Being married has lots of perks. Unfortunately it doesn’t always last, despite our best intentions and attempts to keep things together. And sometimes it can also lead to a major tax headache – especially when one spouse lets the other down, from a tax perspective.
The problem is that when you file a joint return with the IRS, you also both accept what’s called “joint and several” or “joint and separate” liability over paying anything that’s due. That means you aren’t on the hook for half of what’s due – you’re each responsible for 100% of the debt.
If one spouse skips off to foreign pastures, the other spouse is left holding the bag. That can be a bitter pill to swallow, but it can be made even worse when you find out that the spouse who skipped out didn’t pay your taxes before he or she left.
Fortunately the IRS isn’t completely heartless on this point, and you aren’t helpless. Here are three possible options you can take, if you find yourself on the hook for a debt you weren’t expecting:
1. Innocent Spouse Relief.
There are three conditions you must meet to qualify here:
(a) You filed a joint tax return with a large understatement of tax, which was prepared and filed by your spouse. The understatement could be caused either by not reporting your correct income, or by claiming incorrect or false tax deductions and credits.
(b) You are able to show that at the time you signed the return you didn’t know, and had no reason to know, that there was a major problem with it.
(c) Taking into account all the facts and circumstances, it would be unfair for the IRS to hold you liable for the understatement of tax.
Obviously the tough part is being able to show that you didn’t know about the funny business going on. It’s subjective – if the court thinks you knew, or should have known, you’ll be denied. If you’re both well educated it can seem really unfair at times – almost as though the court is punishing you by saying anyone with a good academic background should have looked at the return before it was filed, and then identified the problems in the return.
In 1998 Congress did some tinkering with this law and did make one change. If you only knew (or had reason to know) about part of the understatement, you’re only stuck for that part. So if you had an idea that your spouse was underreporting a few hundred dollars, but it turns out to be several thousand dollars, you should only have to pay the smaller amount.
Here are three other things to know about innocent spouse relief. First, you don’t necessarily have to be divorced or even living apart from your spouse to qualify. If you have assets of your own and want to protect them from collection by the IRS, these rules determine whether you can be held liable. Second, you’ve got make the application within two years of the IRS first contacting you about the problem. And third, this only applies where there’s a problem with the return. If the return was right and your spouse just didn’t pay the tax due, you can’t use innocent spouse relief. In that case, you have to go to the second option: Equitable Relief.
2. Equitable Relief.
This option is only available if you meet all of the following conditions:
(a) You and your spouse did not transfer assets to one another as a part of a fraudulent scheme.
(b) Your spouse did not transfer assets to you for the main purpose of avoiding tax or the payment of tax.
(c) You did not file your return with the intent to commit fraud.
(d) You did not pay the tax.
(e) You do not qualify for innocent spouse relief or separation of liability.
(f) The IRS determines that it is unfair to hold you liable for the understatement of tax taking into account all the facts and circumstances.
One of the good things about equitable relief is that if you qualify you are not only able to be excused from the consequences of tax underreporting, you can also get away from tax underpayment (remember with spousal relief, you can’t get away from underpayment).
But one of the bad things about this option is that’s it’s very subjective. Your success or failure is largely due to the judge hearing hte case and how he or she perceives the facts. For example, in some cases where the applicant had a very high lifestyle the courts have found that the lifestyle was a direct benefit of the other spouse’s tax fraud, and so held the applicant liable to pay the tax in any event.
3. Separation of Liability.
This is the third option. It applies to those who have filed a joint return and meet one of two requirements:
(a) You are either separated or no longer married (through divorce or death) to your spouse.
(b) You were not living with your spouse at any time during the 12 month period prior to making your claim with the IRS.
In all three of these cases your first step is to file an IRS Form 8857, putting the IRS on notice of your claim for relief. But that’s probably your second step. I think you would be better off first contacting an attorney or a tax advisor who is familiar with these types of cases and has a good track record at winning these cases with the IRS. Remember, if the IRS loses they don’t get paid any tax at all, and so in many cases prosecuting you is their last shot at collecting the unpaid taxes.