If you qualify for innocent spouse relief, you can be relieved of responsibility for paying tax, interest, and penalties if your spouse or former spouse improperly reported items or left off items in your income tax return. This is true for California and for the federal government. California has an “Innocent Souse Relief Application“. Generally, the IRS says that if you qualify for innocent spouse relief, then the tax, interest, and penalties can only be collected from your spouse or former spouse and will not be collected from you. However, if you don’t qualify for innocent spouse relief, you are jointly and individually responsible for any tax, interest, and penalties and the IRS can collect these amounts from either one of you.
A consultation with a California tax lawyer might be prudent to determine if you qualify for relief.
To qualify for innocent spouse relief, you must meet all of these 4 conditions:
You filed a joint return which has an understatement of tax due to erroneous items (defined below) of your spouse or former spouse.
You request relief within 2 years after the date the IRS first attempted to collect the tax from you.
You establish that at the time you signed the joint return you did not know, and had no reason to know, that there was an understatement of tax (See Actual Knowledge or Reason To Know, defined below).
Taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax. (See Indications of Unfairness for Innocent Spouse Relief, discussed more fully below in this blog).
To apply for this relief, complete the IRS Form 8857 “Request For Innocent Spouse Relief”.
Erroneous items are either unreported income (which is any gross income item received by your spouse or former spouse that is not reported) or incorrect deduction, credit, or basis (which is any improper deduction, credit, or property basis claimed by your spouse or former spouse.)
Here are some examples of erroneous items:
A deduction was taken for an expense that was never paid or incurred. For example, your spouse deducted $15,000 for computer equipment on Schedule C of your joint Form 1040, but never paid for any computer equipment.
The expense is not a deductible expense. For example, your spouse claimed a business deduction of $5,000 that was for the payment of California State fines. Fines are not deductible.
No factual argument can be made to support the deduction. For example, your spouse claimed $4,000 for repairs related to a home office, which were actually landscaping charges.
Actual Knowledge or Reason To Know
You knew or had reason to know of an understatement if you actually knew of the understatement, or a reasonable person in similar circumstances would have known of the understatement.
Actual knowledge. If you actually knew about an erroneous item attributable to your spouse or former spouse, the innocent spouse relief does not apply to any part of the understatement of tax related to that item. You and your spouse or former spouse remain jointly liable for the understatement. Information about the criteria for determining whether you actually knew about an erroneous item is at Actual Knowledge later under Relief by Separation of Liability.
Reason to know. If you had reason to know about an erroneous item attributable to your spouse or former spouse, innocent spouse relief does not apply to any part of the understatement of tax due to that item. You and your spouse or former spouse remain jointly liable for the understatement.
The IRS will consider all facts and circumstances in determining whether you had reason to know of an understatement of tax due to an erroneous item. The facts and circumstances include:
(i) whether you failed to ask, at or before the time the return was signed, about items on the return or omitted from the return that a reasonable person would question;
(ii) the extent of your participation in the activity that resulted in the erroneous item;
(iii) the nature of the erroneous item and the amount of the erroneous item relative to other items;
(iv) the financial situation of you and your spouse or former spouse;
(v) your educational background and business experience; and
(vi) whether the erroneous item represented a departure from a recurring pattern reflected in prior years’ returns (for example, omitted income from a source usually reported on prior years’ returns).
Partial relief. You may qualify for partial relief if, at the time you filed your return, you had no knowledge or reason to know of only a portion of an erroneous item. If all other requirements are met for that portion, you will be relieved of the understatement due to that portion of the item.
Example. If at the time you signed your joint income tax return, you knew that your spouse did not report $15,000 of gambling winnings. Later, the IRS audited your tax return and determined that your spouse’s unreported gambling winnings were actually $35,000. You demonstrated that you did not know about, and had no reason to know about, the additional $20,000 because of the way your spouse handled gambling winnings. The understatement of tax calculated on the $20,000 will probably qualify for innocent spouse relief if you meet all the other requirements. You will not qualify for relief for the understatement of tax due to the $15,000 of gambling winnings.
Indications of Unfairness for Innocent Spouse Relief
The IRS will consider all of the facts and circumstances of the case in order to determine whether it is unfair to hold you responsible for the understatement. The following are examples of factors the IRS will consider:
(i) whether you and your spouse have been divorced or separated;
(ii) whether your spouse or former spouse deserted you;
(iii) whether you received a benefit on the return from the understatement; and
(iv) whether you received a significant benefit (defined next), either directly or indirectly, from the understatement.
Significant benefit. A significant benefit is any benefit in excess of normal support. Normal support depends on your particular circumstances. Evidence of a direct or indirect benefit may consist of transfers of property or rights to property, including transfers that may be received several years after the year of the understatement.
Example. You receive money from your spouse that is beyond normal support. The money can be traced to your spouse’s lottery winnings that were not reported on your joint income tax return. You will be considered to have received a significant benefit from that income. This is true even if your spouse gives you the money several years after he or she received it.
Under what conditions is equitable relief allowed?
If you filed a joint return, and you do not qualify for traditional innocent spouse or separate allocation of liability relief, you may still be considered for equitable relief from tax that results from an audit or the underpayment of tax on your return. The following are some of the factors considered:
Your current marital status.
Whether you experienced spousal abuse during your marriage.
Whether you had a reasonable belief at the time that you signed the return that the tax was going to be paid; or, in the case of tax resulting from an audit, whether you had knowledge or reason to know of the understatement of tax.
Your current financial situation and your ability to pay the tax liability.
Whose legal obligation it is to pay the tax liability pursuant to a divorce decree or agreement to pay the liability.
Whether the liability is attributable to you or your spouse.
Whether you received a significant benefit from the understatement or erroneous items that gave rise to the liability.
Your compliance with income tax laws in later tax years.
The IRS will figure the tax you are responsible for after you file Form 8857. You are not required to figure this amount. But if you wish, you can figure it yourself. See How To Allocate the Understatement of Tax, within the Publication 971.
Speak with a tax attorney. Call Mitchell A. Port at (310) 559-5259.