"Innocent Spouses" Can File for Tax Relief

Signing a joint income tax return can be costly if your spouse hides income or fails to properly pay taxes. In the eyes of the IRS (Internal Revenue Service), your signature makes you equally liable with your spouse for taxes due, including interest and penalties.

But the IRS is willing to take another look if you can show that your spouse acted without your knowledge. The IRS uses the Innocent Spouse Doctrine to allow current or former spouses who claim they are unwitting participants in underpayment of federal income taxes to apply for relief.

Joint return, joint liability

Joint tax returns are attractive to most married couples because they provide significant tax benefits, according to Alan Orlowsky, president of A.G. Orlowsky Ltd., a law firm in Northbrook, Ill., concentrating in the area of tax law. Orlowsky is a lawyer and certified public accountant who formerly worked as an attorney in the Estate and Gift Tax Division of the IRS and at the accounting firm of Deloitte & Touche, Chicago.

Orlowsky notes that while married couples share in the benefits of filing a joint return, they also share the liability when additional taxes are due.

"When you file a joint tax return, both spouses are jointly and separately liable for the tax that is due," Orlowsky says. "So the IRS can go after either spouse for the entire amount."

The Innocent Spouse Doctrine typically comes into play when one spouse deceives the other about income, tax payments, or both. Orlowsky says his experience and case law alike show that women are more likely to file for innocent spouse relief. These women often focused their attention on the home front while their husbands ran businesses. Under such conditions, income can vary without alerting the innocent spouse to potential problems.

"This goes on all the time," Orlowsky says. "If your spouse is running a business and you're home taking care of the babies, you often don't have knowledge of the income or losses generated by the business."

The "innocent spouse"

Orlowsky's clients currently include a woman whose former husband failed to report approximately $250,000 of self-employment income on their joint tax returns for several years, creating a total additional tax liability of approximately $150,000 including interest and penalties. Now divorced, the woman is seeking innocent spouse relief, pleading she had no prior knowledge that her ex-husband underreported their income. After three years, Orlowsky says the case is still not nearing resolution.

Orlowsky provided three examples of cases where the IRS granted innocent spouse relief.

A woman who was unaware that her husband underreported the proceeds from their joint investment in a gold mine; The wife of an options trader who lacked the information needed to determine that he earned considerably more than he told either her or the IRS; and
"If you're suspicious and things are falling apart, don't sign a joint return."
A woman who was ignorant about the income generated by her husband's illegal drug sales.

"You have to be able to show the IRS two things," Orlowsky says. "First, that you didn't have knowledge that the tax return was improperly prepared, and second, that you had no reason to know of the fraud."

When a taxpayer files a request for innocent spouse status by using Form 8857, Request for Innocent Spouse Relief, the IRS informs the nonrequesting spouse of the filing. If the nonrequesting spouse disputes the request or the initial request is denied, the case can enter the appeals process or may even advance to tax court, where a judge determines liability. The typical case takes roughly two to three years to resolve. Taxpayers who file for innocent spouse relief often work with a tax expert who understands the complexities of IRS substantive and procedural law.

Even with expert assistance, cases are denied if the IRS can show that the filing spouse may be feigning ignorance about the contents of the joint return. For example, Orlowsky says innocent spouse relief was denied to a college-educated nurse who knew her husband was financially irresponsible and also knew that he was deriving income from a dental practice. The court denied relief because the woman failed to question either her ex-husband or their accountant about the potential for underreported income.

"It's about control and the right to knowledge," Orlowsky says. "The IRS draws a fine line."

Seeking relief

You participated in filing a joint return that understates the amount of tax due. The understatement of tax is due to erroneous items on the return that were provided by your spouse. At the time you signed the joint return you did not know, and had no reason to know, that the tax was understated. Based on the circumstances involved, it would be unfair to hold you liable for the understatement of tax. You must request relief within two years after receiving a collection notice from the IRS. The Innocent Spouse Doctrine was established by tax law changes enacted on July 22, 1998, so the doctrine only applies to collection activity initiated after that date.

As part of the process, the IRS scrutinizes each case to determine whether the taxpayer requesting relief received significant benefits due to the underpayment of taxes. A taxpayer who is determined to be an "innocent spouse" is relieved of liability for taxes, interest, and penalties resulting from the understatement of income, even if the couple is still married.

Taxpayers who are no longer married or who are legally separated also may use the Innocent Spouse Doctrine to seek "Separation of Liability Relief." Under this method of relief, the IRS can separately allocate income and expenses to each spouse as if each had filed a separate tax return. The spouse who petitioned for relief then pays the resulting tax based on his or her income alone.

Even when innocent spouse or separation of liability relief is denied, relief still may be available. The Innocent Spouse Doctrine also allows taxpayers to seek "equitable relief," which relieves a now-divorced or separated spouse of an unfair liability for taxes that were properly filed but never paid. For example, Orlowsky says, the wife may tell the husband that she used their $10,000 loan to pay the taxes while diverting the funds for another purpose.

To qualify for equitable relief, the taxpayer must show that he or she was unaware that the taxes were unpaid and that the resulting liability will create a severe economic hardship. The amount of relief granted from taxes, interest, and penalties varies on a case-by-case basis.

Additional information about the Innocent Spouse Doctrine is available on the IRS Web site. Taxpayers can review their eligibility through an interactive questionnaire in the section, "Explore if You Are an Eligible Innocent Spouse."

To prevent exposure to tax liability from a misfiled return, experts advise married taxpayers to stay involved in their family's financial management. Orlowsky says married taxpayers who suspect trouble is looming always have the option to file a separate return. That may mean paying more on your annual return, but the investment is worthwhile if its saves you from being held liable for your spouse's tax problems.

"If you're suspicious and things are falling apart, don't sign a joint return," Orlowsky says.

Published April 28, 2003