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Innocent Spouse

Many married couples find it advantageous to file a joint tax return rather than filing separately. This comes as no surprise as the federal government has built a number of tax advantages for married couples filing jointly into the tax code. These benefits include:

  • Depending income distribution, a lower rate of taxation than they would face filing separately.
  • Increased limits for charitable deductions
  • IRA and retirement account benefits
  • Estate protection
  • Reduced tax administration expenses

However there are also drawbacks to filing jointly with your spouse – especially so if the relationship hits a rough patch or ends in divorce. This is because by filing jointly, you subject yourself to joint and individual liability for everything that appears on the tax return. In other words, absent an exception or relief both members of the couple are liable for everything that appears on the tax form regardless of who prepared it. If your spouse or former spouse made mistakes on the jointly filed taxes or took overly aggressive positions you could find yourself liable for underpayments, fines and penalties.

When is applying for innocent spouse relief appropriate?
The most common instance where issues of innocent spouse relief may come into play is where a couple is headed down the path to a divorce or has already divorced. Often, one of the partners in the marriage was responsible for handling the taxes and the other partner may have only had a limited role in preparing or overseeing the taxes. In the most extreme case, the other spouse may do little more than simply sign off on the return while trusting that his or her partner prepared the taxes thoroughly and accurately.

At some point, the spouse who participated only minimally in the tax preparation process may suspect that his or her spouse may have understated income, overstated deductions or exemptions, or otherwise violated the tax code or committed tax crimes. The innocent taxpayer does not want to remain liable for these outstanding tax debts and penalties because he or she did not create them or cause them. It may be appropriate for a spouse in a spouse in this or a similar position to file for innocent spouse relief.

To apply for innocent spouse relief a taxpayer must file Form 8857 with the IRS. The form must detail and explain why the taxpayer believes that he or she is entitled to such relief. By filing Form 8857 you are asking the IRS to establish a separate tax liability for you that is separate and apart from that of your current or soon-to-be former spouse, or ex-spouse. On the form you must provide information regarding your role in the tax preparation process, whether you were aware of the income, if you had reason to know about the inaccurate statements on the tax form. Depending upon the type of tax relief requested, the filing taxpayer may be required to prove that it would be unfair to hold him or her liable for the tax liability. Whether something is fair or unfair can be highly subjective, but the IRS has provided criteria to help in making this determination. Elements the IRS will examine to determine whether it would be fair to impose the tax against the spouse filing for relief include:

  • The nature of the erroneous item or items on the tax filing
  • The value of the erroneous item or items relative to the remaining items on the tax return
  • The level of participation by the filing taxpayer in the mistake or scheme
  • The filing spouse’s experience in business dealings
  • The filing spouse’s educational history
  • The financial circumstances of each spouse
  • Whether the filing party failed to ask reasonable questions about the return prior to authentication.
  • Is the understatement part of a recurring pattern or an isolated incident?

All of these items will be considered as part of the inquiry as to whether it would be fair to impose the tax liability and decline to provide relief. However other additional requirements apply. For instance, an application for relief must, generally, be filed within two years of the first collection action taken by the IRS, but there are exceptions.

Tax issues after a divorce?
While the standards to be granted innocent spouse status are high, taxpayers are entitled to appeal an IRS determination that is not in their favor to the United States Tax Court. The Brager Tax Law Group can assist you in filing either an initial application for innocent spouse status or in preparing an appeal. By securing this status you may be able to not only resolve the current debt, but will also bring most enforced collection activity to a halt. However, the extent of the relief even if granted can vary based upon the type of relief granted, the terms of the divorce decree, and even the timing of the divorce, and the division of assets. For a confidential tax consultation call our firm at 800-380-TAX-LITIGATOR today or contact us online.

In IRS Notice IR 2012-3 the IRS announced that innocent spouse defenses pursuant to IRC Section 6015(f) will become a little easier. Generally there are three different kinds of innocent spouse defenses, each with its own rules and exceptions. IRS Notice 2012-8, which somewhat confusingly was announced in IRS Notice IR 2012-3, sets out a proposed new Revenue Procedure which will supersede Revenue Procedure (Rev. Proc.) 2003-61. IRS Notice 20012-8 addresses the criteria used in making innocent spouse relief determinations under the equitable relief criteria of Internal Revenue Code Section 6015(f). The IRS Notice covers several topics. It provides for certain streamlined determinations; it creates new guidance on the potential impact of economic hardship, and the weight to be accorded to certain facts in determining equitable innocent spouse relief. Importantly it also expands how the IRS takes into account abuse and financial control by the nonrequesting spouse in deciding whether to grant equitable relief.

The IRS is inviting comments on the forthcoming proposed Revenue Procedure. The comments must be submitted by February 21, 2012.

One important change is that under Rev. Procedure 2003-61, which previously provided guidelines for equitable innocent spouse determinations, lack of economic hardship was treated as a factor which weighed against granting equitable innocent spouse relief. Now if economic hardship exists that is still a factor which weighs in favor of granting innocent spouse relief. However, the lack of economic hardship will no longer be counted against a requesting spouse. Instead it will be treated as neutral.

Another significant change is that the proposed revenue procedure provides that abuse or lack of financial control may mitigate other factors that might weigh against granting equitable relief under IRC Section 6015(f). For example, even though a requesting innocent spouse has knowledge or reason to know of omitted income on a tax return if the nonrequesting spouse abused the requesting spouse or maintained control over the household finances by restricting the requesting spouse’s access to financial information, and, therefore, because of the abuse or financial control the requesting spouse was not able to challenge the treatment of any items on the joint return for fear of the nonrequesting spouse’s retaliation, then that abuse or financial control will result in this factor weighing in favor of relief even if the requesting spouse had knowledge or reason to know of the items giving rise to the understatement or deficiency.

In the end, however, the granting of innocent spouse relief is based upon all of the facts and circumstances. Only by discussing your case with a knowledgeable tax litigation attorney can you determine if you are likely to prevail.
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One of the factors that the Internal Revenue Service (IRS) takes into account in determining whether or not to grant innocent spouse relief, pursuant to the equitable innocent spouse provisions of Internal Revenue Code (IRC) 6015(f), is whether or not the requesting spouse will suffer economic hardship. Rev. Proc. 2003-61, 2003-2 C.B. 296. Economic hardship occurs where the innocent spouse would not be able to pay reasonable basic living expenses if the tax had to be paid.

While this rule is well established, in Williams v. Commissioner, T.C. Summ. Op. 2009-19, the Tax Court made a strong taxpayer friendly statement as to how the term economic hardship is to be interpreted. Mrs. Williams had received nearly $500,000 in her divorce settlement. Nevertheless, the Tax Court found that she would suffer economic hardship if the $25,000 tax payment were made. The Tax Court made its determination because the $500,000 was paid to Mrs. Williams’ parents to reimburse them for the amounts that they had lent to her to pay the legal fees incurred in the divorce. It was the IRS position that this money should have been used to pay the taxes, and therefore Mrs. Williams was not an innocent spouse . The Tax Court held that “Taxpayers are not required to choose among which debt to pay for determining economic hardship….”

This is a very important principle, and one which the IRS almost universally overlooks. This statement from the Tax Court could be useful in future cases; however, its value is limited because Williams is a “summary opinion,” and therefore is not legal precedent.

If you believe you may be an innocent spouse or have other IRS tax problems or Franchise Tax Board problems, contact the tax controversy lawyers at Brager Tax Law Group, A P.C.

Last month, the United States Tax Court (Tax Court) overturned an Internal Revenue Service (“IRS”) ruling, and granted innocent spouse status to the widow of former San Francisco Mayor Joe Alioto. Alioto v. Commissioner of Internal Revenue, T.C. Memo. 2008-185. Innocent spouse relief was allowed pursuant to Internal Revenue Code (IRC) Section 6015(f)
which allows relief if “taking into account all the facts and circumstances it is inequitable to hold the individual liable.” One of the tests that the Tax Court, and the IRS looks at in determining whether an individual is entitled to equitable innocent spouse relief is whether payment of the tax would cause an economic hardship. It is sometimes difficult to convince the IRS that anyone living at anything above the poverty level is suffering economic hardship, and this case was no different.
At the time of trial, Mrs. Alioto had about $100,000 in a retirement account, and little else in the way of assets. She was earning about $121,000 per year. The IRS determined that no economic hardship would ensue if Mrs. Alioto was forced to pay the approximately $2 million dollars that she owed as a result of filing a joint income tax return with the Mayor. The Tax Court took a more liberal view of things holding that indeed she would suffer economic hardship, and went on to allow innocent spouse relief.

If you have a tax problem, and believe that you maybe qualify for innocent spouse relief contact the tax litigation lawyers at Brager Tax Law Group, A P.C.