12 / 19 / 11

Can the IRS Make You Pay for Your Spouse's Mistake?

Consider this scenario...

Let's say you're married and you file a "married filing jointly" return, since you want to take advantage of the unique tax benefits (lower taxes than other filing statuses, higher standard deductions, and other tax benefits that don't apply to other statuses) offered by this particular filing status.

Let's say that you have a regular "day job" where your employer takes out your taxes every paycheck and gives you a W-2 at the end of the year.

Your spouse on the other hand, is an independent contractor and he accepts cash or checks directly from paying customers.

Even though your husband's customers feel that he does great work, he's never really been much for organization, especially when it comes to paperwork.

You know he's expected to pay estimated taxes on those earnings on a quarterly basis, or else he may be penalized.

Rather than doing it this way however, he says "I just don't have time for all that. I'll just do it at the end of the year and deal with it then".

Rather than nag him about the issue, you just remind him to put the money aside so he's ready to pay the tax at the end of the year. He agrees.

He has a shoebox marked 'expenses' that's overrun with receipts in no particular order. He deposits checks as soon as he receives them into a bank account set aside for business.

The End of the Year Comes...

The year-end comes and you receive your W-2. It looks like you might get a decent refund, but that really depends on your husband's business, since you've decided to file jointly.

The two of you decide to take a weekend just to sort through all of the paperwork and get a grip on the tax situation with his business.

After muddling through the records as best you can, and deducting expenses, you determine that he owes taxes on $48,500 of taxable income. Therefore you determine that he owes a tax of $7,475.

That's when he "drops the bomb" that he hasn't been setting enough money aside to pay the taxes. His business account shows $4000, most of which is needed to continue purchasing supplies so he can stay in business.

The tax savings account you had him set up now has a whopping $700 left in it.

This leads to an angry exchange of words and a "chill" between the two of you that lasts for over a week. You finally decide to pay off the tax bill by maxing out the limit on one of your credit cards.

An Unwelcome Surprise from the IRS

A few months go by, things settle down and the only time you think about taxes is when you get your credit card statement.

That is, until you receive a Notice and Demand for Payment notice from the IRS...

...demanding additional taxes of $10,000.

It seems that your husband had an arrangement with a certain business customer who he "thought" wasn't reporting the payments to the IRS. Throughout the year he had received around $60,000 in work from this customer - all paid in cash.

And your husband claims he no longer has the money.

Are You Liable for Your Husband's Error?

At this point you're starting to ask big questions...does he have a drug problem...a gambling problem...a mistress? What's going on? Where did all the money go?

But now you have the IRS to deal with. Your credit cards are maxed out and you don't have a clue how you're going to come up with $10,000.

What if you can't pay? Penalties and interest will start to add up. The IRS may even pursue a tax lien, wage garnishment and/or seizure of your bank account or other personal property to pay off the tax.

Are you personally liable for the $10,000 that your husband owes?

Innocent Spouse Relief

Thankfully, the IRS has a solution for this scenario.

It's called the "Innocent Spouse Doctrine". The IRS website states that:

"By requesting innocent spouse relief, you can be relieved of responsibility for paying tax, interest, and penalties if your spouse (or former spouse) improperly reported items or omitted items on your tax return. Generally, the tax, interest, and penalties that qualify for relief can only be collected from your spouse (or former spouse).

You must meet all of the following conditions to qualify for innocent spouse relief:

  1. You filed a joint return which has an understatement of tax due to erroneous items (defined below) of your spouse (or former spouse).
  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 (See Actual Knowledge or Reason To Know, defined below).
  3. Taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax. (See Indications of Unfairness for Innocent Spouse Relief, later).

Erroneous items are either of the following.

  1. Unreported income. This is any gross income item received by your spouse (or former spouse) that is not reported.
  2. Incorrect deduction, credit, or basis. This is any improper deduction, credit, or property basis claimed by your spouse (or former spouse)."