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Relief Options for Spouses Treated Unfairly on Joint Returns

Published on: Published in: Taxes

Article Highlights:

INTRODUCTION

  • Joint Return Election

INJURED SPOUSE TAX RELIEF

  • Definition and Qualifications
  • Community Property States
  • The 5-Step Process
  • Timeframe for Processing

INNOCENT SPOUSE RELIEF

  • Overview
  • Joint
  • Types of Relief
  • Understatement of Tax and Erroneous Items
  • Indicators of Unfairness
  • Facts and Circumstances
  • Divorce and Legal Separation
  • Economic Hardship
  • Allocating an Understatement of Tax
  • Choosing the Right Type of Relief
  • Suspension of the Statute of Limitations
  • Effect of Offer-in-Compromise
  • Divorce Situations and Joint Returns Signed Under Duress
  • Effects on the Non-Innocent Spouse
  • Timeframe for Processing

Blog: When it comes to filing taxes, married couples often choose to file jointly to take advantage of certain tax benefits. Choosing to file a joint return is an election that carries significant implications. Understanding the potential liabilities and relief options is essential for informed decision-making.  Filing jointly can sometimes lead to complications, especially when one spouse has outstanding debts or when there are discrepancies in reported income. Generally, both spouses may be held responsible, jointly and individually, for the tax and any interest or penalty due on their joint return. The IRS provides two forms of relief to address these issues: Injured Spouse Tax Relief and Innocent Spouse Relief. While both aim to protect individuals from unfair tax liabilities, they cater to different situations and have distinct processes and qualifications. This article delves into the nuances of each, highlighting their differences and providing a comprehensive guide to understanding and applying for these reliefs.

INJURED SPOUSE TAX RELIEF

Definition and Qualifications – Injured Spouse Tax Relief is designed for a married individual who has filed a joint tax return with their spouse and has had their share of a tax refund used to cover their spouse’s past-due debts. These debts can include federal or state taxes, child or spousal support, or federal non-tax debts like student loans. To qualify as an injured spouse, the injured spouse must meet the following conditions:

  • Filed a joint tax return.
  • Have reported income, such as wages, interest, etc.
  • Made and reported tax payments, such as federal income tax withheld from wages or estimated tax payments.
  • Not be legally obligated to pay the past-due amount.

Community Property States – In community property states, income earned by either spouse during the marriage is considered jointly owned. This can complicate the allocation of refunds and liabilities. In these states, the IRS may divide the refund based on community property laws, which can affect the amount of relief an injured spouse receives.

The 5-Step Process:

  • Determine Eligibility: Ensure the spouse meets the qualifications for injured spouse relief.
  • File Allocation Form: Submit the Injured Spouse Allocation form, with the joint tax return or separately if the return has already been filed.
  • Provide Documentation: Include any necessary documentation that supports the claim, such as W-2s or 1099s.
  • IRS Review: The IRS will review the claim to determine the portion of the refund attributable to the injured spouse.
  • Receive Refund: If approved, the injured spouse will receive their portion of the refund separately from any amount applied to their spouse’s debts.

Timeframe for Processing – The IRS estimates it takes 14 weeks to process an Injured Spouse Allocation.

INNOCENT SPOUSE RELIEF

Overview – Innocent Spouse Relief provides protection to individuals who filed a joint tax return and later discover that their spouse understated tax due to erroneous items. This relief is crucial for those who were unaware of the inaccuracies and would face unfair financial burdens if held liable.

Types of Relief:

  • Innocent Spouse Relief: Available if a spouse can prove they were unaware of the understatement of tax at the time of signing the joint return.
  • Separation of Liability Relief: Allows for the separation of tax liability between the innocent spouse and their spouse if they are divorced, legally separated, or not living together.
  • Equitable Relief: Applies when an innocent spouse does not qualify for the other types of relief, but it would be unfair to hold them liable.

Understatement of Tax and Erroneous Items – An understatement of tax occurs when the IRS determines that the total tax should be more than what was reported. Erroneous items include unreported income or incorrect deductions and credits. To qualify for relief, the innocent spouse must demonstrate that they did not know, and had no reason to know, about these items.

Indicators of Unfairness – The IRS considers various factors to determine unfairness, such as:

  • Economic hardship if relief is not granted.
  • Whether the innocent spouse significantly benefited from the understatement.
  • The innocent spouse’s level of involvement in the financial affairs of the household.

Facts and Circumstances – Each case is evaluated based on its unique facts and circumstances. This includes the nature of the erroneous items, the innocent spouse’s knowledge of the items, and any indications of duress or coercion.

Divorce and Legal Separation – If divorced or legally separated, the innocent spouse may qualify for separation of liability relief. This requires that the innocent spouse and their spouse (or ex-spouse) are no longer members of the same household.

Economic Hardship – Economic hardship is a key consideration for equitable relief. If paying the tax liability would prevent the individual from meeting basic living expenses, this may support their claim.

Allocating an Understatement of Tax – The IRS allocates the understatement of tax between spouses based on their respective contributions to the erroneous items. This allocation is crucial in determining the extent of relief.

Choosing the Right Type of Relief – Determining which type of relief to request depends on the innocent spouse’s specific circumstances. Factors considered include marital status, knowledge of the erroneous items, and potential economic hardship.

Suspension of the Statute of Limitations – Filing for innocent spouse relief suspends the statute of limitations on collection activities, providing protection while the claim is under review.

Effect of Offer-in-Compromise – An offer-in-compromise does not affect the eligibility for innocent spouse relief. However, it may impact the overall resolution of tax liabilities.

Divorce Situations and Joint Returns Signed Under Duress – In cases of divorce, the validity of joint returns signed under duress can be challenged. If the innocent spouse can prove coercion, this may support their claim for relief.

Effects on the Non-Innocent Spouse – Granting relief to one spouse does not absolve the other spouse of liability. The IRS may still pursue collection from the non-innocent spouse.

Timeframe for Processing – The processing time for innocent spouse relief claims can vary. It typically takes several months for the IRS to review the application and decide.

Filing these two forms of spousal relief with the IRS can be a complex process that can significantly benefit from the expertise of a tax professional. Tax professionals are well-versed in the intricacies of tax laws and the specific requirements, which can help ensure that the application is completed accurately and efficiently.