by Gregory S. Dowell

August 8, 2018

As a general rule, married taxpayers who file a joint income tax return are jointly and severally liable for the tax reported on the return. This is an example of the long reach of the IRS to perfect the government’s claim and to demand payment for income taxes from the married couple, collectively and individually. This general rule is a good reason why anyone signing an income tax return should have reasonable knowledge about what is on the tax return.

However, in some situations the IRS acknowledges that an individual can be unfairly harmed by the deceit of their spouse. Internal Revenue Code Section 6015(b)(1) provides that a taxpayer who files a joint return can be relieved of the liability for an understatement of tax if the spouse can establish that he or she did not know that there was an understatement, and it would be unfair to hold the “innocent” spouse liable.  To invoke this relief, the innocent spouse has to make the election within two years after the date the IRS begins collection actions. An election to be treated as an innocent spouse treats each spouse as if they filed a separate return, and the separate spouses are responsible for the tax on their separate returns.

In a recent Tax Court Memorandum (2018-115), the Tax Court allowed innocent spouse relief to a husband, who earned a living as a machine operator in a factory, and also worked as a home inspector. The wife was an accountant who had embezzled funds from her employer – not surprisingly, the embezzled funds were not reported on the couple’s tax return as income. The wife handled the family’s finances, and she also handled the depositing of the checks from the husband’s home inspection business.  At tax time, husband gave all of his records to his wife, who then provided all of the records to the paid preparer. The husband did not inspect or look at any of the bank or credit card records. Over several years, the wife embezzled funds from her employer, which was a blood bank, to the tune of about $458,000. During that period, no lavish expenditures were made; the couple did not pay off their mortgage and the husband continued to drive the same car. The husband was able to prove to the Tax Court that he had no knowledge of his wife’s embezzlement until she was arrested in June of 2011. In making the determination, the Tax Court considered the husband’s occupation, his education, the fact that his wife was an accountant, and that he had no interaction with the family’s finances.

In reviewing the case, the Tax Court found that the husband did not have knowledge of the embezzlement with regard to the filing of the couple’s 2010 return, but that he did have knowledge with regard to the 2011 return (she was arrested in June of 2011 and the husband provided the tax materials to the paid preparer).  Thus, innocent spouse relief was granted for 2010 but not for 2011.

This is a case rich in details and is an interesting read, as are many of these cases. The bottom line is that these cases are always based on the specific facts and circumstances. Gathering evidence and communicating the same to the IRS and, in this case, to the Tax Court, is critical.