If a couple files a joint tax return, they are generally both liable for any tax liability, even if only one of the spouses is responsible for the shortfall. However, you might get off the hook if you qualify as an “innocent spouse.” A Tax Court new case, Pocock, TC Memo 2022-55, 6/6/22, shows when equitable relief may be available if paying Uncle Sam would result in economic hardship.
Basic rules: There’s a chance your client may be held personally liable for a tax debt even if they were completely unaware of the situation. And simply getting divorced doesn’t matter.
There’s a way out if they’re treated as an “innocent spouse” under IRS rules. To qualify, they must meet all of the following requirements.
- Filed a joint return that has an understatement of tax due to erroneous items of your spouse (or former spouse).
- Establish that at the time you signed the joint return you did not know, and had no reason to know, that there was an understatement of tax.
- Taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax.
- You and your spouse (or former spouse) have not transferred property to one another as part of a fraudulent scheme. A fraudulent scheme includes a scheme to defraud the IRS or another third party, such as a creditor, ex-spouse or business partner.
If a spouse does not qualify for innocent spouse relief as stated above, they may still qualify for equitable relief. For these purposes, the determination is based on all the facts and circumstances, including several critical factors relied on by the IRS. Notably, as it pertains to the new case, it is significant if the taxpayer requesting to be treated as an innocent spouse will suffer economic hardship in the event that relief isn’t granted.
Facts of the case: A married couple, residents of Michigan, had a rocky relationship for years before the husband left, including allegations of physical and verbal abuse by the husband. The wife relocated to Florida where she started a new life.
However, the husband eventually also moved to Florida and they reconnected.Even though they divorced, the couple lived together in a house they had bought with financial assistance from another party. The wife thought it was best for them to maintain the home for the sake of their two kids.
From 1995 through 2005, the husband fraudulently claimed large refunds on their joint returns by misstating his income and federal income tax withholdings. Although she benefitted from the fraud, the wife had no part in filing these tax returns or any of his illegal schemes.
Finally, the Tax Court determined that the wife would suffer economic hardship if she were for forced to pay her tax liability. The Court would not require the wife to sell the home to help pay the debt.
Result: Innocent spouse relief was granted.