Innocent Spouses Can File for Tax Relief
“For Better, For Worse; For Richer, For Poorer”
You’ve heard of the “marriage penalty” -- two people married to each other with the same income as two single people pay more taxes. Let me tell you about another “marriage penalty.”
If you file a joint return with your spouse and there is a problem and tax, penalties and interest are due, both spouses are liable individually and jointly, and the IRS may collect the owed tax from either spouse regardless of whose income, understatement or fraud was involved.
Most married couples file a joint income tax return because this gives a lower tax than filing two returns as married filing separate. (Although still not as little as two unmarried persons with the same income). The general rule for a joint return is that both taxpayers will be responsible for any taxes, interest, and penalties owed, even if only one spouse was earning the income. Married couples are not required to file a joint return. In fact, filing a joint return is an election. Since it almost always results in a lower combined tax than if each spouse files separate returns, it is routinely and almost automatically elected by married couples. If you file separately, you and your spouse can change your mind and file a joint return within three years after your original return's due date. The converse is not true. If you file jointly, you can't switch back to separate filing (unless there is enough time to do this before the due date for the return) even if your spouse agrees and wants the same thing. When you elect to file and sign a joint income tax return, you consent to joint and several liability.
Joint liability means that both spouses are liable. Several liability means that each spouse is liable for the entire amount The IRS may collect from either spouse. They may collect the tax however they think will be fastest and easiest.
Beware: even if you file separately, you can be liable for tax on your spouse's income if you live in a community property state. When you are married, all income becomes community property income and one-half belongs to each spouse. The IRS can take ½ of your paycheck to pay an old tax bill for your spouse. In any state, the IRS can collect your spouse's taxes from you if your spouse transferred assets to you in an attempt to evade taxes. Relief provisions are not available in this case because both spouses participate in a scheme to evade taxes.
Divorce does not terminate joint liability. Let’s say you were married to Spouse # 1 for 5 years and filed joint returns. You get divorced, and after a few years, marry Spouse #2. It turns out that Spouse #1 had significantly understated his income on one of those joint income tax returns. You get a notice form the IRS that you owe $10,000 in tax, interest and penalties. Unless you can qualify for one of the relief provisions described below, you have to pay the $10,000 because you signed a joint return. Often, as part of a divorce decree or marital property settlement, the spouses will make agreements about who is to pay income taxes. These agreements are not binding on the IRS. The IRS was not a party to the agreement. You can use the agreement to collect from your spouse (if he or she has anything), but the agreement is no bar to collection from you by the IRS. Chances are, if the IRS is coming after you for the tax, it’s because your ex-spouse has no assets, and the tax is noncollectable from the ex-spouse, by you or by the IRS. Before 1998, the only relief available for a spouse in this situation was if she qualified as an “innocent spouse.”
There were many rules and technicalities and this status was hard to demonstrate. In 1998, Congress amended the Internal Revenue Code to provide other mechanisms to allow you to avoid paying taxes that should have been paid by a spouse or former spouse. There are three forms of relief: 1) one is am improved version of the innocent spouse rules, 2) another has more lenient provisions, but is only available if you are no longer married or are separated from your spouse, and 3) the third form of relief is an equitable remedy that applies if it would be unfair to collect the tax from you and you didn’t qualify under 1) or 2). The 1998 new and improved version of the innocent spouse rules require that an innocent spouse must meet the following conditions to qualify: “(1) a joint return understated taxes because of erroneous claims by the requesting party's spouse, such as unreported or under reported income, or unjustified deductions or credits; (2) when the return was signed, the innocent spouse did not know or have reason to know that there was an understatement of tax. If the spouse knew, or should have known, that there was an understatement, but did not know by what amount, partial relief may be given; and (3) in light of all of the surrounding circumstances, it would be unfair to hold the requesting party liable for the understatement of tax.”
Requests for relief under any one of these three provisions is made on Form 8857, Request for Innocent Spouse Relief. Separation of liability is an allocation between the spouses of unpaid liabilities resulting from the understatement of taxes owed. Either 1) the parties filing the joint return are no longer married or are legally separated, or 2) the joint filers were not members of the same household at any time during the 12-month period before the relief is sought. If spouses transferred assets between themselves to avoid tax, this relief does not apply. If the spouse had actual knowledge of the other spouse's erroneous items on a joint return, this relief is also not available. For those situations where the innocent spouse rule or separation of liability does not apply, a third possibility of equitable relief is there. If there has been no fraud and it is “unfair” to hold the spouse seeking relief liable, the IRS can still grant relief. Various factors are considered such as separation or divorce, economic hardship, whether or not there was knowledge of the items causing the understated tax, or whether the spouse seeking relief received a significant benefit from that understatement. Don’t depend on these rules. Even these do not always provide relief. The bottom line is, if you think something is wrong with your tax return, don’t sign it. If your spouse won't file a correct return, file a separate return with married filing separately status. It may mean paying more tax in the short run, but signing a false tax return can mean paying a lot more tax in the long run.
Maybe the marriage ceremony should go like this: "You have the right to remain silent, anything you say may be held against you, you have the right to have an attorney present. You may kiss the bride."
Unfortunately, using married filing separately status is not very favorable from a tax viewpoint. A joint return usually results in a lower overall tax liability.
In general, any payment, whether called a gift or not, to an employee is taxable income to the employee.
