Innocent Spouse Relief – 5 Traps to Avoid
Transfer of Assets
The first and biggest trap in regards to innocent spouse relief is receiving assets from your spouse or former spouse. In some cases, you may either be denied relief or have the amount of relief reduced based on property you may have received.
Receipt of an assets as part of a fraudulent scheme will be grounds for denial of relief. If you and your spouse/former spouse cooked up a scheme to hide assets to avoid creditors (one of which being the IRS) that is a fraudulent transfer. Receiving assets right before or during a divorce are treated as highly suspect so you should be prepared to explain why you received these assets.
Fraud usually requires a showing of an intent to hide assets, lie about assets, or otherwise deceive creditors. In short, be careful what you say or do when receiving any assets from your spouse.
Transfers with an intent to avoid tax or payment of tax are also problematic. Unlike a fraudulent transfer, you can receive property where there is an intent to avoid a tax or payment of a tax but yet it not be a fraud. For example, your spouse may want to transfer an asset to you to support you (and any children) as such an asset might otherwise be seized by the IRS to pay back taxes. Thus no bad intent is required.
Again, be careful. Transfers made within a year before the IRS’ proposed assessment are presumed to be done with intent to avoid. You can overcome that presumption but if you can you want to avoid that problem altogether.
The key here is know what the IRS is looking for with asset transfers and make sure that it does not appear to be either a fraudulent transfer or with intent to avoid a tax or payment of a tax.
Significant Benefit Derived
As I mentioned previously, innocent spouse relief requires a joint tax debt that is as a result of an erroneous item (or underpayment of tax) due to actions of a spouse or former spouse. In addition, you have to show that it is inequitable to hold you liable as well.
If you derive a significant benefit from the unpayment of tax or understatement of tax, then you will be out of luck even if you otherwise qualify. The reason for this is simple. It would be unfair to relieve you of liability if you were put in a better situation due to your spouse’s actions. That doesn’t mean that if you were unemployed that you are stuck with the bill. The IRS has to show that you benefited over and above a normal level of support. Food, clothing and shelter for example.
Examples of significant benefit are:
- Jewelry, home furnishings, improvements
- Cars, trucks and “toys”
- Private schooling for children
Before you request innocent spouse relief, you should consider your lifestyle while you were living together. If you lived a lavish or extravagant lifestyle, then you may be locked out of obtaining relief. You may have to consider other options.
Filing and paying your taxes on time may not be foremost in your mind as you think innocent spouse relief. That would be a mistake. One of the factors the IRS looks at when considering whether or not to grant relief is whether you have filed and paid your taxes on time. Even after you get divorced, legally separated or otherwise away from your spouse/former spouse.
I get it. Sometimes the year you are seeking relief from is often a year in which you are going through a time of hardship. After that year you may have to deal with getting a divorce or otherwise separating yourself from your spouse/former spouse. Many people get behind on paying their taxes along with all the other problems that arise from such a disruption in your life. You still need to show you are getting back on track.
Tax compliance is a factor the IRS considers. Failure to keep current on filing and paying taxes often results in denial of innocent spouse relief. My advice is to get your house in order before requesting relief.
Divorce Judgment Not Binding
Clutching the judgment like a talisman to ward off evil spirits or in this case your former spouse’s share of a joint tax liability will get you nowhere. The IRS is not bound to treat any taxes set aside to your former spouse. This is often a painful lesson to learn when dealing with the IRS. Instead, the divorce judgment is considered as a factor in your favor but that does not mean you win. You are going to have to show that enough other factors favor you to grant relief (such as tax compliance, discussed above).
Better Options May Be Available
Lastly, innocent spouse is only one way to resolve your IRS tax debt. It is not, however, the only way. You might be able to resolve your tax debt through an offer-in-compromise for less than what you might under innocent spouse. Bankruptcy is another option as is requesting hardship status.
Don’t become fixated on innocent spouse relief as the only option to resolve your taxes. You, or someone you hire, should take a look at all your options before taking the step of requesting innocent spouse relief.
Innocent spouse relief is great when it works. Just be careful to not run afoul of certain hurdles, as laid out above. If you think you qualify for innocent spouse relief it may pay to talk with someone. Better to know up front if there is a problem than to find out when you are denied innocent spouse relief.
I am Maine’s IRS Problem Solver. My firm helps Maine taxpayers in trouble. If you or someone you know in Southern Maine wants more information on how to resolve your unpaid taxes, please feel free to contact me directly at 207-502-7181 or by filing out my contact form. A Maine tax attorney can help you consider your options.