Divorced and Separated Spouses Have Options to Protect Themselves From the Internal Revenue Service

Individuals who sign joint tax returns are jointly and severally liable for any tax due. Internal Revenue Code of 1986, as amended (hereinafter "I.R.C."), §6013(d)(3). This applies not only to the tax shown as due on the return, but to any additional amounts owed as a result of an IRS audit, including interest and penalties. Congress has provided, however, that if one spouse is "innocent," then he or she is not liable. I.R.C. §6015. The Taxpayer Bill of Rights 3 substantially liberalized the availability of innocent spouse treatment, providing three alternative sets of rules under which relief may be available. The first is very similar to the innocent spouse treatment that has been available for many years. To qualify, the requesting spouse must make a timely election, show there is an understatement of tax attributable to erroneous items of the other spouse, that he or she did not know and had no reason to know of the understatement, and that it would be inequitable to hold that person liable. I.R.C. §6015(b).

The second alternative allows an electing spouse to allocate any tax deficiency in proportion to each spouse's contribution to the deficiency. I.R.C. §6015(c). This allocation is made without regard to the community property laws. I.R.C. §6015(a). The election may be made only by an individual who, at the time of the election, is no longer married, is legally separated from the other spouse, or is not a member of the same household during the 12 month period ending on the date the election is filed. Liability is increased by the value of any "disqualified asset" transferred to the innocent party. I.R.C. §6015(c)(4)(A). A disqualified asset is any property transferred by the other spouse to the innocent party if the principal purpose of the transfer is the avoidance of tax or the payment of tax. IRC §6015(c)(4)(B).

The third alternative authorizes the IRS to issue rules under which it "may" relieve a spouse of liability if relief is not available under the first two alternatives, and taking into account all the facts and circumstances it would be inequitable to hold the individual liable. I.R.C. §6015(f). A fundamental distinction of this provision is that, unlike the first two it permits relief for tax amounts shown on the return, but not paid, rather than just audit amounts determined by the IRS.

Revenue Procedure 2003-61 provides that in order to obtain equitable relief the taxpayer must meet all of the following threshold requirements:

1. The requesting spouse filed a joint return for the taxable year for which he or she seeks relief.
 
2. Relief is not available to the requesting spouse under section 6015(b) or (c).
 
3. The requesting spouse applies for relief no later than two years after the date of the Service's first collection activity after July 22, 1998, with respect to the requesting spouse.
 
4. No assets were transferred between the spouses as part of a fraudulent scheme by the spouses.
 
5. The nonrequesting spouse did not transfer disqualified assets to the requesting spouse. If the nonrequesting spouse transferred disqualified assets to the requesting spouse, relief will be available only to the extent that the income tax liability exceeds the value of the disqualified assets. For this purpose, the term "disqualified asset" has the meaning given the term by section 6015(c)(4)(B).
 
6. The requesting spouse did not file or fail to file the return with fraudulent intent.
 
7. The income tax liability from which the requesting spouse seeks relief is attributable to an item of the individual with whom the requesting spouse filed the joint return (the "nonrequesting spouse").
 

If the requesting spouse meets all of the above requirements then relief will generally be granted by the IRS if the following conditions are met:

1. On the date of the request for relief, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse, or has not been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date of the request for relief.
 
2. On the date the requesting spouse signed the joint return, the requesting spouse had no knowledge or reason to know that the nonrequesting spouse would not pay the income tax liability. The requesting spouse must establish that it was reasonable for the requesting spouse to believe that the nonrequesting spouse would pay the reported income tax liability. If a requesting spouse would otherwise qualify for relief under this section, except for the fact that the requesting spouse's lack of knowledge or reason to know relates only to a portion of the unpaid income tax liability, then the requesting spouse may receive relief to the extent that the income tax liability is attributable to that portion.
 
3. The requesting spouse will suffer economic hardship if the Service does not grant relief. For purposes of this revenue procedure, the Service will base its determination of whether the requesting spouse will suffer economic hardship on rules similar to those provided in Treas. Reg. § 301.6343-1(b)(4).
 

Even if these conditions are not met the IRS may grant equitable relief. Rev. Proc. 2003-61. § 4.03. The IRS will review the all of the facts and circumstances in making a determination whether it would be inequitable to hold the requesting souse liable. Rev. Proc. 2003-61, § 4.03(2) sets forth the following list of applicable factors that are used in making the determination.

1. Marital status. Whether the requesting spouse is separated (whether legally separated or living apart) or divorced from the nonrequesting spouse.
 
2. Economic hardship. Whether the requesting spouse would suffer economic hardship (within the meaning of section 4.02(1)(c) of Rev. Proc. 2003-61 if the Service does not grant relief from the income tax liability.
 
3. Knowledge or reason to know. In the case of an income tax liability that was properly reported but not paid, whether the requesting spouse did not know and had no reason to know that the nonrequesting spouse would not pay the income tax liability.
 
4. Nonrequesting spouse's legal obligation. Whether the nonrequesting spouse has a legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement. This factor will not weigh in favor of relief if the requesting spouse knew or had reason to know, when entering into the divorce decree or agreement, that the nonrequesting spouse would not pay the income tax liability.
 

While the new innocent spouse rules open up additional avenues to help clients who have been unfairly saddled with a tax obligation, unlike prior law innocent spouse treatment can be obtained only if timely elected thereby creating a trap for the unwary. Since the triggering event may come to the attention of the client's accountant it is important that the accountant be aware of these deadlines so that appropriate steps can be taken to preserve the client's rights.

*Dennis Brager, Esq., is a State Bar Certified Tax Specialist in Los Angeles. A former IRS senior trial attorney, Mr. Brager now devotes his efforts exclusively to helping clients resolve their tax problems with the IRS and California State tax agencies. Services include negotiating Tax Debts, Tax Fraud Representation, Tax Litigation, Tax Audit and Appeals Representation,  Tax Preparer Penalty Mitigation, Payroll Tax Audits, and California Sales Tax Problems. He may be reached at 800.380.TAX LITIGATOR.
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