IRS Eases the ‘Innocent Spouse’ Rules

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IRS Eases the “Innocent Spouse’ Rules

September 2011

Does one spouse have to pay the tax resulting from a fabrication or omission by another spouse on a jointly filed tax return? It depends. If the spouse qualifies, he or she may be able to avoid personal tax liability under the “innocent spouse” rules.

The tax relief isn’t automatic but the IRS is loosening the reins a little. In a new ruling, the tax agency announced it is eliminating a strict timing restriction in the rules. (IRS Notice 2011-70)

This change is effective immediately. What’s more, the IRS has indicated that more favorable tax changes are on the way.

Background: As a general rule, married taxpayers benefit overall by filing a joint tax return on the federal level, especially if one spouse earns significantly more than the other. Filing jointly may also help the couple maximize certain income tax deductions and credits.

But joint filing status comes with a catch. Each spouse is “jointly and severally” responsible for any tax, interest and penalties attributable to the return. And this liability continues to apply even if the couple gets a divorce or one spouse dies.

In other words, the IRS may try to collect the full amount due from one spouse, even if all the income reported on the joint return was earned by the other spouse.

However, the tax law provides tax relief for an “innocent spouse.” Under these rules, one spouse may not be liable for any unpaid tax and penalties, despite having signed the joint return.

In the past, the IRS has imposed the following requirements:

  • The spouses must have filed a joint return that has an understatement of tax;
  • The understatement of tax must be due to erroneous items of one spouse;
  • One spouse must establish that at the time the joint return was signed, he or she did not know — or have reason to know — there was an understatement of tax;
  • Taking into account all of the facts and circumstances, it would be unfair to hold one spouse liable for the understatement; and
  • The relief is requested within two years after the IRS first began its collection activity against the taxpayer.

For this purpose, “erroneous items” are defined as any deduction, credit or tax basis incorrectly stated on the return, as well as any income not reported. (See right-hand box for more of the factors considered.)

New rules: The IRS has announced that it will no longer apply the two-year limit on collection activities to new requests or for requests it is currently considering. (This is the last requirement on the list above.) If a request for innocent spouse relief was previously denied because of the two-year limit, a taxpayer may be able to reapply for tax relief. Your tax adviser can help with necessary paperwork.

This change will be incorporated into new regulations that the IRS intends to issue shortly. The new regulations are expected to include other provisions that will make it easier to qualify under the innocent spouse rules.

Notes: By law, when one spouse applies for innocent spouse relief, the IRS must contact the other spouse or former spouse. There are no exceptions even for victims of spousal abuse or domestic violence.

Courts have traditionally not been generous about granting innocent spouse relief. Also, be aware of possible tax repercussions under state laws. The best approach is for spouses to be fully appraised of their situations before tax returns are filed.

 

What Does the IRS Consider?

All of the facts and circumstances are considered in determining whether it’s inequitable to hold a spouse liable for taxes due on a jointly filed tax return. Some of the factors considered include:

  • The taxes owed are attributed to one spouse or ex-spouse.
  • The couple is no longer married.
  • One spouse thought the other would pay the taxes on the original return.
  • There was an IRS audit and one spouse didn’t know about the items changed.
  • One spouse was deserted.
  • A financial hardship would be suffered by one spouse if he or she were required to pay the tax. The individual would not be able to pay for basic living expenses such as food, shelter, and clothing.
  • One spouse did not significantly benefit (above normal support) from the unpaid taxes.
  • One spouse suffered abuse during the marriage.

In addition, the IRS examines the educational background and business experience of the spouse claiming relief, as well as other factors.