Taxing Lessons From Court Decisions

Decisions — His, hers, theirs … or not

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Image source: Hands Together ID: 238290 Olga Vasilkova, Dreamstime Stock Photos
Image source: Hands Together ID: 238290 Olga Vasilkova, Dreamstime Stock Photos

Filing a joint tax return means you can benefit from tax deductions and credits that may be limited if you’re married but choose to file a return separate from your spouse. But electing to file jointly has a price as well, and the price is joint and several liability, which means you and your spouse are both legally responsible for the tax due on your return. Put another way, the IRS can collect the entire amount due from either of you, even after you divorce or one of you dies. As the old joke goes, taxes on a joint return are not “hers” and “his” but “theirs” – that is, belonging to “THE IRS.”

The tax code does include provisions to provide relief from joint and several liability (section 6015), including what’s commonly called innocent spouse relief.

To qualify for innocent spouse relief, you have to meet three criteria.

1. You filed a joint return that has an understatement of tax that is solely attributable to your spouse’s erroneous item. An erroneous item includes income received by your spouse but omitted from the joint return. Deductions, credits, and property basis are also erroneous items if they are incorrectly reported on the joint return,

2. You establish that at the time you signed the joint return you did not know, and had no reason to know, that there was an understatement of tax, and

3. Taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax

In Docket Number 12087-10 (Mathewson), the taxpayer married during 2001, and filed a joint return with her spouse for that tax year. The joint return included a large capital loss carryforward from the then-single husband’s prior year. The unused loss was the result of a tax shelter. The IRS took the partnership to court, and eventually the partnership losses were disallowed.

Once the partnership lawsuit was settled, the IRS issued a notice to the taxpayer and her spouse for underpaid tax related to the loss carryforward as well as a 40%
penalty on the underpayment.

The taxpayer said she qualifies for innocent spouse relief because the loss carryforward reported on the joint return came from the year 2000, the tax year before she and her husband married.

Based on the criteria above, do you agree the taxpayer qualifies for innocent spouse relief?

 

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THE DECISION

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Interested in more decisions involving joint and several liability?

Click here to read the Taxing Lessons write-up of three decisions from 2014.

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!

No, the taxpayer does not qualify for innocent spouse relief.

The taxpayer argues that whether she knew or had reason to know of her husband’s understatement is irrelevant because the loss carryforward was attributable to the 2000 tax year, before they were married.

We can assume that’s true — but the standard in section 6015(b) is whether the spouse requesting relief knew or had reason to know of an understatement of tax. (Internal revenue code section 6015(b)(1)(C).)

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