Innocent Spouse Relief

When a married couple files a joint tax return, both taxpayers are jointly and severally liable for any taxes owed and any penalties or interest assessed. This is true even if the couple later divorces or if one spouse was the sole income earner. Section 6015 of the Internal Revenue Code provides a few avenues of relief for a spouse who is inequitably held responsible for the other spouse’s error: traditional innocent spouse relief in § 6015(b), separation of liability relief in § 6015(c), and equitable relief under § 6015(f).

Innocent Spouse Relief

Section 6015(b) is the original form of innocent spouse relief. The prerequisites for innocent spouse relief are:

• The couple filed a joint return
  • If there was no joint return, there is no ground for innocent spouse relief
• The joint return contains an error leading to an understatement of tax
• The understatement is based on the non-requesting spouse’s income or other item
  • A spouse is not “innocent” if the understatement is based on his or her own income, deductions, or credits, even if the other spouse prepared the return.
• At the time the return was filed, the spouse claiming relief didn’t know or have reason to know that there was an understatement
  • This has been interpreted to mean that the innocent spouse had no knowledge of the transaction related to the erroneous item. It does not include mere ignorance of the law
  • However, merely signing the return does not disqualify a spouse from innocent spouse relief
  • Reason to Know
    • The Tax Court has adopted the Ninth Circuit’s test stated in Price v. Commissioner, 887 F. 2d 959, 965 (9th Cir. 1989): “A spouse has ‘reason to know’ of the substantial understatement if a reasonably prudent taxpayer in her position at the time she signed the return could be expected to know that the return contained the substantial understatement.”
    • The Pricecourt also listed several factors to consider when determining whether a spouse had reason to know of the understatement: “(1) the spouse’s level of education; (2) the spouse’s involvement in the family’s business and financial affairs; (3) the presence of expenditures that appear lavish or unusual when compared to the family’s past levels of income, standard of living, and spending patterns; and (4) the culpable spouse’s evasiveness and deceit concerning the couple’s finances.”
  • Imposing the tax on the requesting spouse would be inequitable
    • Usually this comes down to whether the spouse claiming relief benefitted from the relevant understatement
    • Courts also consider “whether the failure to report the correct tax liability on the joint return results from concealment, overreaching, or any other wrongdoing on the part of the other spouse.” Jonson v. Comm’r, 118 T.C. 106, 119 (T.C. 2002)
  • Election for relief is made within two years of the IRS’s first collection activity
    • Per 26 C.F.R. 1.6015-5, only four actions are considered a “collection activity,” triggering the two-year period: (1) a § 6330 notice of intent to levy and right to request a collection due process hearing; (2) an offset of an overpayment of the requesting spouse against the joint income tax liability under § 6402; (3) the filing of a suit by the U.S. against the requesting spouse for the collection of the joint tax liability; and (4) the filing of a claim by the U.S. to collect the joint tax liability in a court proceeding in which the requesting spouse is a party or which involves property of the requesting spouse
    • The Regulations specifically exclude “a notice of deficiency; the filing of a Notice of Federal Tax Lien; or a demand for payment of tax”

Separation of Liability

Another way for a spouse to be relieved of liability for a spouse’s incorrect tax return is separation of liability relief under § 6015(c). If separation of liability relief is granted, any deficiency assessed is allocated between the two spouses, and the requesting spouse is only liable for the portion allocated to him or her.

The requirements to qualify are:

• The couple filed a joint return
• The requesting spouse meets one of the following:
  • Divorced or legally separated from the spouse with whom the joint return was filed
  • Widowed, or
  • Hasn’t been a member of the same household as the spouse with whom the joint return was filed at any time during the 12-month period ending on the date relief was requested
• An item of the non-requesting spouse created an understatement of tax
  • Like traditional innocent spouse relief, separation of liability relief does not apply to an unpaid tax
  • The requesting spouse may also have items that led to an understatement, but he or she will be liable for the portion of taxes related to the items allocable to him or her
• Election for relief is made within two years of the IRS’s first collection activity

Certain things will disqualify the requesting spouse from receiving separation of liability:

• Actual knowledge of the item creating the deficiency
  • This does not require knowledge of mistreatment; the requesting spouse is disqualified for simply knowing about the relevant item
  • If the requesting spouse was a victim of spousal abuse or domestic violence, and fear of retaliation led to not challenging the understatement, he or she may still qualify for relief
• Assets were transferred between the spouses to avoid payment of the tax
• Fraud by one or both of the spouses

Equitable Relief

If a taxpayer does not qualify for relief under § 6015(b) or (c), they may request equitable relief under § 6015(f). This form of relief applies to both understatement and underpayment of taxes. In Revenue Procedure 2013-34 and Publication 971, the IRS listed threshold requirements for equitable relief which, if met, led to a streamlined determination. The threshold requirements are:

• The couple filed a joint return
• The requesting spouse is not eligible for traditional innocent spouse or separation of liability relief
• The request is filed before the collection statute has expired (if requesting relief from an unpaid liability) or before the § 6511 limit expires (if requesting a refund or credit for amounts paid)
• No assets were transferred between the spouses as part of a fraudulent scheme
• The non-requesting spouse did not transfer property to the requesting spouse for the main purpose of avoiding tax liability
• The requesting spouse did not knowingly participate in the filing of a fraudulent tax return or fail to file a tax return for the purpose of defrauding the IRS
• The liability from which the spouse is requesting relief is attributable, in full or in part, to an item of the non-requesting spouse
  • If the liability is attributable, in full or in part, to the requesting spouse, such spouse can only be relieved of liability for the portion attributable to the non-requesting spouse
  • Exceptions
    • The item is attributable to the requesting spouse only because of community property law
    • The requesting spouse can rebut the presumption that an item titled in his or her name is attributable to such spouse
    • The requesting spouse did not know or have reason to know that the non-requesting spouse misappropriated the funds intended to pay the tax for his or her own benefit
    • The requesting spouse can prove he or she was the victim of domestic violence or spousal abuse before the return was filed, and the requesting spouse did not challenge the treatment of any items on the return due to fear of retaliation
    • Despite the fact that the item is attributable to the requesting spouse, the non-requesting spouse’s fraud led to the error

If those threshold requirements are met, the IRS will grant relief if the requesting spouse:

• Is no longer married to the non-requesting spouse, is legally separated from the non-requesting spouse, or has not been a member of the same household as the non-requesting spouse during the past year
• Would suffer economic hardship if relief is not granted
• Did not know or have reason to know of the deficiency, or know or have reason to know that the non-requesting spouse would not or could not pay the underpayment
  • This factor is satisfied if the non-requesting spouse abused the requesting spouse, and the requesting spouse did not challenge a known misstatement or underpayment because of fear of retaliation

If any of the threshold requirements or the streamlined factors are not satisfied, the requesting spouse may still be granted relief if, considering all facts and circumstances, it would be inequitable to hold the requesting spouse responsible. Factors to consider are:

• Whether the spouses are still married
• Economic hardship
  • If the requesting spouse would not suffer economic hardship, this factor is neutral and does not weigh against granting relief
• Actual knowledge or reason to know
  • As with the same streamlined factor, abuse weighs heavily in favor of granting relief
• Legal obligation to pay the tax liability, such as via divorce decree
  • This factor is neutral if the requesting spouse knew, at the time of signing the decree or other document, that the non-requesting spouse would not pay the liability
• Significant benefit, beyond normal support, from the unpaid or underpaid tax
• Good faith efforts to comply with income tax laws in the years following the tax year at issue
• Mental or physical health at the time the return was filed

Innocent spouse relief is a useful tool when it would be inequitable to hold a taxpayer liable for tax debts based on the income or actions of a spouse or former spouse. The IRS is especially likely to grant these forms of relief if the requesting taxpayer was abused by his or her spouse at the time of or before filing the tax return at issue. In cases where such abuse can be proven, the reduction in tax liability can be a huge weight lifted from the abused spouse; however, it may be difficult to convince the requesting spouse to recount the abuse he or she suffered. Therefore, it is important to gather as much evidence as possible to support each relevant consideration.

Representation in Tax Audits & Appeals

Need assistance in managing the audit process? Freeman Law’s team of attorneys and dual-credentialed attorney-CPAs regularly represents taxpayers before the IRS and Texas Comptroller. Our team also provides tax return-related representations and helps taxpayers navigate state tax laws. Our Firm offers value-driven services and provides practical solutions to complex issues. Schedule a consultation or call (214) 984-3000 to discuss our tax representation services.