Monday, May 14, 2012

Tax Relief For the Innocent Spouse

Boy meets Girl. Boy marries Girl. After five years, Boy files for divorce from Girl and skips town. Shortly thereafter, IRS contacts Girl, because Boy didn't report all his income on their last joint tax return. Girl signed the return, so she was liable for the tax. Girl screams.
Okay, so it's not exactly a classic love story. But, sadly, it's a story that rings true for many an unfortunate taxpayer -- with some variations. Sometimes, Boy passes away, leaving Girl with the unpaid taxes. Sometimes Boy is available, but bankrupt. Sometimes it's Girl who underpays her taxes and leaves Boy with the bill. Whatever the circumstance, the IRS ends up collecting tax from someone who's liable only because he or she filed a joint tax return.
But, wait -- don't ALL married couples file joint tax returns? Isn't that in the vows somewhere, right after "til death do us part" or "in sickness and in health"? Well, it's true that most married couples do file jointly, simply because it's usually simpler and cheaper to do so. But it's important to keep in mind that filing jointly is an elected practice, and can sometimes create problems.
Filing a joint return means that both individuals are responsible for the taxes owed, even if one person made the majority -- or even the entire amount-- of taxable income, and even if they later divorce. Signing a joint return means consenting to joint and several liability. Joint liability means Boy and Girl are both liable; several liability means Boy and Girl are EACH liable for the entire amount. If the IRS determines there was a deficiency in tax after the return is filed, it is authorized to go after each spouse individually. What does that mean for poor Girl? The IRS doesn't know or care that Boy and Girl are no longer married; it simply is trying to collect back taxes. If the spouse responsible for the erroneous items is inaccessible for collection, then the IRS will look to the "innocent" one.
This is where Innocent Spouse Relief comes into play. Under normal circumstances, the IRS holds both spouses equally responsible for any taxes and penalties on a joint tax return, regardless of who made a mistake. However, a taxpayer may be relieved of responsibility for paying tax, interest, and penalties because a spouse or former spouse failed to report income properly (which can include leaving out income, or claiming improper deductions or credits), if he or she meets all of the following conditions:
1) The spouses must have filed a joint return with an understatement of tax directly related to the spouse's erroneous items.
2) The taxpayer seeking relief can establish that at the time he/she signed the joint return, he/she did not know, and had no reason to know, that there was an understatement of tax.
3) Taking into account all the facts and circumstances, it would be unfair to hold taxpayer liable for the understatement of tax.
The bottom line? It's possible to keep from getting stuck with your ex's back taxes, if you can prove definitively that you were unaware of the error, and that it would be unfair to hold you responsible for the penalty. Girl may still have to deal with the pain, but at least she won't have to get stuck paying for Boy's tax mistake. And that's a happy ending all it's own.
EA Exam Review Tool tip
The rules for innocent spouse relief fall under the category "Specific Types of Representation". Approximately 25% of the questions on the Representation, Practice, and Procedures exam are from this category. A quality EA exam study guide or EA exam preparation course should provide a detailed analysis of these rules. Information on Innocent Spouse Relief is also available in IRS publication 971. If you are like me and prefer something a little easier to follow, you may prefer the streamlined explanations that quality EA exam review courses provide. Regardless of your preference in EA exam study materials, it is important that you have a solid understanding of innocent spouse relief and other specific types of representation before you sit for the IRS Special Enrollment Examination