Innocent Spouse Relief for One’s Own Income

While taxpayers are often aware that innocent spouse relief can eliminate their liability for tax on items of income earned by their spouse (or ex-spouse), fewer taxpayers realize that innocent spouse relief can also help with tax on income they earned themselves. The recent Heydon-Grauss v. Commissioner, T.C. Memo. 2018-209, case provides an opportunity to consider this situation.

Facts & Procedural History

The taxpayer-wife requested innocent spouse relief. She was self-employed, making a profit of $52,023, $83,937, $57,398, $49,387, $60,869, and $49,973 for 2005, 2006, 2007, 2008, 2009, and 2010.

The taxpayer’s business income was deposited into a checking account that she controlled. The checking account had sufficient funds to pay the couple’s income taxes, but the funds were not used to pay the taxes.

Taxpayer-husband was self-employed during these years. He also worked as an employee.

The IRS granted the taxpayer-wife innocent spouse relief for several years, but did so only for the income earned by taxpayer-husband. Litigation ensued for taxpayer-wife’s entitlement to innocent spouse relief for taxes due to her husband’s income.

Innocent Spouse Relief

Couples who file a joint income tax return are jointly liable for the tax stemming from the joint return. This can result in one spouse being liable for the taxes incurred by the other spouse. Congress provided for innocent spouse relief to remedy situations where imposing tax on one spouse would be inequitable or unjust.

While innocent spouse relief is set out in the Code, the rules for qualifying for innocent spouse are set out in Rev. Proc. 2013-34, 2013-43 I.R.B. 397. This guidance sets forth a process the IRS follows in deciding whether to grant relief. The IRS starts with basic criteria and, if those factors are met, considers whether either streamlined or equitable relief is warranted.

Attributable to the Non-Requesting Spouse

The Heydon case focused on one of the basic criteria factors. The general rule for this factor is whether the income tax liability is attributable, in full or in part, to an item of the nonrequesting spouse or an underpayment resulting from the nonrequesting spouse’s income.

Even if the income tax liability is attributable to the requesting spouse, the IRS will grant innocent spouse relief to the requesting spouse where there is (1) attribution of income due solely to the operation of community property law; (2) nominal ownership of income producing assets; (3) misappropriation of funds; (4) abuse; or (5) fraud committed by the nonrequesting spouse. 

With the fourth item, abuse, the term “abuse” includes efforts to control, isolate, humiliate, and intimidate the requesting spouse or to undermine her ability to reason independently. The requesting spouse has to show that the abuse made him or her unable to question the payment of the tax due on a return for fear of retaliation from the nonrequesting spouse.

In the Heydon case, the taxpayer-wife alleged that there was abuse, which the court did not find to be the case:

petitioner did not provide specific testimony supporting a pattern of abuse. Specifically, she testified that there was “abuse in the household. There was alcohol. There were drugs. There were gambling. There were sexual affairs. There was mismanagement of money. Risky investments. Gambling.” She also testified that “[t]here was a lot of anger and yelling in the household.” She testified that documents from the domestic relations court indicated that intervenor abused the children. Specifically, she testified that intervenor “had supervised visits” of the children and the court documents “reference the alcohol and drug testing”. Intervenor specifically denied physical abuse of petitioner and his children. We found his testimony in this regard to be credible. Petitioner’s testimony and the stipulated exhibits fall short of the substantiation needed to sustain an abuse allegation.

There are other indications as to why the court may not have believed the taxpayer-wife’s position.

One is that the taxpayer-wife was seeking innocent spouse to obtain a refund of taxes paid by the taxpayer-husband. Even if granted innocent spouse relief, the law does not allow for refunds for anything other than amounts the innocent spouse paid. The taxpayer-wife may not have realized this as she did not hire a tax attorney to represented her.

The court also noted that the taxpayer-wife had a bookkeeper who prepared her business financials, which were used by the tax prepare to prepare their tax returns. Thus, the taxpayer-wife was in a position to know of the couple’s tax liability and non-payment.

Absent these factors, the court may very well have granted the taxpayer-wife innocent spouse relief for the tax on the income she earned.