Steve A Porter, CPA

By: Steve A. Porter, CPA, CMA

As any married person can tell you, marriage can lead to certain complications in life. And when you mix taxes and marriage, it is inevitable that problems arise from time to time.

Most married people filing US tax returns do so jointly. And checking that little box on your 1040 return that says “married, filing jointly” not only saves you a bundle in taxes, it creates a special kind of liability called “joint and several” liability. I am not an attorney, so I will let you ask your lawyer to explain what that means, but it is important that you know the IRS may look to both you and your spouse, or either one of you separately, to satisfy a tax liability.

Here’s a little true story illustrating what can happen when a person files jointly, and the marriage has, let’s just say, “communication issues.”

A lady called me, almost sobbing, telling me she received a notice from the IRS who wanted a very significant sum in back taxes, penalties, and interest. The lady had divorced a couple of years prior, and it seems her husband (ex-husband now) had been quite a gambler. So good, in fact, he had gambling winnings of $100,000.00. He had somehow kept this a secret from her, and to make matters worse, had tried to keep it a secret from the IRS. He had not reported this income.

Since she had filed jointly with her husband, the IRS came looking for the tax to both parties. They were unable to collect from the ex-husband, but the lady had a nice job, and a little savings which she wanted desperately to protect.

Not fair? No, it is not. But the good news is that the IRS does have a sense of fairness in this type of situation, and actually offers a way around the joint liability created when you sign a joint return.

It is called “innocent spouse relief”, and you can read all about it in IRS Publication 971.

To actually be an innocent spouse, you have to meet the criteria outlined in Publication 971. You must:

• Have signed and filed a joint return with your spouse (or ex-spouse) which contained “erroneous items” which resulted in an understatement of tax liability
• You had no knowledge or (and this is important) reason to know the item in question was erroneous
• Taking into account all the facts and circumstances, it would be unfair to hold you liable
• There must not have been a property transfer as part of a fraudulent scheme which defrauds either the IRS or a third party such as a creditor.

Note that you must have all four. If you meet the requirement for numbers 1 and 2, yet fail to meet number 4, you will not be eligible.

Now, things like “erroneous items” and “reason to know” are explained in further detail in Publication 971. Let’s take a look at some examples of what is considered meeting the criteria as defined by the tax code.

Erroneous Item: Broadly, these are income items which go unreported or under-reported, or deductions, tax credits, or basis calculations that are improper and result in an understated tax liability. The gambling winnings in my example above would be an example of unreported income. A deduction for a dependant that did not meet the requirements for a dependant deduction would be another example.

Actual Knowledge or Reason to Know: Actual knowledge is pretty straightforward, but “reason to know” can be subjective. In the gambling example above, let’s assume the wife often accompanied the husband to the horse track or gambling casinos, and the year in question the husband purchased an expensive vehicle with cash, would it have been reasonable to expect the wife to inquire about where the money came from? If so, there might have been a reason to know making innocent spouse relief unavailable.

Indications of unfairness: In the above example, the husband deserted the wife shortly after the gambling winnings. The wife received no benefit from the income, so it would not be fair to require her to pay taxes. But let’s say, for example, a new house was purchased with the winnings, and the wife got to live in the house, and later received proceeds from the sale of the house. In that case, there was no indication of unfairness, and the relief from tax liability would probably not be granted.

The innocent spouse relief is all about fairness. The strict letter of the “joint and several” liability created when you sign a joint tax return would otherwise punish an innocent party for something done by a spouse.

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