Most married couples file tax returns using the married filing joint filing status. Generally, this is the correct “tax planning” move because married filing joint tax rates are lower than married filing separate rates, the standard deduction is higher, and an additional exemption can be used. Thus, there is a marriage tax bonus (as opposed to a marriage tax penalty).
However, the downside, and it’s a very big downside, to the married filing joint return status is that each spouse is jointly and severally liable for any tax related to that return. That’s true even if only one spouse had income.
Therefore, before filing a joint return, taxpayers should carefully consider if that is the proper filing status for them. If only one spouse has income, and the tax cannot be paid, the proper legal strategy might be to have that taxpayer file under a married filing separate status. Yes, the tax liability will most likely be higher than it would be using a joint status, but only one of the spouses will be liable for the tax (at least in a non-community property state).
I have had numerous cases, where both spouses are liable for hundreds of thousands of dollars in tax, which will never be paid due to financial circumstances (medical crisis, divorce or what have you), where only one spouse would be liable if the proper filing status had been used.
Unpaid joint tax liabilities put joint assets such as houses, bank accounts, and cars at risk. Furthermore, if one spouse dies, the IRS is still free to collect from the surviving spouse. Had a married filing separate status been used, and the liable spouse dies, the tax debt will die with him or her. Also, if spouses file married filing separate and it is a mistake, those returns can be amended to a joint status. The reverse is not possible; file a joint return and you are stuck with it.
Fortunately, there is relief available. Under certain circumstances, one spouse on a joint return can file for “innocent spouse” status. If the IRS concurs with the requesting spouse’s (RS) claim, that spouse will be relieved of the liability and only the non-requesting spouse (NRS) will remain liable.
Generally, there are three types of relief commonly referred to as “innocent spouse” relief. Each has its own legal requirements. Also, it matters whether the tax liability is an “understatement of tax” or an “underpayment” of tax.
An understatement of tax is also commonly referred to in the tax world as a tax deficiency. Usually, the so-called understatement occurs when the IRS audits a tax return and determines that there was unreported tax.
An underpayment of tax is exactly that. The taxpayers file a joint tax return, which reported tax due, but that tax was not paid.
If the taxpayers are faced with an understatement case, then “innocent spouse” relief is available under all thee types of relief. If the taxpayers face an underpayment case, then only the “equitable relief” type is available.
This type of relief is available in cases where the taxpayers are still married and living together. To qualify for this type of relief, the requesting spouse must show:
This type of relief is an election, which is made by the electing spouse to allocate the tax deficiency between the two spouses. Each spouse will be apportioned the amount of tax that was attributable to that person. For example, if 90% of the understatement of tax was generated from the business income of one spouse and 10% was generated from interest income of the other spouse, then the tax is allocated between the spouses 90% and 10%. Generally, picture the tax liability as it would have been had the two spouses filed correct married filing separate returns.
Only taxpayers that are no longer married, legally separated, or not living together may request this type of relief. To qualify for this type of relief, the electing spouse must show:
This type of relief is a catch – all that the law provides for spouses that cannot meet the requirements of the first two types of relief. Also, it is the only type of relief available for underpayment cases. To qualify for this type of relief the requesting spouse must show:
In most cases, Innocent Spouse & Equitable Relief are difficult to get. The IRS does not like granting relief to couples that are still married and living together, and the have reason to know criteria is difficult to beat.
The IRS applies a series of factors to determine if the requesting spouse had reason to know, including, (in IRS speak)
Under Equitable Relief some of the factors the IRS applies to decide whether it is inequitable to hold the requesting spouse liable include:
Getting relief under any one of these three provisions can be tricky (although separation of liability is the easiest). These provisions overlap in some areas and I have found that, in some cases, IRS personnel are not well trained in applying these provisions (I have had three cases within the last month (5-2012) where the IRS employees (two in Exam and one in Appeals) had no idea what they were doing or talking about.
Fortunately, judicial review in the Tax Court is available if the taxpayer’s claim is rejected.