Innocent spouse relief is traditionally relief from tax liability when a spouse is left holding the bag, when they had no idea there was a problem to begin with. The IRS will grant innocent spouse relief if the circumstances of your situation meet the factors below. It is important to understand that some factors are stronger than others, and the IRS makes decisions on a case by case basis. The actual Internal Revenue Code section states the following:
IRC § 6015 (b). (1) In general. Under procedures prescribed by the Secretary, if—
(A) a joint return has been made for a taxable year;
(B) on such return there is an understatement of tax attributable to erroneous items of one individual filing the joint return;
(C) the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement;
(D) taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to such understatement; and
(E) the other individual elects (in such form as the Secretary may prescribe) the benefits of this subsection not later than the date which is 2 years after the date the Secretary has begun collection activities with respect to the individual making the election, then the other individual shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent such liability is attributable to such understatement.
In short, when a taxpayer is held jointly liable because they were on a joint return with their spouse, or ex-spouse, they will be granted innocent spouse relief if they did not know about any tax understatements and it would be inequitable to hold that taxpayer liable for the resulting liability, and they request for innocent spouse relief within two years from the date when the IRS began trying to collect this liability.
Parts (A), (B), and (E) are relatively straightforward. The taxpayer needs to have liability from filing a joint return, their spouse understated their tax liability on that return, and they need to request relief within two years of the IRS’s initiation of collection activities for this liability. Parts (C) and (D) are where most of the questions come from our clients. It is also where the bulk of analysis comes into play when considering whether innocent spouse relief is the best option for our individual clients.
Part C. Taxpayer’s knowledge of the tax understatement:
Part C of the innocent spouse relief statute has the IRS consider whether the taxpayer knew, or had reason to know, about the tax understatement at the time the tax return was signed. In fact, this even applies if you knew only a portion of the return was understated; in this case the IRS will not grant relief for that portion of the item. You are considered to have had actual knowledge of an erroneous item if:
- You knew unreported income was received. (even if there was no cash receipt)
- You knew of the facts that made an incorrect deduction or credit unallowable.
- For a false or inflated deduction, you knew either there was no expense or that the expense was exaggerated
In general, however, it is enough to know that unreported income was received. You do not even need to understand why it was inaccurate to be disqualified for relief; knowledge that the income was received is enough. For example, let us say that you knew that your spouse received dividend income which was left off the return; and you signed off on the joint return anyway because you mistakenly thought that dividend income was not taxable. Your knowledge that the underreported income was received is enough to disqualify you from relief, regardless of whether you knew it was taxable or not.
Part C states that the requesting spouse would be disqualified if they had reason to know about the understated liability. In other words, the IRS is not required to show that you do have actual knowledge; they can infer that you knew. The IRS determines does this by considering these factors:
- Nature of the erroneous item and the amount of the erroneous item relative to other items.
- The couple’s financial situation.
- The taxpayer’s educational background and business experience.
- Whether the taxpayer failed to ask, at or before the time the return was filed, about items on the return, or omitted from the return, that a reasonable person would question.
- Whether the erroneous item represented a departure from a recurring pattern reflected in prior year’s returns.
If your spouse owns a business and they understated their tax liability, but you had no knowledge of it; you may be a potential candidate for Innocent Spouse Relief. Again, you do not actually had to have known to be disqualified. You relief under Innocent Spouse could be compromised if the IRS determines you should have been aware. This could be something as simple as not noticing that your spouse left off a source of income that was normally included on the return previous years. Under similar facts, the IRS will likely claim that you had reason to know; and so you would be denied Innocent Spouse Relief in a case like this. However, there are other provisions that many fail to pursue.
Exception to Lack of Knowledge Requirement (Spousal Abuse)
Prior to discussing the two other provisions, there is an important exception to the lack of knowledge requirement. In fact this exception almost qualifies as a type of relief in itself. This exception is spousal abuse. The IRS takes this situation into serious consideration and it weighs very heavily in favor of granting relief to the taxpayer. The Internal Revenue Manual, which is the manual used by IRS agents when reviewing innocent spouse claims, states the following:
If a RS (requesting spouse) establishes he or she was the victim of domestic abuse prior to the time the return was signed, but did not sign the return under duress (which might invalidate the joint filing status election), and as a result of the prior abuse did not challenge any of the items on the return for fear of retaliation, the actual knowledge and reason to know requirement of IRC 6015(b) will not apply.
This exception was not necessarily made to punish the abusive spouse, but because of how abuse can affect the power dynamics in a relationship. The lawmakers wrote this exception with an understanding of how emotional and physical abuse in a relationship can make it difficult, if not impossible, to challenge or question their abuser. As such, they did not want abused spouses to be held responsible for making a decision to not ask questions when a person in a different relationship would likely have felt comfortable doing so.
Part D. Equitability
Part D of the innocent spouse relief statute asks whether or not it is fair to hold the taxpayer liable. This consideration is another factor test and is based on the unique facts and circumstances surrounding the taxpayer’s situation. The factors include the following:
- Whether a significant benefit was received by the taxpayer (in excess of normal support).
This factor looks at how much the taxpayer benefitted from the income and reporting practices of their spouse. If the spouse kept the money hidden and separate so the taxpayer didn’t get any use out of the money, then this would be a factor that weighs in favor of getting relief. If, on the other hand, the spouse was sharing all of his or her income with the taxpayer and the taxpayer was able to live beyond their means because of the spouse’s income and reporting practices, then this factor would weigh against getting relief.
- Education level of the taxpayer.
This factor looks at how sophisticated the taxpayer was. A taxpayer with a G.E.D. with English as a second language would be deemed to have a harder time understanding the reporting rules compared to a CPA or a CEO with an MBA. With this in mind, if you are considered “uneducated,” this factor will weigh in favor of relief, whereas if you are considered to be highly educated, this factor will weigh against relief.
- Involvement of the taxpayer in household finances.
The IRS uses this factor to look into how much the taxpayer should have been able to control the proper filing and tax reporting. A taxpayer who had no insight into their family’s total income, had no access to their family’s bank accounts, and relied on an “allowance” would be considered to be not involved in his or her family’s household finances. On the other hand, a taxpayer who was aware of their family’s total income, had unrestricted access to their bank accounts, and even handled their bookkeeping would be considered heavily involved in their household finances. The more involved the taxpayer is, the more this factor weighs against relief.
- Whether the non-requesting taxpayer deserted the taxpayer.
The considerations and implications of this factor is a bit nuanced. The policy thought behind this factor is to consider taxpayers who were left with nothing while their spouses kept all of the money and benefits of their underreporting. A straightforward example of this would be when a spouse leaves the country and the taxpayer is left to deal with the spouses’ liabilities. A situation this situation would weigh in favor of relief.
- Health of the taxpayer at the time the return was signed and at the time relief was requested.
From a policy standpoint, when a taxpayer has bad health and is dealing with significant health problems, then it is believed that that individual wouldn’t be as aware or concerned about their filing requirements. This is why the health of the taxpayer is a factor when considering innocent spouse relief. Under this factor, if a taxpayer is suffering from health problems, then this will be favorable for innocent spouse relief.
- Economic hardship of the taxpayer.
This factor is one that will not weigh against the taxpayer. It is a favorable factor if the taxpayer is currently or would experience economic hardship as a result of paying the joint tax liability. The Internal Revenue Manual has stated that this factor will not weigh against a taxpayer if they would not experience economic hardship or are not already experiencing economic hardship.
- Alleged abuse of taxpayer or whether the taxpayer was subject to financial control of their spouse.
This factor goes back to Part C’s exception. Abuse and financial control are important factors that show whether the taxpayer had the ability to correctly report his or her family’s tax obligations. Again, this factor goes into the power dynamics within the relationship, if the taxpayer was in a submissive position, then they would not be able to ensure that their spouse was properly reporting their family’s tax obligations.
- Whether the taxpayer’s spouse was deceitful toward the taxpayer.
When a spouse is deceitful, then the taxpayer who trusts their spouse could be inequitably held responsible for joint tax liability. Therefore, this factor is meant to consider whether the taxpayer was lied to during their relationship in regard to their financial position and actual income. It is important to note that the deceit considered is not always limited to financial deceit. A spouse who has a history of infidelity, for example, is showing a history of not being truthful, and these deceitful tendencies could be used to show that the taxpayer was often lied to; as such, it wouldn’t be unreasonable to think that the taxpayer was also lied to in regards to their spouse’s finances. An open an honest relationship between the taxpayer and their spouse would weigh against tax relief, and a relationship where the taxpayer has been lied to often would weigh in favor of relief.
- Whether the taxpayer received a tax benefit on the return from the understated tax.
Lastly, you must also show that when you signed the return you had no knowledge of the inaccurate filing and that you did not gain a significant benefit from it. This requirement is tricky, because the IRS considers a significant benefit to be any benefit in excess of normal support. The term “normal support” is relative to the taxpayer’s situation.
The no-benefit factor can be difficult to get around. This is because often times when one spouse is understating their liability, the other spouse usually also receives a financial gain they would not have otherwise received; even if that benefit is indirect. In other words, an increase in the cashflow to the household could be viewed as a benefit to the spouse requesting release, even if they were unaware of their significant other’s understatement of liability. The IRS will not grant Innocent Spouse Relief in these cases. Although many of our clients have had success with Innocent Spouse Relief; generally speaking, taxpayers usually have better results requesting a partition of the liability.
The request for relief must be made within two years from the date of the first collection activity with respect to the RS.