Sam Brotman, JD, LLM, MBA July 2, 2020 16 min read

Innocent Spouse Relief

 

Theory of IRS Innocent Spouse Relief

Because of certain benefits that filing jointly allows, many married taxpayers elect to file joint returns. However, filing a joint return carries the added burden of both parties being liable for the tax due. In addition, under the IRS code, married taxpayers who file jointly are each liable for any additions to the tax, penalties, or interest associated with the account.[1] 

This is a concept in the law known as joint and several liability, meaning that the spouses are responsible for any tax liabilities together (jointly) but can be held responsible for them as individuals (severally).

From a practical standpoint, the IRS does not have the resources to make the determination on its own of who is an innocent spouse. This would require the IRS to review thousands upon thousands of joint collection accounts and make individual determinations as to whom should be assessed an increase in liability. 

This is why when a married couple signs their tax return, both parties are attesting to the accuracy of the tax that is owed. As such, if the IRS finds an increase in the amount of tax that is owed, it holds both parties equally responsible for the increase. 

This carries two implications. First, it places the burden on the parties to determine how to pay the liability, rather than the IRS. Second, since both parties are considered responsible for the liability, the IRS can proceed with collection action against either one of them then just limiting itself to one spouse.

Courts have supported the IRS policy of targeting either spouse for a balance that is due. Spouses, even if both agree, may not insist that the IRS first try to collect from one spouse before going after the assets of the other.[2] In addition, courts have also held that the IRS is not bound by divorce decrees and other otherwise legally binding agreements reached by the spouses. [3] 

The rationale behind this is that it would be unfair to limit the collection rights of the IRS by virtue of an agreement that it was not a party to. [4] However, the IRS code recognizes that it is not fair to hold innocent spouses responsible for liabilities in all circumstances. 

Thus, it created several avenues where taxpayers can seek relief from IRS collection activities. Although commonly known as innocent spouse relief, these actually constitute three different ways that taxpayers can absolve themselves from past liability owed.

[1] IRC 6013(d)(3)

[2] Bloom v. United States, 272 F.2d 215 (9th Cir. 1959)

[3] Pesch v. Comm’r, 78 T.C. 100 (1982) (it is clear that a taxpayer cannot avoid such liability through the simple medium of an agreement to which the IRS is not a party.)

[4] Pesch v. Comm’r, 78 T.C. 100 (1982) (it is clear that a taxpayer cannot avoid such liability through the simple medium of an agreement to which the IRS is not a party.)

What is IRS Innocent Spouse Relief?

This is the most commonly known form of relief, which can absolve a taxpayer from liability if their spouse or former spouse either did not report income, made an error in the calculation of income, or misapplied any deductions or credits that they were not entitled to. 

Innocent Spouse Relief relieves a person of any tax, interest, and penalties associated with the account based on the preceding errors. However, the taxpayers are still held jointly and severally liable for any amounts that are not granted innocent spouse relief. The following requirements must be met in order for IRS innocent spouse relief to be granted.

  1. You filed a joint return
  2. There is an understated tax on your return, (i.e., the IRS determines that your total tax should be more than the amount that was actually shown on your return).
  3. That amount is due to erroneous items of your spouse
  4. You can show that when you signed the joint return you did not know, and had no reason to know, that the understated tax existed (or the extent to which the understated tax existed (Absence of “Actual Knowledge” or “Reason to Know”).
  5. Taking into account all the facts and circumstances, it would be unfair to hold you liable for the understated tax. (“Unfairness”).

What is Actual Knowledge?

The actual knowledge or reason to know test is governed by the principle that the IRS will not deem you an innocent spouse if you were aware of the tax deficiency at the time the return was filed. That knowledge, in the government’s eyes, would make you an accomplice to the understatement of tax. 

Because proving an individual’s actual knowledge can be difficult, the government eased its burden and only has to prove that a person should have had “reason to know” of the deficiency. Reason to know is often referred to as willful blindness in other areas of the law and the IRS will consider all the facts and circumstances surrounding a liability when determining whether innocent spouse relief should be granted. 

Among the things that the IRS will consider when determining actual knowledge for IRS innocent spouse relief purposes are:

  • The nature of the erroneous item and the amount of the erroneous item relative to other items
  • The financial situation of you and your spouse (or former spouse)
  • Your educational background and business experience
  • The extent of your participation in the activity that resulted in the erroneous item
  • Whether you failed to ask, at or before the time the return was signed, 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 years’ returns (for example, omitted income from an investment regularly reported on prior years’ returns).

[1] Tax Topic 205 – http://www.irs.gov/taxtopics/tc205.html

[2] IRS Publication 971

[3] IRS Publication 971

Actual Knowledge Versus Reason to Know

The main eligibility requirement for innocent spouse relief is whether you can show you did not know and had no reason to know, the tax was understated when you signed the return.

The “reason to know” test is applied to determine whether someone is eligible for innocent spouse relief because the IRS will not grant a reprieve if you knew there was a problem when the return was filed. Knowing would make you an accomplice to understatement of tax and ineligible for assistance.

Since it is all but impossible to prove a person’s knowledge, the court allows for proof that the person had “reason to know” of the issue, also known as willful blindness. If there is strong evidence that you should have known of the problem, you will not be allowed to cry innocent.

The IRS looks at several circumstances to determine whether there is an innocent spouse, including:

  • Type and amount of the error
  • Financial situation of both parties, even if divorced
  • Educational backgrounds and business experience
  • Extent of participation by each spouse in creating the error
  • Whether you asked about errors on the return, or items omitted from it, before or at the time of signing, that a reasonable person would ask.
  • Whether there is the appearance of a recurring pattern over the course of several prior tax returns of the same type and amount of error

Who Qualifies for Innocent Spouse Relief?

Obviously, the couple needs to file a joint return to be in consideration for innocent spouse relief; that is a given. Otherwise, there are three criteria the spouse must meet to qualify for relief.

  1. One of the taxpayers believes the understatement of tax was due to an error found later by one of the spouses.
  2. There is evidence that one spouse did not know about the error or that the tax was understated.
  3. One spouse believes he or she should not be held responsible for the understated tax once all the facts and circumstances have been taken into account.

Remember, the entire argument hinges on the concept of reason to know, not actual knowledge. Also, the IRS defines understated tax to mean that the total tax should be more than the amount shown on the return. The most common cause of understated taxes is unreported income, often from investments.

Understated taxes also result from calculating deductions incorrectly, reporting incorrect credit, or reporting on an incorrect tax basis.

There is a time limit on how long a spouse has to request relief. IRS Form 9968, Request for Innocent Spouse Relief, must be filed within two years from the date of the first attempt to collect the outstanding debt.

What is Included in the Rules for Relief?

The IRS includes both the time to file and the reference collection activities within the spouse relief rules. As stated before, the spouse seeking relief has two years from the first attempt by the IRS to collect the debt to file for relief under Form 8857. You should file as soon as you become aware of a tax liability that your spouse or former spouse should be responsible for.

The IRS looks at two rules for becoming aware of the liability.

Your qualification for the first rule is determined by examining your return and proposing to increase your tax liability. Certainly, if you received communication from the IRS stating you owe more money, you should be looking into your most recent tax filing activities. The second rule telling the IRS you should be aware of a problem is receiving a notice from the IRS labeled “Instructions for Form 8857.”

Collection activities can also initiate the two-year period. Rule number two above is one activity. Another is the IRS filing a claim on your behalf in a court proceeding you are party to. The IRS can file a claim involving your property, including the filing of bankruptcy.

The two-year period could be initiated when the U.S. files a suit against you to collect the joint liability, or the IRS may issue a notice of the agency’s intent to levy and your right to a Collection Due Process hearing based on the Internal Revenue Code guidelines.

Other notices include Letter 11, Final Notice of Intent to Levy, and Letter 1058, Notice of Intent to Levy.

Your Spouse Will be Contacted

In every case of request for innocent spouse relief, the IRS is required to contact your spouse regarding your claim, even if you have been a victim of spousal or domestic violence. The law states both spouses are to be involved in the process.

Marriage is built on trust. If your spouse trades on that trust by understating taxes on a joint return that you subsequently sign, you will be held liable for the entire amount of taxes due if the IRS finds out. If you can show you had no reason to know there was an issue with the return, you may be qualified for relief as an innocent spouse.

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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