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Relief from Tax Liability for an Innocent Spouse

A. Introduction

Married couples may choose to file their federal tax returns as “married filling jointly” because they may receive more favorable tax treatment by doing so. The flip side of “married filing jointly” filing status, however, is that, in general, both husband and wife are liable for all taxes, interest, and penalties. The liability of both husband and wife occurs even if one spouse earns all or most of the income. Nevertheless, the law provides several types of relief to innocent spouses. This article addresses these types of relief. The remainder of this article will refer to the spouse seeking relief as the “Spouse,” the other spouse as the “Other Spouse,” and the Spouse and the Other Spouse together as “Both Spouses.” Depending on the circumstances, the Spouse and the Other Spouse may no longer be married.

Note that the Treasury Regulations provide that relief will not be granted if property is transferred between Both Spouses as part of a fraudulent scheme, including a scheme to defraud the IRS or a creditor, ex-spouse, or business partner.

B. How to Seek Relief

The Spouse may seek relief by filing with the Internal Revenue Service (the “IRS”) Form 8857 (Request for Innocent Spouse Relief) (“Form 8857”).

C. Types of Relief Available

Type 1: Innocent Spouse Relief. If the Spouse is granted Innocent Spouse Relief, the IRS may relieve the Spouse of for tax, interest, and penalties. If the Spouse is granted Innocent Spouse Relief, the Spouse will be relieved of liability for any tax, interest, and penalties qualifying for relief. In that case, the IRS can collect tax, interest, or qualifying for relief only from the Other Spouse. Nevertheless, Both Spouses will still be liable for any tax, interest, and penalties not qualifying for relief.

a. Conditions for Innocent Spouse Relief. The Spouse must meet all of the following conditions to qualify for Innocent Spouse Relief.

i. A joint return was filed.

ii. Form 8857 is filed no later than two years after the date on which the IRS has begun collection activities with respect to the Spouse.

iii. The joint return contained erroneous items, which consists of either unreported gross income received by the Other Spouse; an incorrect deduction, credit, or basis claimed by the Other Spouse; or both.

iv. At the time the Spouse signed the return, the Spouse did not actually know of the understatement of tax and did not have reason to know of the understatement of tax. Reason to know of the understatement of tax means that a reasonable person in similar circumstances would not have known of the understatement of tax.

The IRS will consider facts and circumstances to determine if a reason to know existed. These facts and circumstances include the nature of an erroneous item and the amount of the erroneous item relative to other items, the financial situation of Both Spouses, the Spouse’s educational background and business experience, the extent of the Spouse’s participation in the activity that resulted in the erroneous item, at or before the time the return was signed, and whether the Spouse failed to question, at or before the time the joint return was signed, about items on the return or omitted from the return, which items a reasonable person would question, and whether the erroneous item represented a departure from a recurring pattern reflected in prior years’ returns.

v. The Spouse establishes that by taking into account all the facts and circumstances of the case, holding the Spouse liable for the understatement of tax would be inequitable. The IRS will consider all facts and circumstances to determine whether holding the Spouse liable for the understatement of tax is fair. These facts and circumstances include whether the Spouse received a significant benefit (any benefit in excess of normal support), whether the Other Spouse deserted the Spouse, whether the Spouse and the Other Spouse have been divorced or separated, and whether the Other Spouse received a benefit on the return from the understatement of tax.

*Relief for a Portion of Liability: If, at the time the Spouse filed the return, the Spouse had no knowledge or reason to know of a portion of an erroneous item, relief may be available for the tax liability due to that portion.

Type 2: Separation of Liability. If Relief by Separation of Liability is provided, the amount of tax, interest, and penalties owed are divided between Both Spouses.

a. Separation of Liability cannot be used to claim a refund. Instead, it only is available for unpaid liabilities.

b. Conditions for Relief by Separation of Liability.

i. A joint return was filed.
ii. Form 8857 is filed no later than two years after the date on which the IRS has begun collection activities with respect to the Spouse.
iii. Either:

1. The Spouse is either no longer married to the Other Spouse or is legally separated from the Other Spouse; or
2. The Spouse was not a member of the same household as the Other Spouse at any time during the 12-month period ending on the date the Form 8857 is filed.

c. Limitations Due to Actual Knowledge of Erroneous Items. Relief from liability will not be available for a deficiency or a portion of it arising from erroneous items allocable to the Other Spouse, of which items the IRS demonstrates that the Spouse had actual knowledge at the time the Spouse signed the joint return unless:

i. The Spouse is a victim of domestic abuse before signing the joint return; and
ii. The abuse caused the Spouse to refrain from challenging the treatment of any items on the joint return for fear of the Other Spouse’s retaliation.

Type 3: Equitable Relief. If the Spouse is ineligible for Innocent Spouse Relief or Relief by Separation of Liability (and for relief under community property law), Equitable Relief may relieve the Spouse of liability for tax, interest, and penalties.

a. Unfairness Under the Facts and Circumstances. The IRS will grant the Spouse Equitable Relief if it determines that under the facts and circumstances, holding the Spouse liable would be inequitable.

b. Application to Understatement or Underpayment. Equitable Relief may apply to an understatement of tax or an underpayment of tax. Innocent Spouse Relief and Relief by Separation of Liability, however, only apply to an understatement of tax. An understatement is the difference between the amount that should have been shown on a return and the amount that was shown on the return. An underpayment is the failure to pay tax liability that is correctly reported on the return.

c. Conditions for Equitable Relief. (as provided in Rev. Proc. 2003-61):

i. The Spouse is not eligible for either Innocent Spouse Relief or Relief by Separation of Liability (or relief under community property law).
ii. Both Spouses did not transfer assets to one another as part of a fraudulent scheme.
iii. The Other Spouse did not transfer property to the Spouse for the main purpose of avoiding tax or the payment of it.
iv. The Spouse did not file or fail to file the return with the intent to commit fraud.
v. The tax liability for which the Spouse seeks relief must be attributable to an item of the Other Spouse unless:

1. The item is attributable or partially attributable to the Spouse solely due to community property law;
2. The item is titled in the Spouse’s name and the Spouse rebuts the presumption that it is attributable to the Spouse because it is titled in the Spouse’s name;
3. The Spouse did not know, and had no reason to know, that funds intended for the payment of tax were misappropriated by the Other Spouse for the Other Spouse’s benefit; or
4. The Spouse establishes that the Spouse was the victim of abuse before signing the return and, because of this abuse, the Spouse did not challenge the treatment of any items for fear of retaliation by the Other Spouse.

For more information, see the IRS’s table that compares the aforementioned three types of relief, the IRS’s Publication 971 (Innocent Spouse Relief), and other documentation on relief for innocent spouses.

*This document contains legal information, but does not contain legal advice.
*This document has examined laws in effect in August 2011.

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