1) the item is attributable to the requesting spouse solely due to the operation of community property law; (2) the requesting spouse has only nominal ownership in the item; (3) the non-requesting spouse misappropriated funds intended for the payment of the tax, and the requesting spouse did not know or have reason to know of the misappropriation; or (4) the requesting spouse has been subject to abuse not amounting to duress
For unpaid income tax liability reported on a joint return, the IRS will ordinarily grant equitable relief if:
- On the date of the request for relief, the requesting spouse is no longer married to, or is legally separated from, the non-requesting spouse, or has not been a member of the same household as the non-requesting spouse at any time during the 12-month period ending on the date of the request for relief
- On the date the requesting spouse signed the joint return, the requesting spouse had no knowledge or reason to know that the other spouse would not pay the income tax liability, and
- The requesting spouse will suffer economic hardship if the IRS does not grant relief
Even so, taxpayers who do not qualify for equitable relief under those conditions may still be eligible for relief. In determining whether to provide relief, the IRS will consider the following nonexclusive factors, with no single factor being determinative or decisive of the matter:
- Whether the requesting spouse is separated (whether legally separated or living apart) or divorced from the non-requesting spouse. A temporary absence is not considered a separation
- Whether the requesting spouse would suffer economic hardship if the IRS does not grant relief from the income tax liability
- Whether the requesting spouse had knowledge or reason to know of either the income tax liability that was properly reported or not paid, or of an item giving rise to a deficiency
- Whether the non-requesting spouse has a legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement
- Whether the requesting spouse received significant benefit (beyond normal support) from the unpaid income tax liability or item giving rise to the deficiency
- Whether the requesting spouse has made a good faith effort to comply with income tax laws in the taxable year(s) to which the request for relief relates
Some factors that, if present, will weigh in favor of equitable relief, but will not weigh against equitable relief if not present, include:
- Whether the non-requesting spouse abused the requesting spouse. A history of abuse by the non-requesting spouse may mitigate a requesting spouse’s knowledge or reason to know
- Whether the requesting spouse was in poor mental or physical health on the date the requesting spouse signed the return or at the time the requesting spouse requested relief
A spouse seeking equitable relief must file Form 8857, Request for Innocent Spouse Relief (and Separation of Liability, and Equitable Relief), or other similar statement signed under penalties of perjury (a promise to tell the truth or suffer the consequences of lying). The form must be filed within two years of the first collection activity against the requesting spouse.
Special Rules for Community Income
IRC § 66 provides rules for the treatment of community income. Usually, absent a separate property agreement, if spouses in a community property state file separate returns, each spouse reports one-half of the community’s income. There are several exceptions to this general rule that may provide relief to spouses in community property states.
The first exception relates to spouses living apart. If the following requirements are met, the community income is treated in accordance with IRC § 879:
- Two parties are married at any time during a calendar year
- They live apart at all times during that calendar year
- They do not file a joint return with each other for any tax year beginning or ending in that calendar year
- One or both parties has earned income that is community income, and
- No portion of that earned income is transferred between the individuals before the close of the calendar year
The second exception allows the IRS to disregard community property laws as to any income if one of the spouses acted as if he or she were solely entitled to that income and failed to notify the other spouse of the nature and amount of that income before the due date (including extensions) for the return for the year in which the income was derived. The effect of this exception is that community income is treated solely as the gross income of the ”entitled-acting” spouse.
The third exception is an equitable one where an item of community income is assigned solely to the other spouse if:
- The relief-seeking spouse does not file a joint return for a taxable year
- The relief-seeking spouse does not include in gross income for that year an item of community income that would be includible in the gross income of the other spouse under IRC § 879(a)
- The relief-seeking spouse did not know, and had no reason to know, of that item of community income, and
- Taking into account all facts and circumstances, it would be inequitable to include that item in the relief-seeking spouse’s gross income
Even if these requirements are not met, equitable relief may be available still if it is nevertheless inequitable to hold the relief-seeking spouse liable for any unpaid tax or deficiency attributable to an item of community income. To seek relief this other equitable relief, a relief-seeking spouse must file Form 8857.
Question for Your Attorney
- Which Innocent Spouse provision to I fit under, if any?
- What evidence do I need to gather to show that I qualify under the Innocent Spouse rules
- I originally lived in a separate property state and then moved to a community property state. How does IRC §66 affect me