Divorcing Joint Tax Liability:
A Primer on Innocent Spouse Relief
You negotiated property division, finalized the divorce, moved out, maybe even got a pet to help you get readjusted into single life, and thought you were finally ready to move on. Not so fast! says the IRS. Despite formally severing all relationships with your ex, you remain liable for all tax liabilities (belonging to both spouses) for years in which you filed joint tax returns. If you’re like most married taxpayers, you file joint income tax returns to qualify for lower tax rates than those available for separate returns. The price you pay for the lower rate is assuming “joint and several” tax liability – meaning both spouses are liable for each other’s tax liability and any resulting penalties and interest. Usually, this is not a problem – particularly in “community property” states – since the money comes out of the same pot. However, things can get complicated for separating or separated couples.
For instance, you may have separated from your spouse, or are in the process of separation, and the IRS commences an audit of tax returns filed jointly for past year(s). Upon reviewing the audit results, you notice that the resulting deficiency and penalties are not from your tax items but belong to your ex. For a joint filed tax return, you’re liable all the same. Luckily, the IRS provides relief to the “innocent spouse” from joint tax liability in limited circumstances. As a threshold matter, innocent spouse relief is available only if the tax return for which relief is sought was filed jointly and relief is being sought within two years of IRS’ commencement of collection action. If these requirements are met, you must next determine which section of the Internal Revenue Code entitles you to relief.
Relief is available under §6015(b) if you’re not legally separated or divorced, upon showing the following: the understatement in tax is attributable to the erroneous tax item(s) of the other spouse; you did not know, and had no reason to know, of the understatement when you filed the joint return; and it is inequitable to hold you responsible for the understatement. In most cases, the knowledge element is difficult to overcome. In order to obtain relief, taxpayer must show by a preponderance of the evidence that he or she did not know, and had no reason to know, of the understatement. Obviously, this involves proving a negative: that not only you did not have actual knowledge about the understatement, but that you also did not have constructive knowledge.
In order to overcome this difficult burden of proof, the following non-exclusive list of factors must indicate your lack of actual or constructive knowledge:
- The nature of the erroneous tax item;
- Couple’s financial position;
- Requesting spouse’s financial and educational background;
- Requesting spouse’s participation in the activity which gave rise to understatement;
- Requesting spouse’s reasonable inquiries into the erroneous tax item;
- How the erroneous item was handled in past years’ tax returns.
If considering all the factors, it appears by a preponderance of the evidence that the requesting spouse had no reason to know of the understatement, he or she is entitled to relief from joint and several liability so long as the other conditions are also met.
If you’re legally separated, divorced, or living apart for at least twelve months, relief is available under §6015(c). Under this subsection, the requesting spouse’s liability for any tax deficiency assessed on the joint return will not exceed the portion of the deficiency properly allocable to him or her. In other words, the deficiency and penalties are pro-rated for each spouse based on tax items allocable to each spouse.
However, the burden of proof remains with the requesting spouse to establish the portion of the deficiency allocable to him or her. One important distinction under this subsection is that if the IRS demonstrates that the requesting spouse had actual knowledge of other spouse’s tax items giving rise to the deficiency, then relief is not available under this subsection. Compared to §6015(b), this subsection does not bar relief under a nebulous “reason to know” standard. But the IRS can still deny relief if it senses that the couple have colluded to frustrate the IRS’ ability to collect the tax due. This typically happens when the IRS can demonstrate that the couple have transferred assets between each other to protect them from the IRS.
Finally, for former or separated spouses who cannot seek relief under §6015(b) or §6015(c), for example if they have not been legally separated and have not lived separate and apart for at least twelve months, equitable relief is available under §6015(f). Under this subsection, relief is available if considering all the facts and circumstances, it is inequitable to hold the requesting spouse responsible for the deficiency in tax, or the underpayment of tax. Notably, subsection 6015(f) provides relief for the underpayment of tax, as well for any underreporting of tax, whereas subsections (b) and (c) provide relief only for the latter tax – that is, a deficiency resulting from adjustments made to tax items as reported on the couple’s filed return.
Request for innocent spouse relief can be made by filing Form 8857 with the IRS, which requests basic information about the claim. The IRS will review the information and render an administrative determination. If the IRS issues an unfavorable determination, it can be challenged by seeking review of the Office of Appeals, or by filing a Petition in Tax Court. If a Notice of Deficiency has been issued for a jointly filed return, one or both spouses can petition the Tax Court for review and raise innocent spouse relief as an affirmative defense to the IRS’ determination.
In the author’s experience, the IRS carefully scrutinizes innocent spouse relief requests. Oftentimes, the IRS will want to interview the spouses and/or third parties and may request court records to substantiate the claims made by the requesting spouse. Since the determination depends on a facts and circumstances analysis, the facts of the case should be thoroughly developed before seeking relief.
Fortunately for the taxpayer, the administrative process is relatively informal and straight forward – and often the last hurdle before complete separation – and frequently, freedom.