Tax Debt After Divorce: Innocent Spouse Relief

If you are going through or have recently gone through a divorce, you may think that the final step in your divorce takes place when the judge signs your divorce decree. Unfortunately, if you have joint tax debt with your ex-spouse, this may not be the case. While your divorce decree may state who will pay your tax debt to the IRS, the IRS is not bound by the divorce decree and will continue to try to collect the tax liability from both of you. Fortunately, in some cases, innocent spouse relief can remove the tax liability from your name. There are three categories of spousal relief that are each frequently referred to as innocent spouse relief.

Category #1: Innocent Spouse Relief

To qualify for innocent spouse relief, you must meet the following criteria:

  1. You filed a joint return;
  2. There was an understatement of tax on the return due to errors made by your spouse;
  3. When you signed the joint return you did not know (and had no reason to know) that the understatement existed;
  4. Less than two years have passed since the IRS first attempted to collect the tax; and
  5. Taking into account all facts and circumstances it would be unfair to hold you liable for the understated tax. Fairness is determined by several factors including whether you received a significant benefit from the understatement.

Claims for innocent spouse relief are usually made after an IRS audit that resulted in joint income tax liability. The IRS spends a large amount of its resources each year auditing small businesses. Therefore, a common scenario arises for innocent spouse relief where one spouse is the owner of a small business and the other spouse has no involvement in the business. In this scenario, the non-involved spouse may have a good case for innocent spouse relief. Of course, the non-involved spouse would have to prove that he or she did not know or have reason to know of the error that caused the assessment and that he or she did not benefit from the error.

If the IRS grants you innocent spouse relief then 100% of the tax liability resulting from your spouse’s error will be removed from your name.

Category #2: Separation of Liability Relief

To qualify for separation of liability relief, you must meet the following criteria:

  1. You filed a joint return;
  2. There was an understatement of tax on the return;
  3. When you signed the joint return you did not know that the understatement existed;
  4. Less than two years have passed since the IRS first attempted to collect the tax; and
  5. You are no longer married, are legally separated or you did not live in the same household as your spouse during the last 12 months.

Again, claims for separation of liability relief are usually made after a joint tax liability has been assessed as the result of an IRS audit. This relief is somewhat more easily attained because the IRS requires only that you had no actual knowledge of the error (as opposed to actual knowledge or reason to know of the error). However, while innocent spouse relief can be granted to anyone who filed a joint return, separation of liability relief can only be granted if you are no longer married, are legally separated or have not lived in the same household as your spouse for the past year.

If the IRS grants you separation of liability relief, the tax liability arising from the understatement will be separated according to which spouse is responsible for the income and the understatement.

Category #3: Equitable Relief

To qualify for equitable relief, you must meet the following criteria:

  1. You are not eligible for innocent spouse or separation of liability relief;
  2. You filed a joint return;
  3. You and your spouse did not transfer assets to one another as part of a fraudulent scheme or for the main purpose of avoiding tax;
  4. You did not knowingly participate in the filing of a fraudulent joint return; and
  5. The income tax liability from which you seek relief is attributable to an item of your spouse’s income.

Unlike innocent spouse relief and separation of liability relief, equitable relief can be granted when there was no error in the joint tax return. It can be granted even if the balance is simply due to an underpayment of taxes. Commonly this occurs when a couple files a joint return with a balance that goes unpaid.

If you are granted equitable relief, the IRS will separate the unpaid liability between you and your spouse according to the proportion of income and the amount of payments each of you made that year. For example, if you made 25% of the income reported on the joint return and there were no payments made by either of you, you would remain liable for 25% of the unpaid tax for that year and 75% would be removed from your name.

Innocent spouse, separation of liability and equitable relief can be a necessary and helpful next step to deal with the tax debt after divorce. If you have gone through a divorce or are going through a divorce and you have joint tax liability with your ex-spouse, it can be invaluable to explore your innocent spouse relief options with a knowledgeable tax attorney.