When it comes to federal tax returns, the Internal Revenue Service (“IRS”) currently offers three types of spousal relief. What is spousal relief, you might ask, and what exactly does it do to “protect the innocent?” Friedman LLP’s Alan Goldenberg takes a look at the three types available and why they are important to taxpayers today.
Married couples typically file joint income federal and state tax returns. Generally, joint filings are advantageous to taxpayers because the married filing jointly tax rates are lower than married filing separate rates and the standard deduction is higher. Accordingly, in most cases there is a marriage tax bonus by filing joint tax returns. The downside to filing joint returns is that each spouse is jointly and severally responsible for the payment of taxes. Even if one spouse contributes little or no income, that spouse is nevertheless liable if the other spouse understates or underpays the tax due.
However, there are some unique situations in which a spouse may not be held responsible for those errors solely attributable to the other spouse. For example, upon separation or divorce, one ex-spouse might not be aware of the incorrect tax reporting or underpayment of tax by the other ex-spouse. Without some protection, the unaware spouse could be left holding the bag on a tax bill run up by the other spouse. This is especially troubling if the “innocent” spouse does not have the wherewithal to pay the tax liability.
In order to protect spouses with no knowledge of the incorrect tax reporting or missing tax payments of the other spouse, Congress, in 1971, enacted the first “innocent spouse” provision of the Internal Revenue Code. The law, having been modified a number of times since, enables a spouse to claim certain types of relief from joint liability for the tax due on a jointly filed tax return. The burden of proof is on the individual making the innocence claim to establish the deficiency allocable to him or her.
The IRS currently offers three types of spousal relief:
- Innocent Spouse Relief which provides relief from additional tax owed if the responsible spouse failed to report income, reported income improperly, or claimed improper deductions or credits;
- Separation of Liability Relief which provides for the allocation of tax owed between spouses when an item of income was not properly reported on a joint tax return; and
- Equitable Relief which applies when a spouse does not qualify for the two other types of relief for items not correctly reported on a joint return and generally attributable to the other spouse. Equitable relief may also be applicable if the amount of tax reported was correct, but the tax was not paid with the return.
A taxpayer must meet all of the following conditions to qualify for innocent spouse relief:
- The filed joint return containing an understatement of tax is solely attributable to the other spouse’s erroneous item. An erroneous item includes income received but omitted from the tax return, or deductions, credits, and property basis if incorrectly reported;
- The innocent spouse establishes that at the time of signing the joint tax return, the spouse did not know, and had no reason to know, that there was an understatement of tax; and
- Taking into account all the facts and circumstances, it would be unfair to hold the spouse liable for the understatement of tax.
To qualify for separation of liability relief, a joint return must be filed and the innocent spouse needs to meet one of the following conditions:
- The innocent spouse is divorced or legally separated from the other spouse with whom the joint tax return was filed;
- The innocent spouse is widowed; or
- The innocent spouse has not been a member of the same household as the spouse with whom a joint return was filed at any time during the 12-month period ending on the date the innocent spouse is requesting relief.
Neither the innocent spouse, nor the separation of liability option, authorizes relief from tax liabilities that were properly reported on the return but not paid. Such relief is available under the equitable relief option. This catch-all provision is intended for the IRS to exercise equitable relief when a spouse “does not know and has no reason to know that funds intended for the payment of tax were instead taken by the other spouse for such other spouse’s benefit.” The exercise of equitable relief by the IRS would also be appropriate if “taking into account all the facts and circumstances it is inequitable to hold an individual liable for all or part of any unpaid tax or deficiency arising from a joint return.”
A number of factors weigh in favor of an equitable relief claim:
- The claimant is separated, widowed, or divorced from the other spouse;
- The innocent spouse would suffer economic hardship if relief is not granted;
- There is evidence of abuse by the spouse, or the spouse maintained control over the household finances by restricting access to financial information, and because of this abuse or control, the innocent spouse was not able to question or challenge the taxes reported on the joint return; or
- The tax for which relief is being requested is attributable to the other spouse.
To request innocent spouse relief (including separation of liability relief and equitable relief), a taxpayer must file Form 8857, Request for Innocent Spouse Relief, and provide an explanation as to why the claimant believes it would be unfair to hold him or her liable for the understatement or underpayment of tax. A favorable IRS determination may also result in state-taxing authorities granting similar relief. However, states may only provide for limited types of relief. For example, New York and Connecticut have adopted all three Federal relief options, whereas Pennsylvania has only promulgated the innocent spouse and separation of liability options, and New Jersey has not enacted any innocent spouse relief provision.
When it comes to spousal relief, every situation, fact, and circumstance is different. Consulting a tax controversy or state tax professional can help determine the course best suited for you. If you have any questions regarding innocent spouse relief, please contact Alan Goldenberg, Senior Manager of Tax Controversy and State and Local Taxation, at firstname.lastname@example.org or 212-897-6421, or your Friedman LLP tax professional.