IRS Broadens Equitable Relief for Innocent Spouse

By Marcia Richards Suelzer, Toolkit Staff Writer

The IRS has eliminated the two-year time limit that now applies to equitable relief requests in order to permit more innocent spouses to avoid tax liability caused by the misdeeds of the other spouse (or former spouse.)

Joint Returns Mean Joint Liability for Taxes

If you file a joint income tax return with your spouse, both of you are jointly and severally responsible for the entire tax liability that the IRS determines is due. This means that you can be held liable for the full amount of the tax, interest, and penalties, even if the tax is due to the income, deductions and credits of your spouse. In addition, joint and several liability means that the IRS does not have to attempt to collect from your spouse; they can pursue you directly.

Warning. Even if you divorce, you remain jointly and severally liable for the taxes--and the IRS still can collect from you without first attempting to collect from your former spouse. This is true even if your divorce decree states that your former spouse will be solely responsible for the tax. The divorce decree will provide you with a way to sue your former spouse for reimbursement, but it will not deter the IRS from pursuing you.

Relief May Be Available for Innocent Spouses

If you find yourself in a situation where your spouse understated or underpaid income taxes, you may be able to avoid the tax liability. There are three types of relief available to married persons who filed joint returns.

• innocent spouse relief;
• separation of liability relief; and
• equitable relief.

Each of these types have separate rules for granting relief. The "innocent spouse" provisions were enacted to provide some relief if your spouse cheated on his or her taxes by understating income or by claiming bogus or overstated deductions or credits. However, getting innocent spouse relief is challenging because you must be able to prove that you did not know and did not have reason to know that your spouse understated an income tax liability. The IRS and the courts interpret the "have reason to know" test very strictly. For example, courts have held that simply knowing one spouse was a member of a partnership was sufficient knowledge to make the other liable for completely fraudulent deductions.

Separation of liability, another option for eliminating your liability for your spouse's misdeeds, allocates the amount of taxes due between you and your spouse (or former spouse.) Only those who are divorced or separated and who are not members of the same household can seek separation of liability relief.

Equitable Relief is "Last Resort"

Equitable relief is relief of the "last resort." You can seek equitable relief even if you don't qualify for innocent spouse relief or separation of liabilities provided that you have not willingly engaged in fraudulent behavior yourself. Equitable relief is also available if you have underpaid tax liability—even if the liability was not understated--if you can show it would be inequitable to hold you liable for your spouse's tax debt.

Although the law was silent on the issue, the IRS issued regulations that stated that requests for equitable relief had to be filed within two years of the IRS’s first collection activity against the requesting spouse with respect to the joint tax liability. Earlier this year, the IRS launched a thorough review of the equitable relief provisions of the innocent spouse program. According to IRS Commissioner Doug Shulman the review was needed "to improve our process to make it fairer for an important group of taxpayers" who are in "difficult situations."

Recently, the IRS made the first change as a result of the review program: it will no longer apply the two-year limit to new equitable relief requests or requests currently being considered by the agency.

Warning. The elimination of the two-year limitation only applies to requests for equitable relief. By law, the two-year period for seeking relief under the innocent spouse or separation of liabilities provisions continues to apply.

The elimination of the two-year limit on equitable relief is effective immediately. The IRS will not apply the two-year limit in any pending litigation involving equitable relief, and where litigation is final, the agency will suspend collection action under certain circumstances. Taxpayers with cases currently in suspense will be automatically afforded the new rule and should not reapply.

Tip. If you were previously denied equitable relief solely because of the two-year limit, your can reapply for relief using IRS Form 8857, Request for Innocent Spouse Relief, provided the collection statute of limitations for the tax years involved has not expired.

Posted August 4, 2011.