The innocent spouse rules have been liberalized in new tax legislation, making it easier for spouses to qualify for tax relief. In addition, the legislation allows a spouse to limit her liability on a joint return to her separate liability. This is a boon to separated spouses who continue to file joint returns with their spouses, and it offers greater protection to divorced spouses who face liability for taxes on returns they jointly filed during marriage.
The innocent spouse provisions provide tax relief to a spouse who jointly files with her husband (or vice versa) if there was a tax understatement attributable to her spouse and she did not know about the understatement when she signed the return, nor did she have reason to know of the tax understatement. If she knew there was an understatement but didn’t realize the extent of the understatement, she may be granted partial relief.
Under new Internal Revenue Code Sec. 6015, a spouse can now elect to limit her liability for unpaid taxes on a joint return to her separate liability amount. That amount is the tax on items that would have been allocated to her had she filed a separate return. There’s one catch though – any item of which the spouse had actual knowledge is allocable to both spouses. The good news is that the IRS must prove that she had knowledge of the misstatement or omission that caused the deficiency.
To qualify for the separate liability election, the taxpayer must be divorced, legally separated or living apart from her spouse for at least a year at the time she files the election. The election must be made within two years after the IRS begins collection efforts against the innocent spouse. But even if the spouse fails these tests, the IRS can grant relief from tax liability if, based on all the facts and circumstances, it is inequitable to hold her liable.
The new rules take effect immediately, as long as the taxes remain unpaid. A spouse who has already paid more than her share of the liability can’t receive a refund under the new law, although there is a special exception for taxes paid between July 22, 998 and April 15, 1999. For that reason, anyone with unpaid taxes who might qualify for the separate liability election should consider her options carefully before she pays any portion of the tax due. Since there is no downside for the spouse filing the separate liability election, she should make the election in all situations in which she qualifies and is faced with a tax deficiency.
Relief from tax deficiencies will not be granted if the item giving rise to the tax deficiency is attributable to the spouse requesting relief, if she had reason to know of the unpaid tax liability, if she significantly benefited from the unpaid tax liability, or if a divorce decree or separation agreement legally requires her to pay the tax liability.
Ginita Wall, CPA, CFP, CDS can be reached via the Internet at www.planforwealth.com or at www.wife.org.