Three paths to innocent spouse relief

Editor: Valrie Chambers, CPA, Ph.D.   Taxpayers who file “married filing jointly” become jointly and severally liable for the tax that is due when the return is filed and for any subsequent increases to tax (Sec. 6013(d)(3)). Often, one taxpayer is surprised to find out that the tax reflected on the return was not paid (or the return was delinquently filed) or that an examination has led to a large increase to tax.

There are three avenues for the unsuspecting spouse to request relief from the unpaid tax. They are the “traditional” innocent spouse claim, the split or allocation of the deficiency, and a request for equitable relief.

The ‘traditional’ innocent spouse claim

If an additional assessment arises, Sec. 6015(b) can provide relief from joint and several liability where there is an understatement of tax attributable to erroneous items of one spouse. Under this provision, the spouse requesting relief (the “requesting spouse”) must establish that in signing the return the requesting spouse did not know, and had no reason to know, that there was a possible understatement and that it would be inequitable to hold the requesting spouse liable for the deficiency. Sec. 6015(b) is commonly referred to as the traditional claim, as it was part of the Internal Revenue Code (with narrower relief) prior to the expansion of innocent spouse relief in 1998.

The critical issues in meeting this section are regularly whether the requesting spouse did not know, and had no reason to know, that there was a potential understatement and that it would be inequitable to hold the requesting spouse liable for the deficiency.

A taxpayer has reason to know of the understatement if a reasonably prudent taxpayer could be expected to know that the return contained the understatement (Briley, T.C. Memo. 2019-55). A taxpayer who signs a return is generally charged with constructive knowledge of its contents. A requesting spouse must establish that he or she was unaware, and had no reason to know, of the facts that gave rise to the error; it is not enough to be unaware of the tax consequences. In short, Sec. 6015 does not protect a spouse who turns a blind eye. Factors to be considered in making this determination are:

1. The requesting spouse’s level of education;
2. The requesting spouse’s involvement in the family’s business and financial affairs;
3. The presence of expenditures that appear lavish or unusual when compared to the family’s past levels of income, standard of living, and spending patterns; and
4. The culpable spouse’s evasiveness and deceit concerning the couple’s finances (see Hayman, 992 F.2d 1256, 1261 (2d Cir. 1993), aff’g T.C. Memo. 1992-228; Butler, 114 T.C. 276, 284 (2000)).

As to the first factor, level of education, it is the requesting spouse’s understanding of finances and tax, and not the level of academic achievement, that is determinative of the requesting spouse’s eligibility for relief (Wang, T.C. Memo. 2014-206).

As to the second and third factors — involvement in the family’s financial affairs and level of expenditure — great weight is given to whether the family’s lifestyle exceeds what could be reasonably expected from the information reported on the return(s).

While all the facts and circumstances are considered (Sec. 6015(d)(3)(B)), the court holdings show that a critical concern is whether the requesting spouse significantly benefited, directly or indirectly, from the understatement of tax. A significant benefit is any benefit in excess of normal support. Mortgage payments on a middle-class home are considered normal support. The receipt of property (including life insurance proceeds) by the requesting spouse that is beyond normal support and that can be traced to items omitted from gross income and attributable to the nonrequesting spouse, can be considered as a significant benefit (Regs. Sec. 1.6015-2(d)).

Election to split or allocate the deficiency

Sec. 6015(c) provides another avenue for relief from joint and several liability from an audit assessment by making it possible to elect separate liability. To do so, the requesting spouse must be divorced, legally separated, or living apart from his or her spouse during the 12 months preceding the request for relief. A surviving spouse can make this election if his or her spouse died more than 12 months before the election.

If the requesting spouse is eligible to make this election, he or she is liable for the amount of tax that arises (or should have arisen) from the requesting spouse’s separate income and deductions at the time the return(s) were filed. If the requesting spouse is successful, the deficiency is allocated by the ratio of the net amount of erroneous items allocable to the requesting spouse divided by the net amount of all erroneous items.

To qualify for relief, the requesting spouse must lack actual knowledge of the facts involving the erroneous item or items. The IRS has the burden of proving actual knowledge.

Relief will not be granted if spouses transferred assets to each other as part of a fraudulent scheme or to avoid tax or the payment of tax. A rebuttable presumption is established that an asset transfer from the nonrequesting spouse to the requesting spouse during the 12-month period before the mailing date of the first letter of proposed deficiency (whether a 30-day letter or a notice of deficiency) is a disqualified asset transfer, but this presumption will not apply to any transfer pursuant to a decree of divorce or separate maintenance or a written instrument incident to such a decree (Sec. 6015(c)(4)(B)(ii)).

Time limit to seek these types of relief

Both a “traditional” innocent spouse claim and an election to split/allocate the deficiency must be made no later than two years after the date that the IRS begins collection activity (Secs. 6015(b)(1)(E) and (c)(3)(B)). Regs. Sec. 1.6015-5(b)(2)(i) defines collection activity as a Sec. 6330 notice; an offset of a refund of the requesting spouse; the filing of a suit by the United States against the requesting spouse for the collection of the joint tax liability; or the filing of a claim by the United States in a court proceeding in which the requesting spouse is a party or that involves property of the requesting spouse. The term “property of the requesting spouse” is defined to mean property in which the requesting spouse has an ownership interest (other than solely through the operation of community property laws), including property owned jointly with the nonrequesting spouse. Collection activity does not include a notice of deficiency, the filing of a Notice of Federal Tax Lien, or a demand for payment of tax.

A claim for relief can also be filed once a liability is proposed during an examination, as part of a petition to the U.S. Tax Court for a redetermination of the Service’s assessment of tax, and as part of a Collection Due Process hearing.

A request for equitable relief

The third avenue that may be available to an unsuspecting spouse is to request equitable relief. Sec. 6015(f) provides relief for unpaid tax or a deficiency when it would be equitable to do so and when relief is unavailable under Sec. 6015(b) or (c). Significantly, this section provides relief for amounts owed when the return was filed. The Service has issued Rev. Proc. 2013-34, detailing qualification for this relief.

The revenue procedure establishes seven threshold requirements to be considered for relief:

1. The requesting spouse filed a joint return for the tax year for which relief is sought;
2. Relief is not available to the requesting spouse under Sec. 6015(b) or (c);
3. The claim for relief is timely filed;
4. No assets were transferred between the spouses as part of a fraudulent scheme;
5. The nonrequesting spouse did not transfer disqualified assets to the requesting spouse;
6. The requesting spouse did not knowingly participate in the filing of a fraudulent joint return; and
7. Absent certain enumerated exceptions, the tax liability from which the requesting spouse seeks relief is attributable to an item of the nonrequesting spouse (Rev. Proc. 2013-34, §4.01).

Where a requesting spouse meets the threshold conditions, he or she is eligible for equitable relief if, taking into account all the facts and circumstances, it would be inequitable to hold the requesting spouse liable for the deficiency. The IRS takes into account the following factors when determining whether to grant equitable relief: (1) marital status; (2) economic hardship; (3) in the case of an understatement, knowledge or reason to know of the items giving rise to the understatement or deficiency; (4) legal obligation; (5) significant benefit; (6) compliance with income tax laws; and (7) mental or physical health. No single factor is determinative, and the IRS weighs and considers all these factors and can assign varying weight to each factor or include other factors, depending on the specific facts and circumstances of each case (Rev. Proc. 2013-34, §4.03).

A request for equitable relief can be filed during the period that the IRS can collect the tax under Sec. 6502 or, if the tax has been paid, during the time when the taxpayer may submit a claim for refund or credit of such payment under Sec. 6511.

How to file for relief; appeal rights

To request relief of any of the types discussed above, use Form 8857, Request for Innocent Spouse Relief. A request can also be made as part of a U.S. Tax Court petition under the Taxpayer First Act, P.L. 116-25.

In the event the request for innocent spouse relief is denied, a requesting spouse is entitled to an administrative appeal. A requesting spouse can petition the Tax Court (a stand-alone petition) within 90 days after the date of the Service’s notice of final determination denying relief. If the IRS does not act upon the request, the requesting spouse can petition the court six months after the date the request for relief is filed, and not later than 90 days after the IRS sends a notice of final determination denying relief.

The Tax Court’s scope of review is de novo and is based upon the administrative record established at the time of the determination and any additional newly discovered or previously unavailable evidence.

Expect a rigorous review

Taxpayers who face unexpected tax liabilities have avenues to request relief from the liabilities. In making a claim, a taxpayer should expect a rigorous review of the facts from the Service.