Sometimes, bad stuff just happens. When it deals with income taxes and you got shafted by your spouse, there is a ray of hope. It is called innocent spouse relief. Essentially, this allows the IRS to let you off the hook for tax shenanigans of your spouse…as long as you didn’t know anything about it.
An innocent spouse is one who has filed a joint return and owes income taxes because of bad activity by the other spouse. It’s a tough spot to be in, but it happens all the time.
Remember, when spouses file joint returns, each spouse is liable for anything that is on the return and certainly all the income tax.
A typical fact pattern is you file a joint income tax return with your spouse in 2011. Things get difficult and you divorce two years later. One day you get a letter from the IRS. The IRS has just notified you that your income for that 2011 return you filed was underreported and that you owe income tax of $50,000.
As it turns out, your spouse was a contractor and failed to report a lot of income.
Anytime you sign a tax return, you pledge it was “to the best of your knowledge true, correct, and complete.” You will be held fully responsible for the accuracy of the return as well as the payment of income tax.
Fortunately, you may be able to not have to pay the income tax under the innocent spouse provisions. There are three types of innocent spouse relief.
To request relief you have to file Form 8857, Request for Innocent Spouse Relief. If you are in this position, you probably should have the advice of a tax professional.
Under traditional relief, the tax return must have been married filing jointly.
There must be income tax due as a result of the actions of your spouse. In addition, you have to show you did not know, and did not have a reason to know of the problems when signing the return.
The IRS looks at the innocent spouse’s education level, experience and knowledge of the family’s finances. It also takes into consideration family lifestyle, lavish expenses, evasiveness or deceit, and reasonable inquiries about items on the return. Bottom line, if you spent $300K and only reported $10K on your income tax return, you are going to have a hard time explaining to the IRS why you thought this was reasonable.
The primary factor to having the innocent spouse request approved under this method is “unfairness.” If the IRS decides that is it unfair to hold the taxpayer liable for the income tax, it may let you off the hook.
There is a second way to get innocent spouse relief. It is the separate liability election. Essentially, the IRS refiles the income tax return as if the spouses were single. Of course, there are some requirements. The spouses must no longer be married, be legally separated, or have lived apart for at least 12 months. The income tax due has to be as a result of an item allocable to the other spouse.
The standard for knowledge under this approach is a bit easier. It is that the taxpayer did not have actual knowledge of one or more of the wrong items. If a separate liability election is allowed, the IRS will allocate income and deductions to the husband and wife, only holding each responsible for their share of the income tax liability.
The third way to get innocent spouse relief is equitable relief. Here, the IRS must determine the circumstances make the taxpayer’s liability unfair. Adverse life issues such as divorce, hardship, or abuse by the other spouse are primary reasons equitable relief is granted.
Equitable relief is available only if the taxpayer does not qualify for traditional or separate liability relief. Basically, it is the catch all that allows the IRS to do the right thing even if you don’t meet the technical requirements of the other two methods.
The IRS is required to notify the spouse or former spouse and allow him respond, so the problems can get difficult and the accusations may fly.
If you want to assert innocent spouse relief, you have to do it within two years of the first IRS collection activity for income tax.
This only addresses the federal income tax. Both Connecticut and New York have their own separate taxes and this proceeding does not resolve them. Alas, both Connecticut and New York have their own innocent spouse proceedings which roughly follow the federal law. So whether you live in Wilton CT or Katonah NY makes a difference.