By filing a joint income tax return, spouses make themselves liable for all of the income tax due on their combined income. While filing a joint return can provide significant advantages, it also can create an unfair burden for a taxpayer saddled with a substantial tax liability (known in this article as the “Requesting Spouse”) because of the wrongdoing of his or her spouse (the “Non-Requesting Spouse”).
When the IRS determines that additional income tax is due on a joint income tax return, it will assess a “deficiency” against both spouses in the amount of the tax owed. A deficiency can arise either because the amount of income tax liability shown on the return is less than it should be (an “understatement”) or because all or some of the income tax liability shown on the return is not paid (an “underpayment”).
A taxpayer against whom the IRS has assessed a deficiency may apply to be relieved from income tax liability through Innocent Spouse Relief. There are three forms of Innocent Spouse Relief for which a Requesting Spouse may apply: General Relief, Separation of Liability Relief, and Equitable Relief, each of which is described below. The IRS recently issued Revenue Procedure 2013-34, in which it expanded the ability of a Requesting Spouse to obtain Equitable Relief.
To qualify for General Relief, there must have been an understatement (rather than an underpayment) of income tax liability on the joint return. In addition, the Requesting Spouse must be able to show that he or she did not know, and had no reason to know, of the understatement of income. In determining whether the Requesting Spouse had reason to know of the understatement, several factors are considered to determine whether a “reasonably prudent taxpayer” would have been aware of the understatement. These include the Requesting Spouse’s level of education and involvement in the couple’s business affairs, the presence of unusually lavish spending habits, and the Non-Requesting Spouse’s deceitfulness regarding the couple’s finances, among others. The final requirement for General Relief is that, under all the facts and circumstances, it would be inequitable to hold the Requesting Spouse liable for tax due on the understated income.
If General Relief is granted, the Requesting Spouse may be fully relieved from the item or items of income with regard to which the request was made. Alternatively, the IRS may determine that the Requesting Spouse only should be partly relieved from liability.
Separation of Liability Relief
Separation of Liability Relief, like General Relief, is available only in the event of an understatement. In addition, one of the following conditions must be met: (1) the Requesting Spouse and the Non-Requesting Spouse are divorced or legally separated or (2) the Requesting Spouse and the Non-Requesting Spouse have not been members of the same household at any time during the 12-month period before the Requesting Spouse files for relief.
Separation of Liability Relief only will be granted for items of income of which the Requesting Spouse had no actual knowledge. Unlike General Relief, the Requesting Spouse will not be disqualified from obtaining relief merely because he or she had reason to know of the item of income resulting in the understatement. Generally, if Separation of Liability Relief is granted, the income tax deficiency will be allocated between spouses as though they had filed separate income tax returns. If all of the items creating the deficiency would have been properly included on the Non-Requesting Spouse’s return, then the Requesting Spouse will be entirely relieved of liability.
If both General Relief and Separation of Liability Relief are unavailable, the Requesting Spouse still may be relieved of income tax liability through Equitable Relief. Equitable Relief is available in the case of an understatement or an underpayment and requires the IRS to weigh several factors, including but not limited to (1) whether, based on the Requesting Spouse’s income and basic living expenses, he or she will suffer economic hardship if relief is not granted, (2) whether the Requesting Spouse knew or had reason to know of the understatement or underpayment, and (3) whether the Requesting Spouse was in poor physical and/or mental health.
Equitable Relief is intended to give the IRS leeway in granting relief to a Requesting Spouse who is unfairly burdened with tax liability when the more rigid requirements of General Relief and Separation of Liability Relief are not met. This leeway has been expanded with the issuance of Revenue Procedure 2013-34.
One of the significant changes implemented by Revenue Procedure 2013-34 is that the IRS will now give greater deference to the presence of abuse when determining whether Equitable Relief is appropriate. If the Requesting Spouse (or anyone in the Requesting Spouse’s household) has been the victim of physical or emotional abuse, then a factor which would otherwise have weighed against Equitable Relief may be neutralized.
Another significant change is the expansion of the timeframe within which a Requesting Spouse may apply for Equitable Relief. Under old rules, a Requesting Spouse had two years to apply. Revenue Procedure 2013-34 allows for applications up to 10 years after the IRS assesses a deficiency.
Finally, Revenue Procedure 2013-34 clarifies that no one factor or majority of factors will control the determination of whether Equitable Relief is appropriate. Thus, relief may be granted even if more factors weigh against relief than for it, and the weight given to each factor will vary according to the specific facts and circumstances of the case at hand.
Revenue Procedure 2013-34 further expands the recourse available to individuals who are burdened with income tax liability as a result of a spouse’s wrongdoing.
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Any taxpayer who believes that he or she may be eligible for Innocent Spouse Relief should contact a qualified tax professional.