The Innocent Spouse Rule: An Insider’s Perspective

One of my favorite innocent spouse tax stories, which fairly encapsulates the issues involved, involves singer-songwriter Pete Seeger. The folk artist penned such classics as Turn, Turn, Turn, If I Had A Hammer, and Where Have All The Flowers Gone? His wife, Toshi, was his producer and business manager. She handled all of Pete’s financial affairs. When tax time rolled around, Pete supposedly could not bear to look at how much money he had made and, perhaps more significantly, how much of his money went to fund wars and other government endeavors he disagreed with. So, according to some sources, Toshi put a blank piece of paper over most of the 1040, and Pete dutifully signed it. 

Today, the same level of trust that Pete and Toshi shared exists in many households. One spouse does pretty much all the tax preparation, and the other spouse signs the return without asking questions. Unfortunately, many spouses take advantage of that trust, and as explored later, tax problems are easy to hide. But trust is not the only dynamic. In some households, one spouse is controlling or even violent, and the other spouse is in no position to question tax returns and other such items. The result of such an inquiry would probably be a curt “none of your business” denial or something much worse. 

 

There are obviously no statistics on this point, but it is reasonable to guess that one of these two environments are prevalent in most American households in the late winter and early spring of each year. 

 

Nevertheless, the IRS assumes that paying taxes is a collaborative process. That’s the reason for the joint and several liability rule. Even if one spouse accounted for 100 percent of household income, both spouses are equally responsible for the tax debt. This presumption does not apply in all cases, and that’s where the innocent spouse rule and other associated provisions come into play. 

 

In these cases, the IRS always tries to collect from the responsible spouse first. For example, if all the accompanying income statements pertain to Joe, the IRS will try to collect the entire delinquent amount from Joe and not his wife. However, if Joe cannot be located, is dead, or has no money, the IRS will try to collect from his wife, and that is usually the beginning of the innocent spouse procedure. 

 

Innocent Spouse Rule Elements 

 

In criminal court, defendants are innocent until proven guilty. But in most other areas of life, including civil tax court proceedings, the opposite is true. There is no way to overcome the presumption that both spouses equally participated in the preparation of the tax return. So, tax defense attorneys must play by the Service’s rules, and that means Section 6015 of the tax code. 

 

A brief aside here. For the rest of this paper, we will generally assume that the party claiming innocent spouse is the wife and the other spouse is the husband. That’s obviously not always the case, but it is the most common scenario. 

 

Understatement of Liability 

 

There is a very big difference between “understatement” and “underpayment” or “nonpayment.” If the return is accurate but, for whatever reason, the responsible spouse fails to pay some or all of the obligation, no Section 6015 relief is available. 

 

There’s also a difference between “understatement” and “fraud,” but this time, the difference benefits requesting spouses. Under Revenue Procedure 2013-34, non requesting spouses can claim innocent spouse relief even if they benefitted from the other spouse’s tax fraud. The theory is that such spouses were clearly victimized. 

 

Under the pre-1998 law, the understatement had to be 25 percent of adjusted gross income before the defense was available in most cases. That could be an awful lot of money. Fortunately, the IRS did away with this requirement and now any understatement will do. 

 

Understatement often involves failing to report a source of income, or at least under-reporting said income source. The other form of understatement — claiming an erroneous credit or deduction — is a little more amorphous. There may be an additional defense here, because to claim a credit or deduction, a taxpayer typically only needs to show reasonable basis, an evidentiary standard which is lower than the one-in-three realistic possibility of success and a little higher than frivolous. 

 

So, if the requesting spouse can prove that the preparing spouse had a reasonable basis for claiming the deduction or credit, there may be no need to examine the two remaining innocent spouse rule elements. 

 

Knowledge 

 

Much to the chagrin of many women’s advocates, the knowledge requirement is still in place, even though the IRS changed many of the other innocent spouse elements in 1998 and again in 2012. Many people claim that the indirect knowledge requirement unfairly punishes women who are well-educated or have financial backgrounds, and others complain that the duty it imposes on women is too heavy. 

 

Another brief aside here. The IRS always contacts the other spouse if one partner files any innocent spouse claim. There is pretty much no way to get around this requirement, so my best advice is to be ready. Fortunately, by this point, most claimants are either divorced or legally separated (indeed, that’s a requirement in many cases), so it is a little easier to work with a family law attorney or the state to get a protective order if needed. An offer in compromise based on doubt as to liability may be an option as well. 

 

Essentially, the way some courts apply the law, women have a duty to not only examine the tax return, but also ask questions about unusual items. As discussed earlier, in many cases, that’s simply not a realistic option. Other courts are more willing to consider the totality of the circumstances, including abuse. Largely because there is really no list of factors to apply, the courts are on their own when it comes to determining knowledge or lack thereof. Some informal factors include: 

 

• Involvement: Women who have at least some control over the checkbook are often hard-pressed to convince a court that they knew absolutely nothing about income understatement. On the other hand, if women are in the dark about daily account balances and other information, lack of knowledge about a tax issue is not much of a leap. 
• Background: This factor was discussed above. 
• Benefit: Some couples go from barely making ends meet to a lifestyle that includes luxury goods and extended vacations. In these cases, the IRS assumes that women are smart enough to know that underpayment of taxes was at least a possibility, and that is pretty much the legal definition of constructive knowledge. 
• Recurrence: This factor does not work the way you think it might. It is more difficult to detect years of understatement than a questionable one-time credit or the sudden disappearance of an income source. 
• Participation: Indirect participation, such as using separate property assets to start an offshore business, almost always sinks an innocent spouse claim. 
• Compliance: If the claimant is evasive during the underlying investigation or is not current on subsequent tax obligations, the IRS often assumes that the claimant has something to hide, and that is tantamount to knowledge of the understatement. 

 

That first compliance area (evasion during the investigation) sometimes bleeds over into the next innocent spouse rule requirement. 

 

Two Years 

 

Some advocates believe that the IRS should have backed off this requirement as well, or perhaps even eliminated it altogether, but it is still in place. Claimants must file for relief within two years after the IRS begins collection activity. 

 

It is very, very easy to conceal tax investigations, at least for the most part. If the husband files a change of address and phone number, the wife will most likely have no idea about any collection activity. Moreover, if the couple is no longer living together when the collection activity begins, there is just about no chance that the husband would share this information with his estranged wife. 

 

Nevertheless, there are no exceptions to the two-year rule. If this element precludes the claim, there may be some other relief available, as outlined below. 

 

Equitable Result 

 

Even if a claim passes the three objective tests with flying colors, the IRS can still deny relief because, dadgum it, forgiving the tax debt would not be “fair.” The good news is this element is not completely subjective, because the IRS does list some factors to consider. 

 

• Current Financial Status: This factor may be the most important one. If the IRS determines, based on income and expenses, that the woman would experience a financial hardship if she had to pay the disputed taxes, the equities are on her side.  
• Abuse: It’s interesting that the IRS claims that it “understands” the issues associated with abusive marriages, yet it does almost nothing to actually help women in these circumstances. However, abuse is a factor in this particular element. 
• Marital Status: Generally, the longer the parties have been divorced, the father the disputed tax is in the rear-view mirror, and the passage of time weighs somewhat in favor of the claimant. 
• Knowledge: The stronger the evidence that the claimant did not know about the understatement, the more the equities weigh in her favor. 
• Health: If the claimant was dealing with a serious physical or mental health issue when the other spouse filed the errant return, it was probably easier to manipulate her or keep her in the dark, so once again, the equities are on her side. 
• Benefit: If the claimant drives to the innocent spouse hearing in the Lexus convertible she purchased because of the understatement of income, relief is highly unlikely. 

 

This non-exhaustive list at least makes this subjective factor a little less subjective, but it is still largely up to the court (and the skill of the tax defense attorney) to determine that relief is equitable under the circumstances. 

 

One final note on this point. Pragmatically, the more tax owed, the more determined the IRS is to collect it. Though it is not a factor in determining equity, the amount due does affect the way the IRS examines the objective evidence. 

 

Innocent Spouse Rule Alternatives 

 

To an extent, the innocent spouse rule is a lot like the offer in compromise. Taxpayers either qualify or they don’t. Fortunately, unlike the offer in compromise program, there are some very good alternative available for those claimants who find themselves on the outside looking in. 

 

As mentioned earlier, spouses are jointly and severally liable for income taxes regardless of their respective incomes. But in some cases, the IRS waives this requirement and apportions the disputed taxes between the spouses. Separation of liability relief is available if: 

 

• Living Apart: The claimant must be divorced, legally separated, or widowed. In some cases, twelve months of physical separation may suffice. What my grandmother used to call an Irish divorce (two people who are legally married yet emotionally separate) does not count, and neither does a temporary twelve-month separation due to something like illness or incarceration. 
• Lack of Actual Knowledge: There is no constructive knowledge requirement. Essentially, unless the claimant “made a deliberate effort to avoid learning about the item” or the spouses “jointly owned the property that resulted in the erroneous item,” there is no actual knowledge. If the claimant proves abuse, the standard may be even lower. 

 

In many cases, separation of liability is a lot easier to prove than innocent spouse relief. Moreover, if the claimant has no assets or income, her separate liability would be zero, so the outcome is the same. 

 

Aside from the fact that it is available in both understatement and underpayment cases, equitable relief is a lot like the innocent spouse rule without the first three objective factors. As the name implies, claimants need only establish that it would be inequitable for them to pay the tax based on: 

 

• Divorce or separation, 
• Economic hardship, 
• Former spouse’s obligation to pay pursuant to a divorce decree, 
• Benefit, 
• Compliance, and 
• Knowledge. 

 

The Seventh Circuit recently added a two-year requirement to equitable relief, similar to the innocent spouse rule. 

 

Note that the knowledge requirement is not a make-or-break element, but simply one factor on the list. Additionally, if the claimant knew about the understatement or underpayment, that knowledge is neutral. It does not weigh against the claimant. 

 

Hopefully, this document has laid out the requirements for the innocent spouse rule and its alternatives. If you believe you may qualify for this relief, contact my office immediately and we will begin work straightaway.