Describing the divorce process, a client once said that splitting assets in a divorce was like separating delicate strands of a spider’s web. Coming to terms with a divorce in general may at times feel like an impossible mess to unravel; let alone to later find yourself in further entanglement with the IRS. With the right guidance however, you can untangle the web of divorce dilemmas for good (at least from a tax perspective). This guide is made to help individuals navigate the issues of tax liability that relate to divorce.
Tax implications are not exactly at the forefront of our thought process when contemplating divorce; however, for many spouses it should be. After tying the knot, most couples choose to file their taxes under a “married filed joint” because of the particular incentives provided. After filing, a liability may be assessed; depending on a taxpayer’s financial circumstances and reporting inaccuracies.
When a taxpayer files alone, it is usually clear who should pay the liability assessed. However, it is not as obvious when a tax report is filed on behalf of two taxpayers. The applicable rule is not entirely intuitive to all and might even come as a shock to others. If a joint return is filed, the liabilities linked to this return are held joint and several between both taxpayers. (Internal Revenue Code, IRC 6013(d)(3)). This means you are both on the hook for the entire tax liability, until it is paid or released.
While the IRS has the ability to pursue both spouses to recover tax liabilities, an individual spouse may be relieved from joint return liability under certain circumstances. Thankfully there is no minimum amount that must be paid if you qualify for the exceptions to joint return liability. If you can make a solid case that you fall under an exclusion to liability, you just might make it out scot-free. We hope our guide helps you get out from under the thumb of the IRS; should you still find yourself in a bind, please feel free to reach out and schedule an appointment with senior counsel
Joint and Several Liability
For a clearer understanding of joint and several liability, please consider the analogy of an egg toss where each losing team pays the winners $10 dollars in total. In an egg toss, both teammates are individually responsible for keeping the egg intact. Regardless of whether player A makes a wobbly pass or player B fumbled the catch, if the egg is dropped the $10 must be paid up. If player A only has $3 dollars, joint and several liability means that player B can expect a visit from the winning team for the remaining $7.
Similar to the winning team in our example, the IRS does not care whether it collects the liability from taxpayer A or taxpayer B (or both); if they can collect the entire amount from you alone then they likely will. If you file a joint return with your spouse and generate $50,000 in taxes owed, both spouses are individually responsible for this $50,000 until it is paid. Again, one spouse could potentially foot the entire bill if the IRS deems necessary.
To add insult to injury, the IRS does not follow divorce decree arrangements. Meaning they will still go after both spouses for the entire amount due, even if the divorce judgement allocates tax liability to one spouse entirely. This will continue until the liability is paid or released. These liabilities often include and tax, interest, and associated penalties for every year under review. Fortunately, however, there are exceptions which may provide a spouse relief from liability.
When clients come in for tax consultation relating to their ongoing divorce, the first step taken is to determine whether it is possible to work with the former spouse to resolve the liability. While some may understandably hope to shoulder the task alone, here are a few reasons why working with a former spouse is usually the best first approach when available:
- Facilitates understanding––When both spouses are on the same page and fully understand the amount and reason for the liability they are also facing, they are much better equipped to handle that liability.
- Prevents miscommunication–– Being on the same page also helps intercept and correct misunderstandings which could otherwise be leveraged against you by the IRS.
- May help reduce amount owed–– The other spouse may have valuable information needed to reduce the liability owed overall or help vindicate you from liability.
That being said, it may not come as a shock to hear that spouses are not always willing to work together during and after a divorce. If your spouse had not been honest about finances during your marriage, you may not expect them to be forthcoming now. Perhaps there are other reasons why you would prefer to avoid entanglement. For some, working together with a former spouse just is not in the cards. If this sounds like the hand you were dealt, resist the urge to fold. You may have other options available. In either case, we next consider whether our client may qualify for any of the following exceptions to liability.
Here are the three options available to provide relief from joint and several liability under a joint return:
- Innocent Spouse Relief–– This exception provides relief if your spouse (or former spouse):
- failed to report income;
- reported income improperly; or
- claimed improper deductions or credits.
- Separation of Liability Relief–– This exclusion to liability provides for partial relief by dividing the additional tax owed between you and your former spouse. Try not to be discouraged by the term “partial” relief; depending on the portion you are responsible for, this exception could knock off a substantial amount of liability for you
- Equitable Reliefmay provide relief when you don't qualify for innocent spouse relief or separation of liability relief for something not reported properly on a joint return and generally attributable to your spouse. You may also qualify for equitable relief if the amount of tax reported is correct on your joint return, but the tax wasn't paid with the return.
(See Topic No. 205 Innocent Spouse Relief (Including Separation of Liability and Equitable Relief))
Innocent Spouse Relief
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 various factors to be considered weigh in favor of granting relief. Some factors are stronger than others, and we will go into greater depth of these factors. 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, be aware that a finding in your favor could 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 is normally included on the return previous years. In this latter case, you will be deemed to have reason to know; and so you would be denied Innocent Spouse Relief
Exception to Lack of Knowledge Requirement (Spousal Abuse)
There is an important exception to the lack of knowledge requirement, and you will notice this exception come up throughout the innocent spouse relief considerations and the other two forms of relief. 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.
Separation of Liability Relief
Under separation of liability relief, the understated tax allocated to you is generally the amount you are responsible for.
An individual may request relief by asking the Service to partition liability. There must be liability that the other spouse was responsible for. You must have filed a joint return and meet either of the following requirements at the time you file Form 8857.
- You are no longer married to, or are legally separated from, the spouse with whom you filed the joint return for which you are requesting relief. (Under this rule, you are no longer married if you are widowed.); or
- You were not a member of the same household as the spouse with whom you filed the joint return at any time during the 12-month period which ends on the day you file Form 8857.
Members of the same household.
To be considered living in separate households, you and your spouse must be estranged and not living together. On the other hand, the IRS would consider you and your spouse as members of the same household if:
- You and your spouse reside in the same dwelling.
- You and your spouse reside in separate dwellings but are not estranged, and one of you is temporarily absent from the other's household as explained in (3) below.
- Either spouse is temporarily absent from the household and it is reasonable to assume that the absent spouse will return to the household, and the household or a substantially equivalent household is maintained in anticipation of the absent spouse's return. Examples of temporary absences include absence due to imprisonment, illness, business, vacation, military service, or education.
The key for this final factor is expectancy of return. Even if the spouse is gone for a long period of absence, if there is an expectation that they will return to the home, then they are still considered part of the household.
The request for relief must be made within two years from the date of the first collection activity with respect to the RS. The two-year time period for making the request is the same as required under IRC 6015(b). See IRM 18.104.22.168.1, Collection Activity, for the definition of collection activity.
Actual Knowledge Invalidates Allocation
If the Service can show that the RS had actual knowledge of the items giving rise to the deficiency at the time the return was signed, those items are not allocated to the non-reporting spouse. The IRS must show that it is more probable than not that the RS had actual knowledge of the items causing the deficiency at the time the return was signed. See IRM 22.214.171.124, Case Development, for additional information.
Both the Knowledge and Partial Knowledge Sections, and the Domestic Abuse section apply to Allocation of Liability as well, please see above under Innocent Spouse Relief
Items Attributable to RS
The Requesting Spouse may not be relieved of any part of the liability that they were personally responsible for.
Limitations on Relief
Even if you meet the requirements discussed previously, separation of liability relief will not be granted in the following situations.
- The IRS proves that you and your spouse (or former spouse) transferred assets to one another as part of a fraudulent scheme. A fraudulent scheme includes a scheme to defraud the IRS or another third party, such as a creditor, former spouse, or business partner.
- The IRS proves that at the time you signed your joint return, you had actual knowledge (explained below) of any erroneous items giving rise to the deficiency that were allocable to your spouse (or former spouse). For the definition of erroneous items, see Erroneous Itemsearlier under Innocent Spouse Relief.
- Your spouse (or former spouse) transferred property to you to avoid tax or the payment of tax. See Transfers of Property To Avoid Tax, later.
Equitable relief is only available if you meet all of the following conditions:
- You do not qualify for innocent spouse relief, separation of liability relief, or relief from liability for tax attributable to an item of community income.
- You have an understated tax or unpaid tax. See Note, later.
- You and your spouse (or former spouse) did not transfer assets to one another as a part of a fraudulent scheme.
If you do not qualify for innocent spouse relief or separation of liability relief, you may still be relieved of responsibility for tax, interest, and penalties through equitable relief. If you did not file a joint return but did not qualify for relief from liability for tax attributable to an item of community income, you may be eligible for equitable relief.
Unlike innocent spouse relief or separation of liability relief, you can get equitable relief from an understated tax, or an unpaid tax. An unpaid tax is liability that you properly reported on your return but you have not paid.
Conditions for Getting Equitable Relief
In order to be considered for equitable relief from joint and several liability, you must meet similar factors as discussed in the equitable Section (D) under Innocent Spouse Relief.
Factors for Determining Whether to Grant Equitable Relief
The IRS will consider all facts and circumstances of your case in determining whether it is unfair to hold you liable for all or part of the unpaid income tax liability or deficiency. They will also consider the factors listed under the Equitable Section of the Innocent Spouse Relief, and whether they should grant full or partial relief.
Again, these factors are similar to the Innocent Spouse statute. Other factors relevant to your case also may be considered. Not one factor is determinative, instead the IRS will weigh the totality of the circumstances. Abuse or the exercise of financial control by your spouse (or former spouse) is a factor that may impact the other factors, as described above. Please see the Innocent Spouse Relief Section under Part D to get an idea of the factors considered.
In addition to the above requirements, you must file a Form 8857 within 2 years after the date on which the IRS first began collection activity against you.
Relief Also Applicable for Taxpayers in Community Property States
Section 66(c) provides relief from income tax liability resulting from the operation of community property law to taxpayers domiciled in a community property state who do not file a joint return. The same factors are considered as discussed above under equitable relief.