Now, innocent spouse relief is a term that gets thrown around fairly often. Innocent spouse relief within the way the IRS views it actually encompasses a few relief provisions. Number one, there is what’s considered standard innocent spouse relief. What that is, is that’s being forgiven on the entire liability.
That is usually reserved in situations where there is emotional or physical abuse, where one spouse completely didn’t know about income that was omitted from a return or– Usually, innocent spouse comes up in situations where there is an audit, or there is an adjustment later after a return is filed and that spouse didn’t have any knowledge as to that item of income. Formal innocent spouse shows up usually in unreported income cases. The charge is that the innocent spouse or the requesting spouse didn’t know that their husband or their wife was funneling all this money through their business.
That’s more of a formal innocent spouse. If you had knowledge of the item on the tax return, that give rise to liability, that tends to defeat innocent spouse because, as I was talking about earlier with benefit, if you knew about the item of income, it was listed on the return and you benefited from it, then the IRS is not keen to give you innocent spouse. They’re going to deem you as having actual knowledge of that item whether or not you really knew about it or not because you did receive a benefit and because you did live this lifestyle.
Formal innocent spouse is usually reserved for omitted income situations on tax returns. The second type of innocent spouse liability is called separation of liability relief. Separation of liability relief is governed under the Internal Revenue Code in section 6015. What that essentially is, is what you’re requesting the IRS do, is partition the liability between spouses. The items of income attributable to husband will go to husband. The items of income attributable to wife will go to wife.
Then again, that innocent spouse hinges on a couple of different things. Number one, you have to have filed a joint return. You can’t file a married filing separate because there’s no reason to separate the liability if you have separate returns. Number two, and perhaps importantly, both spouses have to be living apart or have to have been divorced for at least a year prior to the request being made. Anything that’s considered premature won’t qualify for a separation of liability relief.
You need to make sure what the timing of your innocent spouse application. You can either, not living in the same household for a year, and you’ve not been– It’s either that, or you’re divorced. Keep in mind that the IRS is going to look for situations where they consider what’s called a temporary absence. If you get kicked out of your house and then go back, and then get kicked out, and go back. The IRS is going to look at that as a temporary absence.
Similarly, if you go– We’ve had situations with active duty military who are gone, or people who go to jail, or business trips, on the less extreme side of things. If the IRS can determine that you have an intent to return to your home, they won’t consider that living apart for a year. You have to be very careful with that designation even though it seems straightforward. Then finally, going back to actual knowledge. You can’t have any actual knowledge that any of the erroneous items on the return would– You can’t have any actual knowledge of any of the erroneous items on the return. Whatever gives rise to a tax liability, the requesting spouse can’t know about.
If you don’t qualify for either of those two provisions, then there’s something we call innocent spouse equitable relief that’s under the code, and that’s under 6015(f). That’s basically for situations where you don’t qualify for either of the two avenues of innocent spouse that I mentioned above. One of the requirements of equitable relief is, A, you don’t qualify for innocent spouse under the other two provisions. B, that you’ve been denied relief. There is a revenue procedure which I have notes in front of me, but the revenue procedure is 2003-61, and particularly 2001-32 I.R.B. 296. If you look at those and you want to really dig into the subject because you’re curious, those are the provisions that outline when to apply for equitable relief for individuals.
I want to run through the threshold requirements for you real quick, just so you understand what they are. A, if you file a joint tax return. B, you can’t get innocent spouse relief through the other two provisions. C, you have to submit the request within two years from the IRS initiating formal collections procedures against you. If you don’t do that, then you are barred from getting innocent spouse relief.
There cannot be a transfer of any assets between the spouse. There can’t be any fraudulent conduct. There can’t be any, what they call disqualified assets between the spouses and then again, that the income tax liability stems from an item that’s attributable to the other party, not the requesting spouse. The IRS will look at these factors. You have to meet all seven of these factors and then they’ll take in some additional guidance.
They’ll look at your marital status, the time that your request is entered. They’ll look at whether or not you have an economic hardship because of this liability. Particularly in situations where there’s great income inequality. There certainly could be a hardship. Then, ultimately, they’re looking at knowledge. Really, when you get into tax court cases and appeal settings with spouses, it really hinges on knowledge.
Should the requesting spouse have known? Do they have reason to know? What was the history between the couple? Did they maintain separate finances? From a practical perspective, any income that goes into a checking account where the requesting spouse is a signer on, that’s considered they should have known about that income. They should have known it was coming from somewhere. If they didn’t know, they should have had a duty to ask.
Then we have if they’re separate where somebody is not a check signer or is not involved in a business account. That’s where we frequently see these innocent spouse relief requests getting approved. Obviously, every divorce situation is different. Every innocent spouse relief case is different, but really what it’s going to hinge on is your knowledge of the situation.
Again, if innocent spouse relief doesn’t work in your setting, then you can go back, pursue other avenues for collections relief. You can do an offer in compromise. Paying the penalties associated with the liability or just simply putting yourself in compliance. Those are the big things that you really need to know with respect to divorce and taxes. It’s really about it, making sure you’re reporting correctly, making sure you’re accounting for community income.
The other thing that I should also mention is that transfers of property pursuant to a divorce are not taxable items. If one spouse sells the house that the couple was living in and distributes the proceeds, that’s not considered a taxable event in and of itself. However, payments of alimony are considered taxable. That’s one thing that you need to be aware of when you’re doing that. Child support is not taxable, alimony is taxable.
As I was saying, A, you need to look out for how to report correctly, how to allocate the treatment of income items. Your CPA is going to be able to help you navigate most of those issues. B, if you feel like you’ve been unfairly stuck with a liability, you need to look at doing an offer in compromise or going the innocent spouse way. In either case, depending on what you decide to do, it really is important for you to be in compliance because of the joint and several liability provisions of the Internal Revenue Code, and the fact that the IRS collections won’t honor third-party agreements. That’s what you need to do to protect yourself there.