For most married couples, filing federal income taxes jointly rather than separately results in a lower tax bill. However, this “ all for one, one for all” approach can have a downside if questions arise about the accuracy of the return. The general rule is that both taxpayers will be responsible, individually as well as collectively, for any taxes, interest, and penalties owed, even if only one spouse was earning the income. It may be that in a couple’s division of labor only one spouse is in fact responsible for understating income or erroneously claiming deductions, but, by law, each spouse can be made to answer to the IRS.
It is always good advice for anyone signing a tax return to do so only after carefully reviewing and understanding every line of it. But even such common- sense measures cannot always prevent mistakes and/or deception from happening. To avoid unfairness in such circumstances, the Tax Code has provisions designed to protect “ the innocent spouse.”
Under this general heading, there are three kinds of relief: innocent spouse relief, relief by separation of liability, and equitable relief. To request relief, a taxpayer must file the appropriate form with the IRS no later than two years after the IRS first tries to collect the tax. An attached statement must explain why the taxpayer believes he or she qualifies for relief. If the IRS rejects the claims for the first two types of relief, it will automatically determine whether equitable relief is warranted.
Conditions for Relief
An innocent spouse must meet the following conditions to qualify for relief: (1) a joint return understated taxes because of erroneous claims by the requesting party’s spouse, such as unreported or underreported 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. Among the factors taken into account by the IRS are whether the taxpayer benefited from the erroneous return in the form of a higher standard of living and whether the joint filers later were divorced or separated.
A claim for innocent spouse relief was recently rejected by the Tax Court under circumstances that illustrate some of the factors that weigh against such relief. A husband underreported the income from a family business that, during the relevant tax year, was the couple’s only source of income. His wife, who had retired from another job, helped run the business in a variety of ways, including answering the telephone, sending out mail, paying hired help, and sometimes working on some of the casino game nights that the business provided for customers.
Although both spouses thought of the business as primarily being the husband’s, and only the husband had filed the joint tax return (although the wife had also signed it), the wife was too closely involved in running the business and had too much access to the records of the business to be accorded the status of an “ innocent spouse.”