It’s not uncommon in a marriage where one spouse is responsible for preparing the couple’s joint tax return and the other spouse signs off without reviewing it. After all, it’s their spouse and they’ve always done the taxes. They’re not going to do anything wrong, right?
Typically, when a married couple files a joint tax return, they are jointly and severally liable for the taxes and any interest or penalties that arise from that return, even if they later get divorced. This is true even if their divorce decree says one party is responsible for the debt and the other is not. Divorce decrees are entered by state judges, while taxes fall under federal law. Even if the divorce decree mandates that one spouse hold the other harmless from any tax debt that arose before the divorce, the IRS can still come after both spouses.
What do you do, then, if your spouse makes a major mistake, or even fraud, on a joint tax return and you had no idea? The IRS offers three types of relief: innocent spouse relief, separation of liability relief, and equitable relief.
Innocent spouse relief provides relief from additional tax owed on a joint tax return if your spouse/former spouse failed to report income, reported income improperly, or claimed improper deductions or credit and you did not know about the mistake. To qualify for innocent spouse relief, you must meet all three requirements:
1. You and your spouse/former spouse filed a joint tax return that has an understatement of tax (deficiency) that is solely attributable to your spouse/former spouse’s error – for example, if you get a notice that you owe back taxes from a prior year because your spouse, unbeknownst to you, only reported $40,000.00 in income but actually made $60,000.00 that year, and that is the only reason for the deficiency;
2. You prove that, at the time you signed the joint tax return, you didn’t know and had no reason to know about the error;
3. Considering all the facts and circumstances, it would be unfair to hold you liable for the error.
Innocent spouse relief must be requested within two years of the date the IRS first tried to collect the deficiency.
What constitutes knowing or having “reason to know” about the error? You “knew or had reason to know” of the error if you had actual knowledge of it or if a reasonable person in a similar circumstance would have known about it. You can also be found to have known about it if you make a deliberate effort to avoid knowing about the error to avoid liability, or if the property resulting in the error was jointly owned by you and your spouse/former spouse.
In determining whether you had “reason to know” about an error, several factors are considered, including:
1. Your level of education;
2. Deceit or evasiveness on the part of your spouse/former spouse;
3. How much involvement you had in the activity leading to the tax liability;
4. How much involvement you had in the marital business or household finances;
5. Your business or financial expertise; and
6. Whether there have been “lavish or unusual expenditures” compared to the past.
Separation of Liability Relief comes into play when an item was not reported properly on a joint tax return and provides for the separate allocation of any additional tax owed, making one spouse responsible only for the amount of tax allocated to you, as opposed to jointly and severally liable for all of it. This type of relief is available for joint returns and you must meet one of the following requirements:
1. You are divorced or legally separated from the spouse with whom you filed the joint return;
2. You are widowed; or
3. You have not lived in the same household as your spouse for at least a year before you request separation of liability relief.
Like Innocent Spouse Relief, Separation of Liability Relief must also be requested within two years of the IRS trying to collect the tax owed.
Generally, Separation of Liability Relief is not available when you had actual knowledge of the understatement of tax. Even where there is actual knowledge found, however, you may still qualify for relief if you were the victim of domestic violence before signing the erroneous tax return and you did not challenge the errors on the return for fear of retaliation.
Finally, there is Equitable Relief, which may apply if you don’t qualify for Innocent Spouse Relief or for Separation of Liability Relief. This is available where something was not properly reported on a tax return and this error is attributable to your spouse/former spouse, or if the amount of tax reported on the tax return is correct but the tax owed was not actually paid. This type of relief must be requested during the period the IRS can collect the tax from you.
To qualify for equitable relief, it must be found that under all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax or the underpayment of tax. If the relief you’re requesting is 100% based on an item of your spouse/former spouse or unpaid taxes from your spouse/former spouse’s income, total relief will be considered. If, however, the tax liability is only partially attributable to your spouse/former spouse, relief will likely only be granted to you for the portion of the liability attributable to your spouse/former spouse.
These types of relief are not an Injured Spouse claim, which can arise when there is a joint tax return filed but one spouse owes past-due child support, federal agency non-tax debts, state income tax obligations, or certain unemployment compensation debts. In those cases, the injured spouse may be entitled to request a portion of their refund back.
Any of these types of relief are not available and will not be granted if any of the following apply:
1. The IRS can prove that you and your spouse/former spouse transferred assets to each other as part of a fraudulent scheme, whether you planned to defraud the IRS or any other third party;
2. The IRS can prove that at the time you signed the joint tax return, you had actual knowledge of the errors (and the domestic violence exception doesn’t apply); or
3. The IRS can prove that your spouse/former spouse transferred property to you to avoid tax or paying taxes.
This blog is only intended as a general overview of a possible option available under the law and should not be relied upon in taking a legal position or with the IRS. If you believe that you may be entitled to one of these forms of relief, you should contact an experienced tax attorney to discuss your options and potential relief.